Weekend Read: Tax Planning for Retirement Withdrawals – Which Accounts to Tap First?
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One of the most important decisions retirees face is how to withdraw from different types of accounts—taxable, tax-deferred, and Roth—in a way that helps reduce the taxes you pay and helps extend the life of your savings. It’s not just about taking money out, but doing so strategically to help keep more of what you’ve worked so hard to save while paying as little as possible in taxes.
Start with Taxable Accounts
When you begin drawing down your savings, starting with your taxable accounts (like your brokerage accounts) tends to be a good starting point. The key reason for this is that the money in these accounts has already been subject to taxes on dividends, interest, and capital gains over the years. So, accessing these funds typically have a lower tax consequence.
If you’ve held investments in your taxable accounts for over a year, you’ll likely benefit from long-term capital gains rates, which are often more favorable than ordinary income tax rates. For many retirees, this could mean paying 0%, 15%, or 20% on capital gains, depending on your income. Compare that to the taxes on withdrawals from tax-deferred accounts, which are taxed at your ordinary income rate (often higher than capital gains rates), and it’s easy to see why taxable accounts can be an appropriate first choice.
For example, let’s say you need $50,000 to cover your retirement expenses. If you withdraw it from your taxable account by selling investments that have appreciated over time, you’ll only owe taxes on the capital gains portion, not the entire $50,000. If you withdraw the same amount from a traditional IRA or 401(k), the full amount would be taxed as ordinary income, potentially bumping you into a higher tax bracket. The difference can add up over time.
Next, Tap Tax-Deferred Accounts
After your taxable accounts, it’s time to turn to your tax-deferred accounts, such as Traditional IRAs and 401(k)s. Withdrawals from these accounts are taxed as ordinary income, so it’s best to use them strategically, especially if you find yourself in a lower tax bracket during retirement.
You’ve likely been able to defer taxes on these accounts for many years, which is great, but the tax deferral comes to an end once you start taking withdrawals. Timing matters here—by deferring these withdrawals until you’ve exhausted your taxable accounts, you allow the tax-deferred investments to keep growing for longer.
Also, don’t forget about Required Minimum Distributions (RMDs). Starting at age 73 and in 2033 it will become 75, the IRS requires you to begin withdrawing a certain amount from your tax-deferred accounts each year. This rule can’t be ignored—there are significant penalties for missing an RMD, so it’s important to factor these into your planning.
Both RMDs and the tax strategies used to help reduce them are a crucial piece of the financial planning pie. The following are two posts I wrote to explore each in more detail than I can here.
Understanding Required Minimum Distributions (RMDs)
Rethinking Traditional IRA/401k Strategies
Save Roth Accounts for Last
In my opinion, Roth IRAs are the crown jewel when it comes to tax-efficient retirement planning. Withdrawals from Roth accounts are tax-free, which gives you a tremendous amount of flexibility, especially later in retirement. By leaving your Roth accounts untouched for as long as possible, you’re allowing those investments to continue growing tax-free.
One of the biggest advantages of a Roth IRA is that it’s not subject to RMDs, which means you aren’t forced to withdraw funds at any point. This allows you to hold onto Roth assets for when you need them most—or even leave them to your heirs, tax-free.
Roth IRAs also offer additional flexibility in high-income years. Let’s say you decide to sell an investment property or have a particularly high earning year. Those transactions could push your taxable income up significantly. In years like that, tapping into your Roth IRA can be a smart move because it allows you to cover your spending needs without increasing your taxable income. Roth withdrawals won’t push you into a higher tax bracket, making them a great tool when you need to manage your tax situation.
A Few Caveats
While this general strategy—starting with taxable accounts, followed by tax-deferred, and saving Roth for last—works well for many retirees, every situation is unique. For instance, in years where your income is particularly low, you might consider converting some of your traditional IRA assets into a Roth IRA, even if you still have taxable assets available. Or, if you’re facing large healthcare expenses or other one-time costs, you might need to adjust the order to better manage your taxable income.
The Bottom Line
A well-planned, tax-efficient withdrawal strategy can make a huge difference in how long your retirement savings last. By starting with your taxable accounts, moving to tax-deferred accounts, and keeping your Roth accounts in reserve, you can help reduce your tax burden and maintain flexibility as your retirement needs evolve.
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The views expressed herein are those of the author and do not necessarily reflect the views of Steward Partners or its affiliates. All opinions are subject to change without notice. Neither the information provided, nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results.
Conversions from IRA to Roth may be subject to its own five-year holding period. Unless specific criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals of contributions along with any earnings are permitted. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
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