Written by: Barbara Maietta, CFP®
“The hardest thing in the world to understand is the income tax.” – Albert Einstein
Let’s Review Basic Strategies For Withdrawals From Retirement Accounts
The order in which you withdraw money from your investment accounts in retirement can make a big difference – not just in how much income tax you pay during retirement, but also in what your heirs may owe later. Let’s explore three common strategies.
Taking from Tax-Deferred Accounts First
With this approach, you use up your tax-deferred accounts (like traditional IRAs or 401(k)s) before tapping into other savings. While it may seem straightforward, this strategy can leave more of your taxable investments untouched. Since those accounts generate taxable gains every year, it can slow overall growth and deplete your retirement savings more quickly.
Taking from Taxable Accounts First
Some retirees prefer to draw from taxable accounts before touching their tax-deferred savings. This allows the money in tax-deferred accounts to continue compounding without being reduced by ongoing taxes. The trade-off, however, comes later. Eventually, the IRS requires you to take Required Minimum Distributions (RMDs). If most of your wealth sits in tax-deferred accounts, these withdrawals can become quite large – pushing you into higher tax brackets. In addition, if your heirs inherit large IRA balances, they must withdraw the full amount within 10 years, paying taxes at their own income tax rates.
A 50/50 Withdrawal Strategy
This blended approach balances withdrawals between taxable and tax-deferred accounts. It can support continued growth in retirement accounts while reducing the size of future RMDs. By spreading withdrawals across both account types, you may also be able to keep your annual income in lower tax brackets.
Adding Roth Conversions to the Mix
For even more flexibility, some retirees combine the 50/50 approach with Roth conversions. By strategically converting a portion of tax-deferred savings into a Roth IRA during years when your income is lower, you can “fill up” lower tax brackets and avoid paying higher rates later. This can smooth out your tax liability over time and potentially reduce the tax burden on your heirs.
Because every retiree’s situation is different, the results of these strategies can vary widely. That’s why it’s important to work with a financial advisor to design a withdrawal plan that fits your goals, your tax situation, and your long-term financial security.
