How to Strategize Your Retirement Account Withdrawals

Editor's Note: This story originally appeared on Boldin.

When it comes to retirement withdrawals, deciding the order in which you tap into your various accounts can be an important consideration.

The sequencing of accounts for withdrawals can significantly impact the longevity of your savings, the amount of taxes you pay, and even your Social Security benefits.

The traditional withdrawal sequence has its advantages, but alternative approaches can be beneficial depending on your goals.

In this article, we’ll explore the traditional withdrawal order, discuss alternative strategies, and highlight what each method seeks to achieve.

The Traditional Withdrawal Order

The traditional retirement withdrawal strategy is a straightforward approach that typically follows this sequence:

1. Taxable Accounts (e.g., savings and brokerage accounts): The reason for withdrawing from these accounts first is that long-term capital gains are often taxed at a lower rate than ordinary income, and this allows tax-deferred accounts to continue growing.
2. Tax-Deferred Accounts (e.g., 401(k)s, traditional IRAs): Withdrawals from these accounts are subject to ordinary income tax, and required minimum distributions (RMDs) must begin at age 73 or later, depending on your birthdate.
3. Tax-Free Accounts (e.g., Roth IRAs): Roth IRAs are often saved for last because withdrawals from these accounts are tax-free, provided that you follow the rules. Since Roth IRAs have no required minimum distributions (RMDs), they can be left to grow indefinitely.

Benefits of the Traditional Withdrawal Order

The traditional order for retirement withdrawals is widely recommended because it is designed to maximize tax efficiency and extend the life of your retirement savings.

Here are the key reasons to consider a traditional withdrawal order:

• Maximize tax-deferred growth
• Take advantage of lower capital gains rates
• Preserve tax-free accounts
• Smooth out your tax impact over time
• Estate planning considerations — if you are planning on leaving a legacy, it may make sense to leave tax-deferred assets to heir
• Maximize after-tax cash flow, increase your spendable money

A Proportional Approach to Withdrawals

A blended or proportional withdrawal strategy involves taking money from both taxable and tax-advantaged accounts in rough proportion to each other.

By carefully balancing the withdrawal amounts, retirees can manage their tax bracket more efficiently.

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Benefits of a Proportional Approach

• Tax Bracket Management: By taking withdrawals from both taxable and tax-deferred accounts, you may be able to control your taxable income and avoid jumping into a higher tax bracket.
• Smoother Tax Impact: Instead of dealing with large tax bills in later years due to RMDs, this method spreads the tax burden more evenly over time.
• Reduce Shadow Taxes: Depending upon your situation/circumstances, a proportional approach may help to avoid subjecting more of your Social Security benefits to tax, and/or incurring IRMAA surcharges on your Medicare Premiums.

The Reverse of a Traditional Withdrawal Order

The reverse of the traditional retirement withdrawal order involves tapping into tax-free accounts (like Roth IRAs) first, followed by tax-deferred accounts (such as traditional IRAs and 401(k)s), and lastly withdrawing from taxable accounts.

This strategy is less commonly used but can offer specific benefits depending on an individual’s goals and tax situation.

Benefits of a Reverse Withdrawal Order

The reverse of the traditional withdrawal order — starting with Roth IRAs, then tax-deferred accounts, and saving taxable accounts for last — can provide tax benefits, especially in the early years of retirement. It can help retirees keep their taxable income low, manage taxes effectively, and delay RMDs, potentially lowering the overall tax burden.

However, it also reduces the long-term growth of tax-free assets and may leave retirees with larger RMDs down the line if not managed carefully.

This strategy is particularly useful for those who prioritize tax efficiency early in retirement and want to maximize flexibility when managing taxable income. And it’s advantageous for early retirees seeking to maximize their premium tax credits for ACA health care plans.