Window of Opportunity, Part 3: Making Retirement Withdrawals More Tax-Efficient

‍ After spending decades accumulating retirement savings, eventually the question changes.

Instead of asking, “Where should I save?” you begin asking, “Where should I take money from?”

The answer can have significant tax consequences.

Retirees often reach retirement with assets spread among several types of accounts. There may be traditional IRAs and 401(k)s, Roth accounts, taxable brokerage accounts, cash savings and other investments.

A dollar available to spend may look like a dollar regardless of where it comes from. From a tax perspective, however, those dollars can be very different.

Not all retirement dollars are taxed the same way

Generally, distributions from traditional tax-deferred retirement accounts are taxable when withdrawn. Qualified Roth IRA withdrawals can be tax-free. A withdrawal from a taxable investment account may include both principal and investment gains, with the tax treatment depending on the assets sold and other factors.

That creates choices, and those choices can become an important part of retirement tax planning.

It can be tempting to adopt a simple rule for withdrawals, such as spending down one type of account completely before touching another. But the most tax-efficient approach isn’t necessarily that straightforward.

The better question may be: Which combination of accounts should fund my needs this year while also positioning me well for future years?

Retirement tax planning is a multi-year exercise

Consider someone who retires before beginning Social Security and before RMDs are required.

If that person funds all living expenses from cash or a taxable account, taxable income could remain very low. At first glance, that might seem ideal.

But leaving large tax-deferred accounts untouched can mean carrying larger balances into the years when RMDs begin. Meanwhile, potentially valuable room in lower tax brackets during the early retirement years may have gone unused.

In some circumstances, deliberately taking taxable distributions or completing Roth conversions during those lower-income years may produce a more favorable long-term result.

Later, once Social Security and RMDs are part of the picture, the strategy may change again.

That’s why retirement withdrawals shouldn’t necessarily be viewed as a fixed sequence. They can be managed dynamically based on your income, tax brackets, account balances and anticipated needs.

From accumulation to decumulation

Most retirement advice focuses heavily on accumulation: save consistently, invest appropriately and take advantage of tax-favored retirement accounts.

Decumulation deserves the same attention.

The order and timing of withdrawals can affect not only current income taxes but potentially future RMDs, taxation of Social Security benefits, Medicare premiums and the amount and type of assets ultimately passed to heirs.

There isn’t one withdrawal sequence that works for everyone. The right approach depends on the types of accounts you own, the income you need, your tax situation today and what your finances are likely to look like years from now.

That makes retirement an especially valuable time to shift from annual tax preparation to multi-year tax planning.

The objective isn’t simply to determine where next month’s spending money should come from. It’s to coordinate your different resources so that each withdrawal decision supports your broader retirement and tax strategy.

If you’re approaching retirement or beginning to draw from your savings, our team can help evaluate your retirement accounts together and identify opportunities for a more tax-efficient withdrawal strategy.