Which Accounts to Withdraw From First in Retirement

After years of saving, retirement brings a new challenge: figuring out how to turn your savings into income. Many retirees have money spread across different types of accounts, each with different tax rules. The order you withdraw from these accounts can significantly affect how much you pay in taxes over your lifetime and how long your money lasts.

Three main types of accounts

Understanding how each type of account is taxed is the foundation of a smart withdrawal strategy.

Taxable accounts include regular brokerage accounts, savings accounts and other investment accounts without special tax treatment. You generally pay tax on interest and dividends each year, and on capital gains when you sell investments for more than you paid. Long-term capital gains, from investments held more than a year, are often taxed at lower rates than ordinary income. Withdrawing your original investment, known as your cost basis, isn’t taxed.

Tax-deferred accounts include traditional 401(k)s, 403(b)s and traditional IRAs. Contributions were often made with pre-tax dollars, and investments grow without annual taxes. Withdrawals are generally taxed as ordinary income in the year you take them.

Roth accounts include Roth IRAs and Roth 401(k)s. Contributions were made with after-tax dollars, and qualified withdrawals, generally after age 59½ and once the account has been open at least five years, are tax-free, including earnings.

Health savings accounts can also play a role, since withdrawals for qualified medical expenses are tax-free.

The conventional withdrawal order

A common rule of thumb is to withdraw from taxable accounts first, then tax-deferred accounts, and Roth accounts last.

The logic is to let tax-advantaged accounts keep growing as long as possible. By spending taxable money first, you allow your tax-deferred and Roth accounts more time to grow without taxes. Roth accounts, which grow tax-free and have no required minimum distributions for the original owner, are saved for last because they’re the most tax-efficient to hold for the long term and can be especially valuable to pass on to heirs.

Why a blended approach can be better

Strictly following the conventional order can backfire in some situations. For example, if you spend down your taxable accounts first and leave traditional IRAs and 401(k)s untouched for years, those accounts may grow large. Later, required minimum distributions could force you to withdraw substantial amounts, potentially pushing you into a higher tax bracket, making more of your Social Security benefits taxable and increasing your Medicare premiums.

Instead, some retirees use a blended approach, taking some money from tax-deferred accounts in years when their income is lower, such as in the early years of retirement before Social Security and required minimum distributions begin. This can help them use up lower tax brackets and smooth out taxes over time.

Roth conversions are another strategy. Converting part of a traditional IRA to a Roth IRA means paying income tax on the converted amount now, but future qualified withdrawals from the Roth will be tax-free, and Roth IRAs aren’t subject to required minimum distributions for the original owner. Conversions can make sense in lower-income years, such as between retirement and the start of Social Security. However, conversions can have complex tax effects, so planning is important.

Other factors to consider

Required minimum distributions from tax-deferred accounts begin at a certain age set by federal law, which has been raised in recent years. Once they begin, you must withdraw at least a certain amount each year based on your account balance and life expectancy, or face penalties. Check current rules on irs.gov.

How much of your Social Security benefits are taxed depends on your other income. Withdrawals from tax-deferred accounts count toward that income, potentially making more of your benefits taxable, while qualified Roth withdrawals generally don’t.

Higher income can raise Medicare premiums. Medicare Part B and Part D premiums include income-related adjustments for people with higher incomes, based on income from two years earlier. Large withdrawals or conversions could trigger higher premiums.

Health insurance subsidies matter for early retirees. If you retire before 65 and buy coverage through the Health Insurance Marketplace, your income affects your eligibility for premium subsidies.

Leaving money to heirs is another factor. Roth accounts can be especially valuable to pass on, since qualified withdrawals by heirs are generally tax-free, though most non-spouse beneficiaries must empty inherited accounts within a set period. Taxable accounts may receive a step-up in cost basis at death, which can reduce capital gains taxes for heirs.

Charitable giving can play a role too. Qualified charitable distributions allow people age 70½ and older to donate directly from an IRA to charity, which can count toward required minimum distributions without being included in taxable income.

Get personal advice

The best withdrawal strategy depends on your specific accounts, tax bracket, income needs, health, goals and the rules in effect when you retire. A tax professional or fee-only financial planner can run the numbers, model different strategies and help you create a withdrawal plan that minimizes taxes and helps your savings last throughout retirement.