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Savvy Retirement Account Withdrawal Strategies

couple revieweing their retirement account withdrawal strategies

Much is made about the importance of diligently contributing to retirement accounts during working years. But what happens to those accounts when you retire? Learn how to make smart decisions about retirement account withdrawal. 

How Does the IRS Tax Retirement Accounts? 

Whether your retirement account withdrawals are taxed depends on whether your retirement account is pre or post-tax. Pre-tax contributions went into the retirement account before taxes were paid, or you received a tax deduction for putting money into the account. Post-tax refers to money taxed before it was added to the account. 

In general, distributions from pre-tax accounts are taxable in retirement, while those from post-tax accounts are tax-free. 

How Are Account Types Taxed? 

The specific taxation of a particular kind of retirement account depends on what kind of account it is. 

Account Type Tax Treatment of Qualifying Distributions in Retirement Subject to Required Minimum Distribution Rules? 
Pre-Tax 401(k) Subject to income tax Yes 
Roth 401(k) Not taxed as long as the distribution is qualified and the account is at least five years old.Yes 
403(b) Subject to income tax Yes 
Traditional IRA Subject to income tax Yes 
Roth IRA Not taxed as long as the distribution is qualified and the account is at least five years old.Not until the death of the owner 
Simplified Employee Pension Plan (SEP) Subject to income tax Yes 
SIMPLE IRA Subject to income tax Yes 
Health Savings Account (HSA) Not taxed if distributions are made for qualified medical expenses.
Taxed at ordinary income tax rates (without 20% penalty) if you are disabled or 65+.

Five Potential Retirement Account Withdrawal Strategies 

There is no one-size-fits-all answer to how to prioritize drawing down your retirement accounts. Because every situation is nuanced, it’s always a good idea to consult with a qualified financial advisor before making any decisions regarding how you’ll approach your distributions. Here are some general strategies to consider when planning how you’ll take money out of your retirement accounts after retirement.

1. Take Your Required Minimum Distributions. 

For most retirement accounts—Roth IRAs being an exception—account holders must take out a minimum amount every year after reaching a certain age. These annual minimum amounts are called required minimum distributions, or RMDs, and they are taxable. 

Currently, if you reach age 70½ in the year 2020 or later, you must take your first RMD by April 1 of the year that you turn 72 years old. 

Your annual RMD is based on the amount in your IRA and your life expectancy. Generally, you can find out your annual RMD from the company holding your retirement account. 

The penalties are significant for failing to withdraw your total RMD amount—50% of the amount not withdrawn—so be sure you don’t miss your annual RMDs.

Note that you may be able to reduce your annual RMD amount if your spouse is at least 10 years younger than you are and you have named them as the sole beneficiary of your IRA. In this situation, your RMD amount is calculated based on a joint-life expectancy table. 

2. Consider Drawing Down Pre-tax Accounts First. 

One of the beauties of post-tax retirement accounts such as Roth IRAs is that the money in them grows tax-free indefinitely. 

To maximize this tax-free growth, it may be advisable to draw down your taxable accounts such as traditional IRAs and pre-tax 401(k)s before tapping into your post-tax accounts. 

But of course, if you want a consistent tax situation throughout retirement, you may simply want to draw down your taxable and tax-free accounts proportionately. 

3. Keep Tabs on Tax Rates. 

Though it makes sense to draw down pre-tax accounts first, there are strategic reasons you might do the opposite. If you anticipate tax rates to decrease significantly in the future, it may be wiser to prioritize post-tax distributions now. This would save your taxable distributions (to the extent you can, considering RMDs) for a future, lower-tax-rate environment. 

No one has a crystal ball telling them what Congress will do to tax rates, but paying attention to new administrations and their tax agendas could prove beneficial for you in terms of determining which accounts to take distributions from and when. 

4. Consider the Unique Taxation of Social Security Benefits.

Typically, an item of income is either taxable or nontaxable, but this is not the case with Social Security benefits. 

Whether or not your Social Security benefits are taxable depends on the amount of your other taxable income—such as your taxable income from pre-tax retirement accounts like traditional IRAs and pre-tax 401(k)s. 

If the amount of all your other taxable income for the year plus tax-exempt interest is greater than the amounts shown in the table below for your filing status, all or some of your Social Security benefits may be taxable. 

Filing Status Base Amount 
Single, head of household, or qualifying widow(er) $25,000 
Married filing separately and lived apart from spouse the entire year $25,000 
Married filing jointly $32,000 
Married filing separately and lived with your spouse at any time during the year $0  

If you are delaying receiving your Social Security benefits to maximize your monthly payment amount, it may be wise to draw down your taxable retirement accounts before you start taking Social Security. That’s assuming this strategy makes sense from a tax and cash-flow perspective. 

By doing so, you may be able to reduce or even eliminate the taxes you will pay on your Social Security benefits. 

5. Forecast Your Distribution Needs in Retirement. 

Apart from the tax implications, you want to ensure your cash flow is covered in retirement. 

The last thing you want is to depend on a specific annual distribution amount from your retirement accounts only to have your IRA run out of money because you haven’t adequately anticipated your future needs. That said, if you forecast that the combination of Social Security income, pension distributions, and your retirement account withdrawal will not provide you the life you want in retirement, be sure that you understand all of your options for retirement cash flow.  

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