Strategic Withdrawals: Maximizing Your Retirement Income While Minimizing Taxes

As you approach or begin retirement, one of the most important decisions you'll face is how to withdraw funds from your retirement accounts in a way that maximizes your income while minimizing taxes. This is where a strategic withdrawal plan can make a significant difference.

Without proper planning, withdrawing funds without considering the tax implications can result in more of your hard-earned savings going to the IRS. With a little strategy, however, you can create a tax-efficient retirement income plan that helps you keep more of your money.

What are Strategic Withdrawals?

Strategic withdrawals refer to a carefully planned sequence of pulling funds from your various retirement accounts, taking into consideration how each withdrawal will affect your tax bill. Different types of retirement accounts—such as Traditional IRAs, ROTH IRAs, and taxable investment accounts—are taxed differently, and coordinating withdrawals from these accounts can reduce your overall tax burden.

Why a Withdrawal Strategy is Important

1. Control Your Tax Bracket: Your retirement income may come from multiple sources, such as Social Security, pensions, and withdrawals from retirement accounts. Each source can push you into higher tax brackets if not managed carefully. A well-designed withdrawal strategy can help you control your taxable income and potentially avoid higher marginal tax rates.

2. Minimize Taxes on Social Security: Up to 85% of your Social Security benefits can be taxed, depending on your income. By managing when and how much you withdraw from taxable accounts, you can reduce your combined income and possibly lower the taxes on your Social Security benefits.

3. Avoid or Minimize Required Minimum Distributions (RMDs): Traditional IRAs and 401(k)s are subject to RMDs starting at age 73, which can force you to take larger withdrawals than you might need, increasing your taxable income. By implementing strategic withdrawals before RMDs kick in, you can spread out your tax liability and avoid being hit with a large tax bill.

4. Preserve Tax-Free Growth: By delaying withdrawals from tax-free accounts like a ROTH IRA, you allow those funds to grow tax-free longer, leaving more money for future expenses or as a legacy for your heirs.
   

How to Create a Strategic Withdrawal Plan

A successful withdrawal strategy often involves using a combination of different types of accounts to manage your tax exposure. Here are some common tactics:

1. Tap Taxable Accounts First

   One common strategy is to withdraw from taxable investment accounts before dipping into tax-deferred or tax-free retirement accounts. This allows your tax-deferred accounts like IRAs and 401(k)s to continue growing without being taxed.

   Since capital gains in taxable accounts are generally taxed at a lower rate than ordinary income, this approach can reduce the overall tax burden on your retirement income.

2. Consider Roth Conversions Early

   As discussed in our previous blog, converting traditional IRA funds to a ROTH IRA early in retirement (before RMDs begin) can be a tax-efficient strategy. You’ll pay taxes on the conversion now, but future withdrawals from the ROTH will be tax-free.

   By gradually converting IRA funds to a ROTH, you can minimize the tax impact in any single year and manage your taxable income more effectively.

3. Take Advantage of Lower Tax Brackets

   If your taxable income is low in a particular year, consider taking larger withdrawals from your tax-deferred accounts. This can allow you to pay taxes on those withdrawals at a lower rate. By carefully managing the amount you withdraw each year, you can avoid pushing yourself into higher tax brackets down the road.

4. Delay ROTH IRA Withdrawals

   One of the most valuable features of a ROTH IRA is that it doesn’t require RMDs, meaning you can leave those funds untouched as long as you wish. Many retirees choose to withdraw from their taxable and tax-deferred accounts first and save their ROTH IRA for later years or leave it as part of their estate plan.

5. Manage RMDs to Your Advantage

   When you reach age 73, RMDs become mandatory from your traditional IRAs and 401(k)s. If you haven't been proactive, these required distributions can dramatically increase your taxable income. By starting strategic withdrawals early, you can reduce the size of these mandatory distributions and better manage your tax exposure.
   

The Impact of Healthcare and Medicare Costs

It's important to consider how your withdrawals will affect your Medicare premiums. Withdrawals from tax-deferred accounts can increase your modified adjusted gross income (MAGI), which can push you into a higher income-related monthly adjustment amount (IRMAA) for Medicare Part B and Part D premiums.

By managing your withdrawals and keeping your taxable income below certain thresholds, you can avoid higher Medicare premiums.

Working with a Retirement Planner

Navigating the complexities of retirement withdrawals and tax planning can be overwhelming. At RETIRESIMPLY™, we specialize in helping individuals create personalized strategies that maximize income while minimizing taxes. Our planners can help you coordinate withdrawals from your various accounts, reduce your tax burden, and ensure that your retirement savings work as hard for you as possible.