Tax-Efficient Retirement Withdrawal Strategies

When taking withdrawals in retirement, we not only want to preserve assets for as long as possible but also distribute the assets in a tax-efficient manner.

Various account types can be used to control the tax implications. Ideally, retirees accumulate assets across three primary “buckets”:

• Taxable accounts 
• Tax-deferred accounts 
• Tax-free accounts 

Think taxable brokerage accounts, Traditional IRAs, and Roth IRAs.

A commonly cited withdrawal strategy is to spend taxable accounts first, followed by tax-deferred, and then Roth accounts last. However, when evaluating taxes over an investor’s lifetime, this approach does not always produce the best outcome. Strategies such as proportional withdrawals, tax-bracket management, or Roth conversions can improve after-tax wealth and portfolio longevity.

The Basic Withdrawal Approach

There is logic behind spending taxable assets first. In taxable brokerage accounts, dividends, interest, and realized capital gains create annual tax liability, or “tax drag.” By drawing down taxable assets first, retirement accounts can continue compounding on a tax-advantaged basis.

Additionally, withdrawals from taxable accounts are not restricted or taxed, although realized capital gains and investment income can still increase taxable income. The tax-free withdrawals can help retirees remain in lower tax brackets during the early years of retirement. As we can imagine, retirees may find themselves in unusually low tax brackets, especially if income primarily consists of Social Security benefits and taxable account withdrawals.

However, a potential issue arises when tax-deferred accounts continue growing for many years before meaningful withdrawals begin. Because distributions from Traditional IRAs are generally taxed as ordinary income, large future withdrawals, such as Required Minimum Distributions (RMDs), can push retirees into significantly higher tax brackets later in life.

Higher taxable income may also increase Medicare premiums through Income-Related Monthly Adjustment Amounts (IRMAA) and potentially trigger the Net Investment Income Tax (NIIT).

With the basic approach, a retiree may end up paying far more in cumulative lifetime taxes, with the bulk of the taxes being paid later in the retirement period.

Tax-Planning Approach

A more strategic approach involves intentionally managing taxable income throughout retirement rather than simply following a fixed withdrawal order.

For example, a retiree may choose to target a specific marginal tax bracket, such as the 22% or 24% federal bracket. A retiree needing $100,000 annually may choose to withdraw $50,000 from a taxable account and $50,000 from a Traditional IRA in order to remain within a target tax bracket. The goal is to recognize income gradually over time rather than allowing large RMDs later in retirement to create significantly higher tax burdens.

This strategy results in intentionally paying moderate taxes earlier in retirement to hopefully avoid higher taxes later.

In many cases, this involves combining withdrawals from taxable and tax-deferred accounts while preserving Roth assets for later years, if possible.

Roth Conversions

Early retirement years—particularly before RMDs begin—can create valuable Roth conversion opportunities.

A Roth conversion involves transferring assets from a Traditional IRA to a Roth IRA, intentionally recognizing taxable income in the year of conversion. This strategy can reduce future RMDs and increase the amount of tax-free assets available later in retirement.

Qualified Roth IRA withdrawals are tax free, and Roth IRA assets generally pass income-tax free to beneficiaries.

For retirees experiencing temporarily lower income years, partial Roth conversions may be an effective long-term tax-planning tool when coordinated carefully with broader tax considerations.

Planning Considerations for Investors

Optimizing taxes over a lifetime, and not a single year, can have a meaningful impact on after-tax wealth. 

Younger investors can start by funding different account types to provide flexibility in retirement. Excessive balances in a tax-deferred account can lead to higher taxes later in life. At the same time, too much in a tax-free account can lead to a very low tax rate, reducing the benefits of the tax-free account.

In summary, strategically planning distributions and optimizing between account types is worth the effort.

Ultimately, retirement distribution planning should be evaluated as part of a broader financial and tax strategy. Tax planning should always be coordinated with a qualified CPA or tax professional. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.  Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax. A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply. Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.