Imagine you've worked hard, saved diligently, and entered retirement with a sense of financial security. Now, the challenge isn't just about how much you saved, it's about how you withdraw those savings to make your nest egg last while keeping taxes at bay. A well-thought-out withdrawal strategy can be the key to safeguarding your retirement savings and getting the most out of every dollar.
Below, we'll explore smart, tax-efficient withdrawal strategies and actionable steps to help stretch your retirement funds and ensure your financial peace of mind.
Why a Thoughtful Withdrawal Strategy Matters
The Impact of Taxes on Your Retirement Income
It is not uncommon that retirees who have failed to plan pay more taxes in retirement than during their highest earning years. While this is counterintuitive, the changing of income sources and timing can come as a huge surprise.
Without a tax-efficient plan, retirees risk losing thousands of dollars to unnecessary taxes, reducing the potential of their hard-earned savings.
Avoiding Common Mistakes
One common pitfall is withdrawing funds reactively instead of strategically. For example, failing to account for tax implications can lead to higher-than-expected tax bills or even bump you into a higher tax bracket. Another risk is prematurely depleting accounts without considering long-term needs, leaving you financially vulnerable in your later years.
Types of Retirement Accounts and Tax Implications
Tax-Deferred Accounts (Traditional IRAs and 401(k)s)- Always Taxable
Tax-deferred accounts allow your contributions to grow tax-free, but withdrawals are taxed as ordinary income. These withdrawals are optional until 75 at the latest, when required minimum distributions (RMD’s) are needed starting at roughly 4% of the prior year balance. These accounts are advantageous during your working years but require a plan to minimize taxes during retirement.
Roth Accounts (Roth IRAs and Roth 401(k)s)- Never Taxable
Roth accounts offer tax-free growth and withdrawals, since they are funded with post-tax contributions. These are excellent tools for reducing taxable income in retirement.
Taxable Accounts- Sometimes Taxable
These accounts are subject to capital gains tax on profits, but provide more flexibility in withdrawals. Funds from these accounts are typically tapped first in a tax-efficient withdrawal sequence.
Steps to Build a Tax-Savvy Withdrawal Plan
Step 1 - Understand Your Tax Bracket
Knowing your tax bracket is essential for managing withdrawals. Avoid "tax bracket creep" by carefully planning withdrawals to ensure you don’t cross into a higher bracket.
Below is an example of our projected annual tax bill for a family we work with that is preparing for retirement. In a few years when they stop working, their tax bill will understandably decrease. Zooming out further, we can see that their tax will ratchet back up when their expected taxes annually are expected to be the highest in their life, only 6 years after RMD’s kick in.
Our planning will help save taxes in the future, by strategically paying taxes in lower income years, to save tens of thousands each year and increase their legacy (or spending ability) by hundreds of thousands over their lifetime.
Step 2 - Use the General Withdrawal Sequence
The common rule of thumb for withdrawal order is this:
- Taxable accounts – Start with these to take advantage of lower capital gains tax.
- Tax-deferred accounts – Then move on to IRAs and 401(k)s, balancing withdrawals to manage Required Minimum Distributions (RMDs).
- Tax-free accounts – Finally, tap Roth IRAs for tax-free withdrawals later in retirement.
By following this sequence, you can lower your taxable income and allow tax-advantaged accounts to continue growing.
Step 3 - Incorporate Roth Conversions
Converting a portion of your Traditional IRA to a Roth IRA during lower-income years (like early retirement) can be one way to provide long-term tax benefits. While you pay taxes on the conversion now, future withdrawals from the Roth account are tax-free, benefiting both you and your heirs.
Step 4 - Navigate Required Minimum Distributions (RMDs)
Starting at age 73, retirees must withdraw a minimum amount from tax-deferred accounts. To avoid penalties, start planning withdrawals earlier to smooth the impact of large RMDs down the line.
Leveraging Financial Tools and Strategies
Dynamic Withdrawal Strategies (e.g., Guardrail Approach)
If retiree’s are flexible about their spending, they can safely distribute more from their portfolio, while minimizing the risk of running out of funds. This approach adjusts withdrawals based on market performance:
- Increase withdrawals during strong markets to enjoy the gains.
- Decrease withdrawals during downturns to preserve your savings.
This flexible method helps protect your nest egg from premature depletion, while maximizing the enjoyment you can derive from your portfolio
Minimize the Tax Impact on Social Security and Medicare
Managing "combined income" by strategically withdrawing from accounts can reduce taxes on Social Security benefits and avoid higher Medicare premiums triggered by Income-Related Monthly Adjustment Amounts (IRMAA).
Nerd Note: Higher taxable income can push Medicare premiums up significantly, proper planning can help you avoid this!
Use the 0% Long-Term Capital Gains Tax Rate
If your taxable income is within specific thresholds, you may qualify for a 0% capital gains tax rate. Strategizing withdrawals to align with this rate offers a valuable tax-saving opportunity.
Nerd Note: A married couple that is newly retired in 2025 with no income can convert $30,000 of IRA to a Roth, AND realize $96,700 in capital gains in their portfolio to live off of, while paying $0 in federal tax. If they converted another $96,950, for a total of $126,950 now in their Roth account, they would pay less than $12,000 and never have to worry about taxes on those funds again.
Future-Proofing Your Strategy
Maintain Flexibility in Market Downturns
Retirement is unpredictable, so maintaining flexibility in your withdrawal plan allows you to adapt to changes in market conditions or unforeseen expenses. For instance, temporarily reducing withdrawals during a downturn can help preserve your portfolio's longevity.
Plan for Legacy Goals
Want to leave a financial gift for your loved ones? Roth accounts are excellent vehicles for tax-free inheritance. Aligning your withdrawal and estate planning strategies ensures your legacy is passed on effectively.
Nerd Note: Did you know that Roth accounts don’t require RMDs, so the funds can continue growing tax-free for your beneficiaries?
Review and Adapt Regularly
Life changes, tax laws evolve, and market conditions shift. Conduct annual reviews of your withdrawal strategy to ensure it aligns with your current financial needs and goals. You only get one shot at retirement, so don’t hesitate to consult a tax minded financial advisor for expert guidance.
Take Charge of Your Retirement Income Today
Retirement planning is about empowering yourself to enjoy your golden years with security and confidence. A tax-efficient withdrawal strategy isn’t just a tool, it’s your lifeline to financial freedom over decades.
Why leave your future to chance? Contact HealthyFP to build a retirement income plan tailored to your unique goals. We are here to help make the most of what you have worked for.
