Some people will spend decades saving and investing for retirement, only to discover that they missed a step along the way. That commonly "missed" step? Devising their plan for decumulation -- in other words, their retirement withdrawal strategy. Because just as you need a plan to build your nest egg, you need one to draw down on it wisely as well.
Image source: Getty Images.
A retirement withdrawal strategy is simply a plan for drawing upon your assets to cover your expenses in your golden years. Let's say you have a single retirement account, like a self-directed Roth IRA. While it's essential to have a withdrawal strategy regardless of how many accounts you have, planning is simpler when you only have one. That's because the order in which you withdraw from your retirement accounts and the proportions you use when you tap them will impact how much you pay in taxes. That, in turn, is likely to play a meaningful role in determining how long your money will last.
Required minimum distributions
One decision involves whether you'll begin making withdrawals from your retirement accounts in the first year you retire, or wait until you're mandated to do so due to required minimum distributions (RMDs). RMDs are withdrawals that you must begin taking from defined contribution plans -- like IRAs and 401(k)s -- once you reach age 73 (though that will rise to 75 for those born in 1960 or later). The size of those mandated withdrawals is calculated as a percentage of the assets in the account, and that percentage grows each year older you get.
Failure to take an RMD can result in a steep IRS penalty.
Brokerage accounts, 401(k)s, IRAs, etc.
Because everyone deals with a different set of circumstances, there's no single set of rules to tell you in which order to make your withdrawals. However, as the following scenario will show, a good starting point is to first consider brokerage accounts, then tax-deferred accounts, and finally, tax-free accounts.
Don and Nancy
Imagine a couple named Don and Nancy. Both are 67 years old, and each collects $1,500 monthly in Social Security. That means Don and Nancy start with an annual guaranteed income of $36,000. In addition, Don and Nancy have $1 million invested across their various retirement accounts.
- Brokerage account: $300,000 (profits taxed as long-term capital gains)
- Traditional 401(k)s: $400,000 (taxed at their ordinary tax rate)
- Roth IRAs: $300,000 (no taxes due)
Don and Nancy want to withdraw a total of 4% from their retirement accounts annually to help cover their expenses. That will add another $40,000 to their income this year.
An eye on taxes
The couple realizes that they may have to tweak their strategy as circumstances change through the years, but right now, it's all about saving money on this year's taxes.
Between Social Security payments and retirement account withdrawals, the couple has an income of $76,000. Their ultimate goal is to remain in the 12% tax bracket ($23,850 to $96,950).
Deductions
Don and Nancy aren't worried because they know they only have to pay taxes on their adjusted gross income (AGI) -- the income they end up with after deductions are taken. Here's where their deductions stand for the year:
|
Base standard deduction, married filing jointly |
Standard deduction for age 65+ |
New deduction for seniors, for tax years 2025-2028 |
Total deductions |
|---|---|---|---|
|
$31,500 |
$3,200 ($1,600 per spouse) |
$12,000 ($6,000 per spouse) |
$46,700 |
The couple takes a closer look at each of their retirement accounts, carefully considering the impact of each on their tax burden.
- Brokerage account: Don and Nancy have had their brokerage account for years, and any profits they book on shares they sell at this point will be taxed at the lower long-term capital gains rate. And in fact, their income will be low enough that they'll owe nothing in capital gains tax.
- Tax-deferred account: Because 401(k)s are tax-deferred accounts, Don and Nancy didn't pay any taxes on their contributions in the years that they earned those funds. But now, withdrawals from the couple's 401(k)s will be taxed at their ordinary marginal tax rates.
- Tax-free accounts: With Roth IRAs and similar types of tax-advantaged accounts, you do pay taxes on the funds that you contribute in the year that you earn the money. But later in life, all your withdrawals are tax-free.
Years ago, the couple agreed that any money in their Roth IRAs would be earmarked for use in late retirement, when their healthcare costs and living expenses might be higher. In the meantime, they're determined to give those tax-free accounts more time to grow by not making withdrawals from them until absolutely necessary.
Parceling out $40,000
Since withdrawals from their Roth IRAs are off the table for now, the couple must choose how much to take from the remaining accounts. They decide to withdraw 60% from their 401(k)s ($24,000) and 40% from their brokerage account ($16,000).
Devising a withdrawal strategy is not an exact science, and this couple's priorities may shift from year to year, but for now, their total taxable income remains well within the 12% marginal tax bracket. And, due to their joint income being below $96,700, they'll owe no federal taxes on the money they withdraw from their brokerage account.
One size truly does not fit all
While the method of drawing from brokerage accounts first, then tax-deferred accounts, and finally, from tax-free accounts may be popular, it won't be right for everyone.
Once you've retired, you'll undoubtedly spend time determining the best withdrawal strategy for you, and the right answer could change over time as you move through different phases of retirement. You may have a single retirement account or many accounts from which to draw funds. Your situation will be unique to you. This is where a good financial or retirement advisor can be helpful in determining the best tactics to help your nest egg last.
