Which Accounts Should You Withdraw Funds From First in Retirement?
Retirement is a major financial milestone that requires careful planning and strategic decision-making, especially when it comes to withdrawing funds. The order in which you withdraw money can significantly impact your long-term financial security and tax situation. Understanding the various types of accounts you have and the implications of withdrawing from them is crucial to maximizing your retirement income and minimizing tax liabilities. Here’s a breakdown of which accounts you should consider withdrawing funds from first in retirement.
1. Taxable Accounts
Why Withdraw First?
Taxable accounts (such as brokerage accounts) should generally be the first source of income in retirement. This is because the funds in these accounts are already taxed, allowing you to avoid incurring additional taxes on withdrawals. Since capital gains and dividends in taxable accounts have preferential tax treatment and can be strategically withdrawn to minimize taxes, starting from these accounts can help preserve tax-advantaged funds longer.
Considerations:
- Withdraw capital gains or income first from investments in these accounts to keep your tax burden lower.
- Evaluate your investment strategy to ensure you’re not heavily liquidating high-performing assets unnecessarily.
2. Traditional IRA and 401(k) Accounts
Why Withdraw Second?
After exhausting taxable accounts, the next source of funds typically comes from tax-deferred accounts like Traditional IRAs and 401(k)s. Withdrawals from these accounts are subject to ordinary income tax, which means you’ll be taxed on the total amount you withdraw.
Considerations:
- Start withdrawing funds in a way that keeps you within a desirable tax bracket. You may want to spread out withdrawals over several years to avoid pushing yourself into a higher tax bracket.
- If you have both a Traditional IRA and a 401(k), you may want to consider withdrawing from the account that has a lower balance or higher fees first to minimize administrative burdens.
3. Roth IRA Accounts
Why Withdraw Last?
Roth IRAs are typically the last accounts you should withdraw from in retirement. Withdrawals from Roth IRAs are tax-free, provided you are over 59½ and the account has been open for at least five years. This tax-free status means that retaining funds in a Roth IRA allows for continued tax-deferred growth, which can be beneficial if you expect to live for several years in retirement.
Considerations:
- Since Roth IRAs do not have required minimum distributions (RMDs) during your lifetime, they can act as a strategic preserve for your wealth, allowing it to grow for your heirs.
- Consider your potential heirs’ tax situations. Inheriting a Roth IRA can provide tax-free income to beneficiaries, making it a valuable legacy tool.
4. Considerations by Individual Situation
Your personal financial situation, expected expenses, and tax strategies can impose further nuances to the withdrawal order:
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Projected Tax Rates: If tax rates are expected to rise, it might be prudent to withdraw from tax-deferred accounts earlier to minimize future tax burdens.
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Market Conditions: If the market is down, withdrawing from taxable accounts, which may be losing value, could lead to worse long-term outcomes. Prioritize accounts that have appreciated or have a better growth trajectory.
- Income Needs: If you need to cover specific expenses (such as healthcare) and certain accounts will afford you better tax advantages or fewer penalties, factor this into your withdrawal strategy.
Conclusion
Ultimately, the decision of which accounts to withdraw from first during retirement can significantly shape your financial landscape and tax obligations. It’s essential to approach retirement withdrawals with a strategic mindset, taking into account your overall financial plan, tax implications, and personal circumstances. Consulting with a financial advisor or tax professional can also help clarify the best strategy for minimizing taxes while maximizing your retirement income. With proper planning and the right approach, you can achieve a fulfilling and secure retirement.
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Spoiler Alert! The answer is "It Depends". If you are expecting a simple one size fits all answer you won't find it in this video. The goal of the video is to provide education on the subject to help you understand some of the key factors. It will be different for each person depending on your unique financial situation. For a professional plan you could consider working with my firm https://www.martinsenwealth.com/
6:12 How is an RMD tax postponed? Isn’t it, by definition, a taxable distribution? Similarly, how is ”ordinary income” qualified/tax postponed?
I came across your channel through this video—case studies are incredibly valuable, and I'm eager to see more in the future! Building wealth involves establishing routines, like consistently setting aside funds at regular intervals for smart investments.
Amazing video, A friend of mine referred me to a financial adviser sometime ago and we got to talking about investment and money. I started investing with $150k and in the first 2 months, my portfolio was reading $274,800. Crazy right!, I decided to reinvest my profit and get more interesting. For over a year we have been working together making consistent profit just bought my second home 2 weeks ago and care for my family.
If you don’t need the money then the taxable brokerage account is the same as the tax advantaged for your heirs and you can argue the brokerage account is better during your lifetime as you can harvest losses as well as deferring gains and passing it on with a step up in basis. I have had a brokerage account for 40 years and never paid $1 of capital gains (although I do have some dividends and harvest my losses annually). My plan is to try to spend down as much of my tax deferred money as possible and let the rest grow to be passed down tax free.
My breakdown 60% tax deferred. 25% taxable brokerage with high cost basis and 15% tax free (including house and life insurance and small Roth).
Great presentation. There is one more thing that can be added in the "Tax Advantaged" bucket, an "HSA". It goes in Pre-Tax, the balance over a prescribed limit can be invested and earn market returns, and (as long as the money is used for an approved health expense) is also Tax Free to spend anytime.
You are simply amazing… my wife and I are so worried about this topic that I started the process of your 20-page report for strategies. Unfortunately my wife and I did not start a 401k or Roth until we turn 55 so we have a sort of an uphill battle going on LOL
Should I take taxes out of my ss check?
MAKING RETIREMENT PLANS IS GREAT, BUT HAVING A SOLID RELIABLE PASSIVE INCOME IS PREFERABLE.
Big ups to everyone working effortlessly trying to earn a living while building wealth. I'm 40(retired worker) and my wife 34. We are both retired with over $3 million in net worth and no debts. Currently living smart and frugal with our money. Saving and investing lifestyle made it possible for us this early even till now we earn monthly through passive income.
But what is the answer to the title on your video?
Never answered the question.
Retired sept 2021 biggest fear ,the biden administration
My spouse and I are adding a variety of stocks/ETF to my present holdings for the long term, We've set aside $250k to start following inflation-indexed bonds and stocks of companies with solid cash flows, I believe it is a good time to capitalize on the market for long-term gains, but it wouldn't hurt to know means of actualizing short term profit
So "Which accounts should you withdraw funds from first in retirement?"
Well, watching this video was taxing…and 10 minutes too long with the info presented. ROI was very low … Book promo vid.
Just retire overseas and don’t worry about American broken healthcare system or running out money at old age.
Thank you for posting this helpful and informative video
The presenter didn't answer the question asked in the title of the video. He just explained why it was important, and what things to consider. And he did it in the most long-winded possible presentation. Every section of the video was essentially, "it depends". At the end of the video, the conclusion was, buy my book, or hire someone like me to figure out the answer for you. Not sure which I dislike more, the government that created our horrible retirement system, or the accounting and legal vultures which drain your hard earned savings by being paid to "manage" it or provide ongoing advice on how to game the system.
I think using a marginal tax rate is more realistic, 25% on 38k isn’t realistic and hasn’t been for decades. This is a great demonstration thou!
I just plan on living off my pension, rental income, and social security. My 401k and IRA are reserved until RMD time, and the remaining balance for the kids upon my death.
At 10:00. I know you're simplifying for your comparison, but tax rates for tax advantaged and tax postponed really aren't the same. Tax postponed contributions reduce tax at the marginal rate but distributions are taxed at the average rate (all else being equal). For example, if you contribute to a 401k while making $150k/yr, you reduce taxes by 24% of the amount saved. But later if you withdraw $150k/yr, assuming your 401k distribution is your only income, it will be taxed at all tax rates starting at 0% (for the standard deduction) and only a fraction will be taxed at 24%. Even if you have SS (or some other source of fixed income), your 401k distribution will be taxed at the average rate starting with where SS leaves off–which I guarantee won't be in the 24% tax bracket!
What happens if your tax rate goes down during distribution because your income is less in retirement.?