How to Create a Tax-Efficient Retirement Withdrawal Plan in Retirement

When you’ve earned an income all your life, it can be a challenge to transition to retirement when you enter a ‘decumulation’ phase. Pre-retirees need to take this time to develop a strategy for drawing on their savings that both: 

  1. Provides them with the income they need to live a lifestyle they’re comfortable with.
  2. Effectively minimizes taxes on their retirement income to maximize the longevity of their nest egg.

So, how do you start withdrawing from your savings in a tax-savvy way? Here are a few things to consider about your retirement income strategy. 

Understand What Accounts You Have – And How They’re Taxed

Your first step as a pre-retiree is to understand what types of accounts you currently have, and how they’re taxed. When you have a grasp on what type of taxes you can expect to incur during retirement, you’ll be better able to create a tax-efficient strategy that reduces your taxable income while timing other tax hits (like capital gains taxes) appropriately.

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Source: https://www.fidelity.com/viewpoints/retirement/tax-savvy-withdrawals

The table above, created by Fidelity, is an incredibly helpful primer for understanding where your nest egg is “housed” and how it might be taxed throughout retirement. 

Minimize RMDs

One way to minimize taxes in retirement as part of your overall withdrawal strategy is to minimize the Required Minimum Distributions (RMDs) you must take during retirement from your applicable accounts (401k, Traditional IRA, etc.). You can minimize these by choosing to donate a portion of your RMD to charity (known as a Qualified Charitable Distribution, or QCD), continuing to work and earn an income, or converting your savings to a Roth IRA using a rollover strategy. Minimizing your RMDs can help you to minimize your taxable income in retirement. 

A Simplified Withdrawal Strategy

While this simplified withdrawal strategy won’t work for everyone, there is a general order that retirees can follow to minimize taxes in retirement:

  1. Leverage your non-qualified brokerage accounts first. Any investment accounts you have that aren’t pre-tax or a Roth account will have the biggest tax “hit”. Getting them out of the way first can help your other accounts continue to grow in a tax-efficient way.
  2. Spend your pre-tax savings. This could be money in your 401k, Traditional IRA, or other pre-tax savings vehicle. 
  3. Turn to your Roth accounts. The longer funds in your Roth accounts can earn interest tax-free, the better. 

Of course, this strategy won’t work for everyone, but it’s a good place to start thinking about how you withdraw your wealth in retirement. 

You may be wondering: What other strategies are there? Some retirees choose to take a proportional amount of money from each of their retirement accounts each year throughout their retirement. This may be an effective strategy if hefty long-term capital gains aren’t expected in any of your accounts. 

Have Questions? 

We’re here to help! Get in touch with us today by clicking here. We’re happy to help you understand how taxes will impact your retirement withdrawal strategy and the best way for you to strategically draw down your nest egg over time.

Wood Smith Advisors, a woman-owned Registered Investment Advisor (RIA), is a fee-only financial services firm that partners with its clients to simplify their financial lives. We focus on women, entrepreneurs, and individuals with complex financial situations, providing objective and competent advice, education and services to help them develop and build their businesses and reach their financial goals. We can be reached by clicking here.

"Finance Made Simple" blog posts are intended for educational purposes and not for specific advice. Each person’s situation is different. Consult your financial advisor for advice relating to topics discussed.

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