The Best Order to Dip Into Retirement Funds

Dear Rich Lifer,

Ready to start using what you’ve spent your whole life accumulating?

For retirees, the conventional advice has always been to tap into savings in taxable brokerage accounts and bank accounts first. You’re supposed to wait to use funds from tax-deferred accounts such as 401(k)s or IRAs until age 72, when the required minimum distribution (RDM) comes into effect.


Theodore Sarenski, a wealth manager and certified public accountant (CPA) in Syracuse, New York, remarks, “We’ve had clients [in their 60s] come in and say, ‘We paid no taxes the last five years. Isn’t that great?’”

Well, as it turns out, this news is not so great. 

The issue with this approach is that many retirees get hit with huge tax bills in their 70s after they start collecting Social Security and begin dipping into tax-deferred accounts. 

Instead, Mr. Sarenski advises paying more taxes in early retirement in order to reduce overall lifetime taxes. 

When you begin tapping into tax-deferred accounts earlier in retirement, you will be paying taxes on lower income. For example, a couple over 65 years old with no other taxable income can withdraw $108,850 and pay only $9,328 in taxes, an 8.6% tax rate. Once they begin collecting Social Security, that rate of taxation starts to go up. 

Today, we present some more advice for anyone saving for retirement or thinking about retiring soon. Planning for retirement can be a daunting task, so consider these tips to save the most money as a retiree…. 

Three Buckets of Money

Greg Will, a financial advisor and certified public accountant in Frederick, Maryland, warns that the 60s are the most important years of retirees’ lives. This is when they need to make a solid retirement plan that will carry them through the rest of their retirement.

Will advises dividing your retirement funds into three buckets of money: an after-tax bucket, a tax-deferred bucket, and tax-free bucket for the Roth IRA.

The best way to save money is to alternate between the three buckets and draw from them strategically. Will advises, “If we have flexibility where we can draw from any of the three accounts, we have a lot more leverage over their future taxes.”

For example, if at the end of the year, your funds are putting you in a higher tax bracket, the best thing to do is to start taking money out of an after-tax account instead of a tax-deferred account.

Roth Conversions

Converting tax-deferred accounts into Roth accounts early in retirement is one of the best ways to avoid steep taxes later in retirement. 

In a simple Roth conversion, investors can transfer their funds from a tax-deferred account into a Roth account, and the funds are taxed as ordinary income at the time of the transfer.

If you take this route, any money you take out of the Roth IRA for the rest of your life as a retiree will be tax-free or could be left to your heirs tax-free.

It is best to consult with a wealth advisor or CPA when deciding if it’s best to convert your savings. Remember, when you convert to a Roth account, you will have to pay those taxes immediately, and depending on your income level, the amount of taxes will vary.

Economist Laurence Kotlikoff of Boston University also points out that because of the ultralow interest rates, deferring taxes is less desirable.

Kotlikoff observes that a lot of retirees have a lot of wealth in bonds, which are usually kept in tax-deferred accounts in order to avoid paying taxes on the interest. But now, bonds are yielding less than inflation, so it’s pointless to let them sit in tax-deferred accounts.

His final advice is: “If you’re in a period when you’re in a low tax bracket, that’s when you want to take it out of your IRA. The real gain from this game is smoothing tax brackets” later in retirement.

Be Smart When Converting

Another pro of moving money out of tax-deferred accounts has to do with Medicare premiums. If you are a retiree with a large chunk of your nest egg in a tax-deferred account, you will likely have higher Medicare premiums when the RMD goes into effect at age 72. 

But again, consult with your financial advisor before making any big moves because taking too much money out of a tax-deferred account or doing a large conversion can also trigger higher premiums.

Financial advisors know it can be a hard sell to convince retirees to pay more in taxes earlier in life. Sometimes people need to see the numbers laid out for them to understand how big the savings can be.

Lucky for us, Kotlikoff sells software that shows safe ways that individuals can boost their income!

He analyzed a made-up, 62-year old retiree with $1 million in tax-deferred assets, $250,000 in a savings account, and $250,000 in a tax-free Roth account. 

If this pretend retiree waited until 66 to begin withdrawing funds from his tax-deferred account, he would pay no taxes from 62 to 65 but then would see his taxes skyrocket.

According to Koltikoff’s analysis, if the imaginary retiree began taking money from his tax-deferred account earlier in his retirement, he could have saved $25,000!

This number was a result of spending tax-deferred money at lower tax rates earlier in retirement and avoiding higher Medicare premiums down the road by lowering his RMDs.

So there you have it! It might be time to throw conventional wisdom out the door and explore the ways you can be smarter about taxes in your retirement. 

Benjamin Franklin is credited for the sound advice: “nothing is certain except death and taxes.” 

Taxes may be certain. But by increasing your financial education and listening to your financial advisor, you may be able to significantly lower them. 

To a Richer Life,

The Rich Life Roadmap Team 

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