When to Withdraw From Which Account: A Tax-Saving Guide

Imagine this

You’re on a road trip across the country, finally exploring those scenic byways and bucket-list destinations you’ve been dreaming about for years. But there’s one catch—your car has a few different fuel tanks, and each one works differently. Some are taxed at the pump, some aren’t taxed at all, and others have restrictions on when and how you can use them. Choosing which tank to use first isn’t just about getting from point A to point B—it’s about optimizing every mile you drive.

Retirement savings work in much the same way. After years of diligent planning, investing, and saving, you’re finally ready to enjoy the fruits of your labor. But knowing which accounts to tap first—your “fuel tanks”—can mean the difference between a smooth financial journey and one filled with unnecessary tax detours and penalties.

This guide is here to help you navigate the road ahead. By understanding the sequence of withdrawals, you can maximize the longevity of your savings and keep more money in your pocket. Whether it’s the tax implications of tapping your 401(k) early, the advantages of delaying Roth IRA withdrawals, or how to manage Required Minimum Distributions (RMDs), we’ll walk through each step so you can cruise through retirement with confidence.

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Understanding the Different Types of Accounts

Think of your retirement savings as a collection of treasure chests, each with its own lock and key. Some chests are guarded by the taxman, others are free to access, and a few have conditions that make them most valuable when left untouched until the right time. To make the most of your retirement, it’s essential to understand what’s inside each chest and the rules for opening them.

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1. Taxable Accounts

These are like the everyday spending cash in your wallet. You’ve already paid taxes on it, so you can access it freely. Stocks, bonds, or mutual funds in a brokerage account fall into this category. They offer flexibility, but withdrawals may trigger capital gains taxes if you’ve made a profit.

Example:
Let’s say Tom, a retiree, wants to take a trip to Europe. Instead of dipping into his 401(k) and facing higher income taxes, he uses the dividends from his taxable account to cover the costs. By doing so, he avoids increasing his taxable income and keeps his tax bracket low.

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2. Tax-Deferred Accounts

These are your 401(k)s and traditional IRAs—the heavy lifters of retirement savings. Contributions to these accounts were pre-tax, meaning you’ll pay income tax on withdrawals. While these accounts are powerful tools for growing wealth, the IRS doesn’t let you keep the money in them indefinitely. RMDs start at age 73, so careful planning is crucial to avoid large, taxable withdrawals in later years.

Imagine these accounts as fruit trees in your backyard. You’ve nurtured them for years, and now they’re ripe with growth. But as the harvest comes in, Uncle Sam shows up with a basket, ready to take his share of the fruit. Picking just enough for your needs—and not overloading his basket—is the key to minimizing taxes.

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3. Roth Accounts

Roth IRAs and Roth 401(k)s are like your treasure chest with no strings attached. You’ve already paid taxes on the money you contributed, and withdrawals in retirement are entirely tax-free, including the growth. These accounts are often best saved for last, allowing them to grow tax-free for as long as possible.

Example:
Consider Susan, who’s in her early 70s and still has funds in her Roth IRA. By leaving it untouched, she not only avoids RMDs but also keeps it as a tax-free legacy for her children, ensuring the most value for her heirs.

The Sequence of Withdrawals – A Tax-Saving Strategy

Once you understand the types of accounts in your retirement portfolio, the next step is deciding which to draw from and when. This sequence can significantly impact your tax burden and the longevity of your savings. While there are common strategies, the right approach depends on your unique situation. It’s always wise to consult a fiduciary financial professional who can guide you based on a full understanding of your circumstances.

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Step 1: Consider Starting with Taxable Accounts

Taxable accounts are often seen as a good place to begin withdrawing funds. Since you’ve already paid taxes on these investments, accessing them may not increase your taxable income significantly. This can help preserve the tax advantages of your other accounts for later.

Story:
Barbara and Mike, a couple in their early 60s, chose to use their taxable brokerage account to fund their dream of traveling the U.S. in an RV. This approach allowed them to keep their income relatively low in their early retirement years. However, every retiree’s situation is different, so consulting with an advisor was critical for them to determine whether this was the best move for their goals.

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Step 2: Explore Partial Withdrawals from Tax-Deferred Accounts

Your tax-deferred accounts, like traditional IRAs and 401(k)s, may be a key source of retirement income. Withdrawals from these accounts are taxed as ordinary income, so it’s important to manage them carefully. Some retirees may choose to withdraw just enough each year to “fill up” lower tax brackets, reducing the risk of larger tax bills when Required Minimum Distributions (RMDs) begin.

Things to Consider:

• Are you currently in a lower tax bracket than you expect to be in the future?

• Would smaller withdrawals now help reduce the size of your RMDs later?

Example:
Greg, a 65-year-old retiree, spoke with his financial advisor to review his tax situation. Together, they decided to take modest withdrawals from his IRA while his income was lower than usual. This strategy helped him avoid potentially higher taxes down the road. Such decisions should always be made with the guidance of a professional who knows your full financial picture.

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Step 3: Look Into Saving Roth Accounts for Last

Roth IRAs can be particularly valuable when left untouched as long as possible, thanks to their tax-free growth and withdrawals. Some retirees may prefer to use these accounts sparingly or save them for unexpected expenses or as a legacy for loved ones.

Think of Roth accounts as a safety net—they can catch you when unexpected costs arise without adding to your tax burden.

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When Ellen’s husband needed funds for unanticipated medical expenses, their Roth IRA provided a vital resource without increasing their taxable income. For Ellen, working with her advisor to keep the Roth IRA intact until it was truly necessary turned out to be a wise move.

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The Importance of Personalization

While these strategies can serve as a helpful starting point, every retiree’s situation is different. Factors like your tax bracket, healthcare costs, and financial goals all play a role in determining the right withdrawal sequence. A fiduciary professional who understands your specific circumstances can help craft a plan tailored to your needs.

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At Grinstead Wealth Management, we specialize in helping retirees navigate complex financial decisions with confidence and care. If you’re unsure about the best way to approach your retirement withdrawals, we’re here to guide you. Schedule a complimentary consultation today, and let’s work together to create a personalized strategy that makes the most of your hard-earned savings.

Your retirement deserves nothing less than a plan designed just for you. Contact us now to take the next step toward financial peace of mind.