Planning for retirement goes well beyond saving. Withdrawing your funds in a tax-efficient manner, for example—selecting which accounts to draw from and when—can help preserve more of your wealth and potentially enhance your retirement lifestyle. This article explores specific strategies to help you navigate retirement withdrawal complexities and thus ensure your hard-earned savings work smarter for you in your golden years.

Retirement accounts and taxes

Different types of retirement savings accounts have different tax treatments; withdrawals from each likewise have different implications. Three primary categories exist in this respect: taxable, tax-deferred, and tax-free earnings/withdrawals.

Taxable accounts

Taxable accounts include standard brokerage accounts, savings accounts, and other investment vehicles whereby contributions are made with after-tax dollars. Unlike with tax-advantaged accounts, no special tax advantages exist in this case—but they do offer far more flexibility with no contribution limits, required distributions, nor early withdrawal penalties.

Tax-deferred accounts

Just as the name implies, tax-deferred accounts allow you to postpone paying taxes on contributions and investment earnings until you withdraw the funds (typically during retirement). Examples include traditional IRAs, 401(k) plans, and 403(b) plans, the primary advantage of which is contributions typically made with pre-tax dollars: reducing your taxable income in that same year. Distributions are taxed as ordinary income upon withdrawal—sometimes beneficial for those in a lower tax bracket during retirement versus their working years—but required minimum distributions (RMDs) (which we’ll discuss in more depth) can have major tax implications.

Tax-free earnings and withdrawal accounts

Contributions to accounts such as Roth IRAs and Roth 401(k) plans are made with after-tax dollars; while you won’t receive a tax deduction in the year of contribution, both earnings and withdrawals made in retirement are tax-free (provided certain conditions are met). This can be particularly advantageous for those who expect to occupy a higher tax bracket during retirement or plan to leave the account as an inheritance—as Roth accounts don’t have RMDs during the original account holder's lifetime.

Tax brackets and withdrawal strategies

The most tax-efficient withdrawal strategy depends on a variety of factors, one of the most important of which is your tax bracket. If you anticipate occupying a lower tax bracket in retirement, maximizing contributions to tax-deferred accounts is often wise as it allows you to defer taxes until you’re in a lower bracket: reducing the tax you’ll pay on retirement income.

Conversely, if you expect to occupy a higher tax bracket in retirement—possibly due to income from Social Security, pensions, or other retirement income sources—contributing to Roth accounts now might is perhaps more beneficial. While this involves paying taxes on contributions upfront, you avoid paying higher taxes on withdrawals during retirement as part of an approach that can provide significant tax savings in the long run (particularly if tax rates increase in the future).

Capital gains

Another thing to keep in mind when crafting your withdrawal strategy is capital gains, profits realized when you sell an investment for more than you paid for it. These gains are categorized as either short-term or long-term, depending on how long you’ve held the investment. Short-term capital gains—from assets held for one year or less—are taxed at your ordinary income tax rate. Their long-term counterparts (held for more than a year) benefit from lower tax rates that range from 0% to 20% depending on one’s income.

When planning your withdrawal strategy, it's important to consider how selling assets in taxable accounts can generate capital gains and how exactly these are taxed. While withdrawing from taxable accounts first and selling investments that have appreciated significantly can trigger a hefty tax bill due to capital gains taxes, those in a lower tax bracket might see long-term capital gains taxed at 0%: making taxable account withdrawals more attractive.

Required minimum distributions (RMDs)

The last thing we’ll touch on before diving into specific withdrawal strategies is required minimum distributions (RMDs), mandatory withdrawals that must be taken from most tax-deferred retirement accounts (e.g., traditional IRAs, 401(k) plans, and 403(b) plans) beginning at age 73. The specific RMD amount is based on account balance and life expectancy and increases as you age. Note these are taxed as ordinary income, and a failure to take your full RMD can result in penalties of up to 25%.

RMDs can complicate your retirement withdrawal strategy—especially if you have substantial balances in tax-deferred accounts—and can push you into a higher tax bracket (increasing your overall tax liability) as they’re taxed at ordinary income tax rates.

Withdrawal strategies

How you withdraw funds from retirement accounts can significantly impact your tax liability. In choosing the right strategy, you can optimize your income and minimize taxes; as with much of retirement planning, however, a one-size-fits-all “best” strategy unfortunately doesn’t exist. Instead, the right option for you will depend on a variety of factors and may involve a combination of several strategies such as…

Conventional strategy: taxable, tax-deferred, Roth IRAs

One popular and straightforward approach to tax-efficient withdrawals is withdrawing first from taxable accounts, then from tax-deferred accounts, and finally from accounts such as Roth IRAs that have tax-free withdrawals.

This strategy has several potential benefits. First of all, withdrawals from taxable accounts often trigger capital gains taxes (typically at a lower rate than ordinary income). Therefore, taking withdrawals from taxable accounts first can potentially keep you in a lower tax bracket. Exhausting your taxable accounts early on in retirement, meanwhile, allows your tax-deferred and Roth accounts to continue growing.

Next are withdrawals from tax-deferred accounts such as traditional IRAs and 401(k) plans, which allow Roth accounts (with tax-free earnings) to continue to grow; since withdrawals from tax-deferred accounts are taxed as ordinary income, the idea here is to begin taking distributions when your income (and therefore your tax bracket) are perhaps lower.

While this strategy is popular, it does raise some potential issues for investors. For example, those with substantial balances in tax-deferred accounts might wind up in a higher tax bracket due to RMDs and thus pay more taxes.

Balanced withdrawal strategies

One response to potential issues raised by the conventional withdrawal order is enlisting the help of a more balanced approach that withdraws from a combination of taxed and tax-advantaged accounts. Two such examples are a bracket-topping strategy—in which you take tax-advantaged withdrawals so you reach (but don’t exceed) your current tax bracket—or a capital gains strategy whereby you take from taxable accounts and pay capital gains when in a lower tax bracket.

Another option is to delay selling investments in taxable accounts to avoid adding capital gains to already increased taxable income during years when you’re required to take RMDs. In years you don’t have large RMDs, meanwhile, you might sell appreciated assets in taxable accounts to take advantage of lower capital gains tax rates.

Proportional withdrawal strategy

As another alternative to the conventional taxable, tax-deferred, Roth strategy, a proportional withdrawal strategy involves taking withdrawals from different types of accounts each year in proportion to their balances: aiming to balance your tax liability by spreading it across different types of accounts, avoiding the spike in taxable income that can occur if you focus solely on tax-deferred accounts.

For example, if you withdraw 60% from tax-deferred accounts, 30% from taxable accounts, and 10% from Roth accounts, you can manage your tax bracket more effectively: spreading out taxable income and thus benefitting from lower tax rates on long-term capital gains in taxable accounts while also taking advantage of tax-free Roth withdrawals. This strategy requires careful planning and monitoring but can provide a more stable and predictable tax situation throughout retirement.

Roth IRA conversions

Converting some (or all) of your tax-deferred account balances into a Roth IRA, Roth IRA conversions are a strategic way to manage taxes during retirement. While you’ll pay taxes on the converted amount in the year of the conversion, future Roth IRA withdrawals are tax-free—provided you follow the rules.

The primary benefit of Roth IRA conversions is the ability to manage your tax bracket over time, converting smaller amounts during years when you’re in a lower tax bracket to avoid larger tax bills later on when RMDs from traditional accounts might push you into a higher one. Roth conversions also eliminate the need for RMDs from converted funds—allowing for greater withdrawal strategy flexibility—but require careful consideration as large conversions can push you into a higher tax bracket that same year, triggering a significant tax bill.

The takeaway: tax-efficient retirement withdrawal strategies

Minimizing taxes and maximizing retirement income requires careful planning and coordination to create a personalized plan. It’s important to continually monitor and adjust your retirement savings strategy accordingly, as changes in income, tax laws, and your own financial situation can all impact your tax bracket and (consequently) your optimal retirement contribution strategy. With this in mind, regularly review your financial plan with a tax advisor or financial planner so you can make informed decisions and ensure your strategy remains aligned with your long-term goals.

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The content in this post was developed by our team of writers and reviewed by our team of CFP® professionals here at Vision Retirement.

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Tax-Efficient Retirement Withdrawal Strategies