• 4-Minute Article
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  • Jan 30, 2019

Tax-Smart Ways to Time Retirement Income Withdrawals

See which accounts to withdraw from and when to lessen the tax impact.

Questions this article can help you answer:
  • What retirement accounts get taxed?
  • What retirement money should I use first?
  • When should I revisit my retirement plan?

Created in Collaboration with Kiplinger.

An important goal for any retiree is making their savings last. Once you start taking money out of retirement accounts or start receiving pension payments or other guaranteed income, however, income taxes will come into play. By making a plan to strategically withdraw from different accounts at different times, you can lessen the tax impact throughout retirement and leave more tax-free retirement resources intact to potentially grow.

The following sequence may make sense for some of today’s retirees. Discuss this and any strategy with your financial or tax professional to ensure the right steps for your retirement plans.


Required minimum distributions (RMDs) from employer-sponsored retirement plans and traditional IRAs

The IRS requires RMDs be taken each year generally beginning with the year a retiree turns age 721, whether or not the cash is needed, as a way to spread out distributions over your lifetime. Failing to take these withdrawals on time leads to a steep IRS penalty: 50% of the amount that wasn’t withdrawn on top of any income taxes due.

Here are the basic rules2 regarding timelines:

  • Generally, the first RMD must be taken by April 1 of the year after you reach 72.
  • In the years after that, the RMD must be taken by December 31.
  • If the first RMD is delayed to the next calendar year, two RMDs will be required in a single tax year (the first and second years’ withdrawals).

For 2020, the IRS has provided additional clarification3:

  • “If an RMD statement is provided for 2020 to an IRA owner who will turn age 70½ in 2020, the IRS will not consider the statement to be incorrect, but only if the financial institution notifies the IRA owner no later than April 15, 2020, that no RMD is due for 2020.”
  • “IRA owners who reached age 70½ in 2019, and have not yet taken their 2019 RMDs… are still required to take those distributions by April 1, 2020.”


Withdrawals of any non-taxable amounts from taxable accounts

Interest and dividend earnings from non-retirement accounts, such as investment or bank accounts, generally are taxed whether or not the interest or dividend is paid in cash to the owner. So, tapping that money that has already been taxed generally may not result in a bigger tax bill. Of course, if you sell or redeem assets, such as from an investment account, there may be tax on any gains and so it is important to consult with a tax professional.

If you decide to sell off assets which may generate taxable gains, you should discuss with your tax professional whether to start by taking withdrawals from long-term investments — held for longer than one year — as that may minimize capital gains taxes if the gains are eligible for taxation at the long-term capital gains tax rates. Long-term capital gain tax rates are generally lower than short-term capital gain tax rates.


Withdrawals from tax-deferred accounts

Drawing money from traditional IRAs and 401(k) accounts generally will increase current taxable income. But remember, withdrawals of taxable amounts are subject to ordinary income tax. Withdrawals made before age 59½ may also be subject to a 10% federal income tax penalty.


Withdrawals from tax-free accounts

This allows funds in tax-free accounts, like Roth IRAs, the longest possible time to continue growing, offering the highest level of future tax-free income. It’s important to consider your specific accounts, including for a Roth IRA account whether a distribution qualifies for non-taxable treatment.

Exceptions to This Strategy

There are times when it may make sense to re-order the sequence or consider a different strategy. For example: someone facing a large, unexpected expense (like a hospital bill or major home repair) could be pushed into a higher tax bracket due to additional withdrawals.

To avoid the increased tax bill this situation creates, there are two options: draw funds to pay qualified medical expenses from a Health Savings Account (HSA) or take money from a Roth IRA for any type of expense (assuming the Roth IRA distribution is a “qualified distribution” meaning that it will meet the requirements of the tax code to be taken without incurring taxable income). Because these withdrawals are generally tax-free (as long as you follow all the rules), they don’t increase taxable income.

As an added benefit, avoiding the bump in taxable income also may help you avoid triggering a high-income Medicare surcharge and higher tax on Social Security income.

Planning Ahead

The “gap” years between retirement and RMDs open up opportunities to potentially reduce the post-RMD tax burden ahead of time.

While income is lower (after you retire and before you begin taking RMDs), shifting money from traditional IRAs and 401(k) plans into Roth IRAs could allow you to take advantage of lower tax rates. Roth IRAs don’t have RMD requirements, so money can be withdrawn tax-free as needed instead of by an IRS deadline.3 Because conversions from a Traditional IRA to a Roth IRA are taxable, resulting in tax payments years or even decades ahead of when required, it is important to consult with your tax professional and consider your tax bracket. Accelerating the taxes through a conversion of all or part of a Traditional IRA may be worthwhile if the taxes paid at conversion are paid in a low tax bracket.4

Timing It Right

Talk with your financial professional to determine the best plan to strategically manage withdrawals, lessen the impact of taxes, and maximize your accounts. By planning ahead, you can help preserve more of your income to support your retirement vision.

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