Rosalind Evans
A specific order is to follow when withdrawing money from your retirement accounts. This article outlines the standard withdrawal order for different fund types while mentioning important exceptions to consider.
Cash:
Before tapping into any other accounts, utilize your cash reserves for income during retirement. However, ensure you have an emergency fund equivalent to six months of expenses. If, for instance, your monthly payments are $10,000 and you have $100,000 in the bank, use cash or cash equivalents for the first $40,000 of income.
The reasons for this are twofold: growth and taxes. Cash tends to grow more slowly than other investments, so it’s best to allow riskier investments with higher growth potential and more time to accumulate. Additionally, drawing from cash first can keep your taxes low in the initial years of retirement, allowing you to consider moving funds from a pre-tax account to a Roth IRA at a potentially lower tax rate.
Taxable accounts:
Once you have depleted your emergency fund, it’s time to tap into your taxable investments. These accounts include individual, joint, and revocable trust accounts. Withdrawals from taxable accounts held for more than a year are typically subject to more favourable long-term capital gains tax rates. Furthermore, these accounts do not offer tax-deferred growth, which may grow more slowly than retirement accounts.
Social Security:
Deciding when to start claiming Social Security benefits requires careful consideration. While tapping into Social Security is optional after exhausting taxable accounts, analyzing breakeven points based on life expectancy and tax and legacy considerations is essential. The longer you delay claiming Social Security retirement benefits (available from age 62 to a maximum of 70), the higher the monthly payout will be.
Pre-tax retirement accounts:
This category includes traditional IRAs, 401(k)s, 403(b)s, 457s, SEP IRAs, and similar accounts that still need to be subject to income taxes. These tax-deferred accounts will be taxed as income upon withdrawal. Generally, waiting longer to withdraw from these accounts is beneficial, but the required minimum distributions (RMDs) must eventually be taken. The table below provides the latest age at which RMDs must commence.
Roth accounts:
Roth accounts offer tax-free growth, and qualified withdrawals are tax-free. Roth IRAs are among the most tax-efficient savings vehicles, except for health savings accounts. Following the principle mentioned earlier, prioritize allowing Roth accounts to accumulate over time due to their efficient growth potential. Moreover, the SECURE Act has made Roth IRAs practical legacy transfer tools, as beneficiaries can receive tax-free disbursements, and withdrawals can often be deferred for up to 10 years after the account holder’s death.
It’s worth noting that the SECURE 2.0 Act has eliminated minimum distribution rules for all Roth accounts, enabling the possibility of never withdrawing from these accounts. This can result in intelligent tax planning for the benefit of your children, although some may prefer enjoying their savings while alive.
Understanding the order of retirement account withdrawals is crucial for maximizing your income and optimizing tax efficiency during your retirement years. By following the suggested order of cash, taxable accounts, Social Security, pre-tax retirement accounts, and Roth accounts, you can make informed decisions about which accounts to tap into first. Individual circumstances may vary, so it’s always wise to consult with a financial advisor to create a personalized retirement withdrawal strategy that aligns with your specific goals and needs.
