Retirement withdrawal strategies
February 22, 2022
You have spent your entire career working and saving for retirement and now retirement is here. If you have several retirement accounts, how do you choose from which to draw?
Should I delay paying taxes on my retirement savings?
Conventional wisdom might say to delay paying taxes as long as possible and to always take funds from the source with the least tax impact. This could make sense for you depending on your lifestyle and goals. The time value of money principle says that delaying taxes is beneficial.
Some of your retirement accounts may be tax-deferred, such as traditional IRA or 401(k) accounts. Withdrawals from those accounts are taxed at your highest marginal rate.
A Roth IRA (assuming you follow the applicable rules) provides tax-free withdrawals, as well as a health savings account (HSA) when you use it to cover qualified medical expenses.
Appreciated taxable investments in your other retirement savings accounts are taxed at preferential capital gains rates as long as they are held for at least a year and a day.
Should I pay taxes on my retirement savings up front?
In other cases, it might make sense to pay some additional taxes now to reduce taxes down the road. For example, if you're in a relatively low tax bracket in retirement but are not yet age 72, it might make sense to convert some of your traditional IRA money to a Roth IRA. This will cause an added immediate tax liability but can remove the need to take Required Minimum Distributions (RMDs) from that account during your lifetime. If you don’t need the RMD money to support your lifestyle, this allows more money to remain invested. If you do, the withdrawals will no longer increase your taxable income.
If you're still working when you reach retirement age and are in a higher bracket than you will be later, try to limit yourself to taking withdrawals from your tax-free savings, such as a Roth IRA. The tax bite on your taxable funds will be lower when you earn less, and your bracket drops. For example, if you move from the 32% bracket to the 24% tax bracket, a $10,000 withdrawal from a traditional IRA will rise from $6,800 (the net amount you’ll receive) to $7,600 - an $800 difference.
If it's not an RMD, try to keep out of your taxable retirement savings for as long as you're in a higher bracket.
Don't take lightly the way you withdraw from retirement savings. There can be significant tax advantages to taking withdrawals from one account over another, and the most appropriate order of withdrawal can vary based on your circumstances at various stages of retirement.
Old Dominion Capital Management (ODCM) is headquartered in Charlottesville, VA and is a division of Dixon, Hubard, Feinour & Brown, Inc. (DHFB). DHFB is a wholly subsidiary of Atlantic Union Bank and an SEC registered, fee-only investment adviser based in Roanoke, VA. ODCM provides this for informational purposes only. It does not constitute or form part of any offer to issue or sell, or any solicitation of any offer to subscribe or to purchase, shares, units or other interests in investments that may be referred to herein and must not be construed as investment or financial product advice. ODCM has not considered any reader's financial situation, objective or needs in providing the relevant information. Any opinions provided herein should not be relied upon for investment decisions.