How to plan your retirement withdrawal strategy: The smart order for maximum returns
When it comes to dipping into your retirement savings, the order you withdraw from your accounts matters. Why? Because each type of retirement savings comes with its own set of withdrawal rules and tax requirements.
While there’s no one-size-fits-all withdrawal strategy, here’s a smart rule of thumb to follow: Take your required minimum distributions (RMDs) if you’re 73 or older — simply because they’re mandatory. Next, withdraw from your taxable accounts at your brokerage or investment platform, which gives your tax-advantaged accounts more time to grow. After that, tap into your tax-deferred accounts like traditional 401(k)s or IRAs. Finally, leave your Roth accounts for last, since they grow tax-free and you’ll want to give them as much time as possible.
Let’s dive into why this paydown strategy makes sense for many retirees and factors that can affect the order you follow.
In what order should you use your retirement funds?
A simple yet wise strategy to follow is to approach your retirement funds in the following order:
1. Take the required minimum distributions (RMDs)
Once you hit 73 or older, you’re required by the Internal Revenue Service (IRS) to withdraw a certain amount from most retirement accounts each year, including traditional 401(k)s and traditional IRAs. These are your required minimum distributions — or RMDs.
Planning to tap into your retirement accounts that require RMDs helps you dodge some hefty penalties. Fines range from 10% to 25% of the required distribution you didn’t take in time, which could really put a dent in your retirement funds. So, even if you don’t need the money, it’s smart to take out your RMDs to help your retirement savings last longer.
2. Withdraw from your taxable accounts
If you’ve already taken care of your RMDs or you’re not yet 73, your next stop should be your taxable accounts. These are your accounts at brokerages or investment platforms you’ve used to invest in stocks, bonds, mutual funds and other assets.
The money in your taxable accounts doesn’t get any special tax perks: You’ve already paid income tax before investing since it’s post-tax income, and you’ll owe capital gains tax on any profits when you sell your assets. But these taxable accounts give you more flexibility since they don’t have penalties for taking money out early.
This makes them a great option to tap into if you plan to retire early. Plus, you pay lower taxes on assets you’ve held in your taxable account for more than a year. So, try to cash out these assets first to take advantage of those lower long-term capital gains taxes.
Dig deeper: Tax breaks after 50 you might not know about
3. Tap into your tax-deferred savings
Next up are the retirement funds you’ve got in traditional 401(k) or traditional IRA accounts. When you put money into these accounts, a perk is postponing paying taxes until you start taking money out. This ability to defer taxes allows your retirement savings to grow tax-free over time.
You can tap into these accounts penalty-free once you’re 59 1/2 or older. Before that, you’ll face a 10% early withdrawal penalty. That’s a big reason why using your taxable accounts first makes more sense.
Any funds you take out of your tax-deferred accounts get taxed as ordinary income. This income falls into different tax brackets, each with its own tax rate.
You can optimize your withdrawal rate by taking out just enough to maximize your current tax bracket without going into a higher one. This strategy is called bracket management, and it’s a smart way to stretch your retirement funds and minimize your tax burden.
But keep in mind that the IRS requires you to take out required minimum distributions (RMDs) once you’re 73 or older. So plan ahead for the impact your RMDs can have on your tax bracket.
Dig deeper: 401(k) withdrawal rules: What to know before cashing out — and how to avoid penalties
4. Use your Roth accounts
Finally, it’s time to tap into your Roth accounts, which includes Roth IRAs and Roth 401(k)s. The funds in these accounts are the cherry on top of your retirement savings. That’s because you’ve already paid taxes on this money, so you won’t pay any additional taxes when you take it out in retirement.
This tax-free status applies to the original amounts you add to your Roth accounts as well as growth over time. That’s why it’s best to leave these funds untouched as long as possible to let them grow without any tax burden, potentially giving you a larger nest egg down the road. Plus, if you end up not needing the money during your lifetime, you can leave your Roth accounts to your loved ones as a tax-free inheritance.
Remember that, unlike traditional retirement accounts, Roth IRAs don’t require minimum distributions during your lifetime. Starting in 2024, the same rule applies to Roth 401(k)s.
3 factors that can change your retirement fund withdrawal strategy
Your current and future tax brackets, retirement goals, market conditions and additional factors can all play a role in defining your best strategy for tapping into your retirement savings.
1. Your current and future tax brackets
Where you fall on the tax bracket ladder now and where you might be in the future can help shape your withdrawal strategy. This is especially true for withdrawals from taxable brokerage accounts, traditional 401(k)s and traditional IRAs since they increase your tax liability.
For example, if you expect to be in a higher tax bracket later, it might make sense to tap into these accounts now while your tax bracket is lower. On the other hand, if you think you’ll be in a lower tax bracket down the road, you might want to hold off on those withdrawals as long as they aren’t required.
Dig deeper: What to consider when downsizing for retirement
2. Retirement goals
You might have a retirement dream in mind, from traveling the world to starting a garden to enjoying beautiful days with your grandchildren. Your retirement goals can shape your withdrawal strategy.
If you plan on buying an RV or a boat early in retirement, you might need to make bigger withdrawals early on. But if you’re aiming for a steady lifestyle, you could spread your withdrawals more evenly.
Then there’s the legacy you leave behind, which influences which accounts you tap first. For example, Roth accounts are a great vessel for passing on tax-free assets to your loved ones, while traditional IRAs and 401(k)s are better used during your lifetime.
Dig deeper: How to budget in retirement and maintain your finances on a fixed income
3. Market volatility
At least a portion of your retirement funds might be invested in the stock, bond or mutual fund market. This means that economic ups and downs can change the impact of each withdrawal you make.
For example, you might want to avoid making larger withdrawals during downturns to avoid selling assets at a low price. But you could feel more comfortable taking out more money when the market is riding high.
That’s why it helps to keep your eye on market conditions even after you retire to know when and where to draw your retirement income from.
How much should you save for retirement?
How much you save for retirement depends on your needs when the time comes to retire. Consider your current expenses now and remember that, generally, many retirement experts suggest you’ll spend upward of 80% of your pre-retirement income when you retire.
If you’re unsure, use a calculator to see if you’ve saved enough or are on the right track to save enough before your eventual retirement. If not, adjust your savings plan to max out your IRA and, if possible, your employer-sponsored 401(k). While an employer match is nice, not everyone has that opportunity at work. Still, you should try to put as much as possible into your retirement accounts while you still can.
Remember that as you get closer to retirement, your portfolio should be less risky. Consider safer assets in your investment strategy. If stocks made up most of your portfolio when you were in your 40s and 50s, you might drop that to 30% to 50% of your portfolio when you’re in retirement.
Markets shift and change constantly. Even if you’re taking money out of your retirement accounts in a down year, having safer asset allocation means you’ll lose less if the market takes a turn when you’re set to take distributions.
Dig deeper: How to invest your money after retirement — and make it last through your golden years
How much to withdraw during retirement: The 4% rule of thumb
Figuring out how much to take out during retirement isn’t always easy. The 4% rule was designed to help retirees make regular withdrawals without running out of money.
The 4% rule says to take out 4% of your tax-deferred accounts — like your 401(k) — in your first year of retirement. Then every year after that, you increase your retirement withdrawals by the previous year’s inflation rate.
Say you have $1 million in your accounts for retirement. In the first year of your retirement, you’d withdraw $40,000. If inflation were up 3% that year, you’d multiply that by the amount you took out the first year — $40,000 — and you get $1,200. That means in year 2, you’d withdraw $41,200. If inflation were up another 3%, you’d take out $42,436 in year 3. And you’d do this annually to calculate how much to withdraw every year.
While the 4% rule is more of a guideline and less of a stringent rule, it’s a good idea to use this as a way to measure how to make responsible withdrawals in retirement. You might need to work out your math differently based on your retirement income needs and how much you’ve saved — you might find that a 3% rule works just fine for you or you prefer to boost it to 6% to cover all your bases.
Dig deeper: The 4% rule for retirement: Is it time to rethink this popular withdrawal guideline?
FAQs: Tapping into retirement savings
How can I tell if my retirement nest egg is big enough?
Everyone’s retirement needs are different, so what you have in your account might be enough to cover all your needs. You’ll be able to tell if your retirement nest egg is big enough by calculating your expected retirement income and what your expected retirement spending is. If your income is higher than your expenses, you may have enough. But if you’re coming in the negative, you may still need to save more, earn more or find ways to cut expenses.
How long will $1 million last in retirement?
For many folks, $1 million is how much we’ve been told to save for retirement. But where you live and your lifestyle greatly affect how you’ll spend that $1 million. If you live in a high cost-of-living area or you have health concerns that require assisted living, a home health aide or expensive medication, you might go through that amount of money quickly. If you live in a lower cost-of-living area and you’re relatively healthy, it may take you longer to go through that money.
Sources
Capital gains and losses. IRS. Accessed September 9, 2024.
Retirement plan and IRA required minimum distributions FAQs. IRS. Accessed September 9, 2024.
About the writers
Yahia Barakah is a personal finance writer at AOL with over a decade of experience in finance and investing. As a certified educator in personal finance (CEPF), he combines his economics expertise with a passion for financial literacy to simplify complex retirement, banking and credit topics. He loves empowering people to make informed financial decisions that improve their everyday and long-term wellness. Yahia's expertise has been featured on FinanceBuzz, FX Empire and EarnForex. Based in Florida, he balances his love for finance with freediving, hiking and underwater photography.
Dori Zinn is a personal finance journalist with more than a decade of experience covering credit, debt, investing, real estate, student loans, college affordability and personal loans. Her work has been featured in the New York Times, the Wall Street Journal, Yahoo, Forbes and CBS News, among other top publications. She loves helping people learn about money.
Article edited by Kelly Suzan Waggoner