How to Plan Your Retirement Withdrawal Strategy

After spending decades saving for retirement, you may feel a little uneasy when it comes time to start withdrawing and living off that money. What can you do to make it last? You may be surprised to learn that tapping your assets in the right order can make a big difference on that front.

"Not all investments are subject to the same tax treatment," explains Hayden Adams, CPA, CFP®, and director of tax planning at the Schwab Center for Financial Research. "And by liquidating them in the most tax-efficient way possible, you may be able to extend the life of your savings."

Following this order can help:

Anyone turning 73 between 2023 and 2032 will need to take required minimum distributions (RMDs) from their 401(k), individual retirement account (IRA), and other tax-deferred retirement accounts or face up to a 25% penalty on the difference between what was required and what they withdrew. The RMD starting age will rise to 75 in 2033.

"Because of the penalty, RMDs should be your first stop when tapping your retirement portfolio," Hayden says.

Withdrawals from such accounts will be taxed as ordinary income, assuming all the contributions were made on a pre-tax basis. So, if you don't need this money to cover your living expenses, consider investing it through a taxable brokerage account. Any potential gains could help offset some of the tax hit.

Next, withdraw any interest and dividends generated by investments in your taxable accounts. Interest is taxed as ordinary income (unless it's from a tax-free municipal bond or municipal-bond fund). Dividends, on the other hand, are often taxed at the lower long-term capital gains rates of 0%, 15%, or 20% (depending on your income level, how long you've held the asset, and other requirements).

Withdrawing just the interest and dividends means maintaining your original investment, which can then potentially grow, generating more dividends and interest in the future.

If you still need cash, you could tap the principal from a maturing bond or CD next. Generally speaking, you won't owe taxes on the principal, as long as you hold the bond or CD until maturity.

If you don't need the money when your bond or CD matures, consider reinvesting the principal in another bond or CD as part of a laddering strategy to help generate regular income.

If you still don't have enough to cover your expenses, you'll need to sell additional assets—but which ones may depend on your tax situation.

If you have modest tax-deferred savings and your RMDs aren't likely to push you into a higher tax bracket later in retirement, turn to your taxable brokerage accounts. Consider selling investments that have lost value, as you can use capital losses to get a tax break on your capital gains. And if you have excess losses, you can use up to $3,000 of those losses to offset your ordinary income. Then focus on investments you've held for more than a year to take advantage of long-term capital gains tax rates, which are lower than the income tax rates that apply to short-term capital gains.

If you have significant tax-deferred savings and suspect RMDs from these accounts could push you into a higher tax bracket later in retirement, you may want to consider withdrawing from your tax-deferred accounts once you reach age 59½.

"This strategy can help smooth out the potential spike in income caused by RMDs, which may reduce your total taxes paid in retirement," Hayden says.

It's generally best to delay tapping Roth IRA assets for as long as possible, because such accounts aren't subject to RMDs and withdrawals are entirely tax-free starting at age 59½, assuming you've held the account for at least five years. Plus, if you leave a Roth IRA to an heir, their withdrawals will also be tax-free.

Unlike Roth IRAs, Roth 401(k)s are subject to RMDs for 2023—so if you have one, it could make sense to roll it into a Roth IRA. But be aware that this could reset the five-year holding requirement unless the Roth 401(k) funds are rolled into an existing Roth IRA. That said, the RMD rule for Roth 401(k)s disappears beginning in 2024 due to the changes within SECURE 2.0 Act. Regardless, if you're considering a rollover, it's always a good idea to check with a financial advisor before you act.