How to Plan Your Retirement Withdrawal Strategy

After you’ve built up your retirement savings over decades, the idea of withdrawing that money may make you uneasy. However, by tapping the right assets at the right time, you can make that process as painless as possible.

“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.”

Here’s what to tap when.

1. Start with your RMDs

If you turned 70½ before or during 2019, you’ll need to take required minimum distributions (RMDs) from your 401(k), individual retirement account (IRA), and other tax-deferred retirement accounts once the 2020 RMD waiver due to COVID-19 is lifted. Failure to do so could mean getting hit with a 50% penalty on the difference between what was required and what you withdrew. If you turn 70½ in 2020 or later, your RMDs won’t kick in until age 72, thanks to the SECURE Act of 2019.

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

Whatever you withdraw from these accounts will be taxed as ordinary income, if all of your contributions were made pre-tax. So if you don’t need this money to cover your living expenses, consider depositing and investing it into a taxable brokerage account, where you could potentially generate gains.

2. Tap interest and dividends

The next stop is withdrawing any interest and dividends generated from 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.

3. Cash out maturing bonds and certificates of deposit (CDs)

If you need cash after exhausting your first two options, 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.

4. Sell additional assets as needed

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. Sell those investments that have lost value first, to offset any gains you may realize. Then sell those investments you’ve held for more than a year to take advantage of lower long-term capital gains tax rates.
  • If you have significant tax-deferred savings and suspect RMDs from these accounts could push you into a higher tax bracket later in retirement, start withdrawing from your tax-deferred accounts. “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.

5. Save your Roth IRAs for last

Consider tapping Roth IRAs last, since they’re not subject to RMDs and withdrawals are entirely tax-free starting at age 59½, if you’ve held the account for at least five years. If you leave your Roth IRA to an heir, their withdrawals will also be tax-free.

Unlike Roth IRAs, Roth 401(k)s are subject to RMDs—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. If you’re considering a rollover, it’s always a good idea to check with a financial advisor before you take action.