How To Take Money Out Of Your Accounts In Retirement
September 22, 2016Updated April, 2018
We typically spend most of our working life putting money in accounts for retirement, but how do we take them out after we retire? I recently received a question from a “long time reader, first time caller,” about how to order which accounts he will withdraw from when he retires soon. The conventional wisdom is to withdraw money first from taxable accounts, then tax-deferred accounts, and then tax-free accounts in order to allow your money to grow tax-deferred or tax-free as long as possible. However, there are a few other things you might want to consider too:
Will you need to purchase health insurance before you’re eligible for Medicare at 65? If so, your eligibility for subsidies under the Affordable Care Act is partly based on your taxable income. In that case, you might want to tap money that’s already been taxed like savings accounts and money that’s tax-free like Roth accounts to maximize your health insurance subsidy (but not so low that you end up on Medicaid instead). You can use this calculator to estimate what that amount would be.
Are you collecting Social Security yet? Withdrawing from tax-free Roth accounts can also reduce the taxes on your Social Security. That’s because the amount of your Social Security that’s taxable (either 0, 50%, or 85%) depends on your overall taxable income plus nontaxable interest (like muni bonds) but not tax-free Roth withdrawals.
How can you minimize your tax rate? First, you’ll want to withdraw (or convert to a Roth) at least about $12k a year from your pre-tax accounts because the standard deduction makes that income tax-free. If you have other deductions, you may be able to have even more tax-free income. Then take a look at the tax brackets and see how much income you can withdraw before going into a higher bracket.
For example, a married couple’s first $19,050 of taxable income is only taxed at 10%, with the next $58,350 is taxed at 12% according to 2018 tax brackets. Any long term capital gains at those levels are taxed at 0%. If you’re about to go into a higher bracket, you may want to use tax-free income to avoid those higher rates. Just keep in mind that pensions and taxable Social Security (see above) will also count as income in determining your tax bracket.
How do you put it all together? Your withdrawal strategy may change and adjust based on the situation. You may tap into savings accounts (including your HSA) and sell taxable investments to maximize your health insurance credits until 65. Then you may withdraw from taxable accounts until you collect Social Security benefits at age 70, which draws down your required minimums at 70 1/2 while maximizing your Social Security payment. At that point, you can continue withdrawing from your taxable accounts to fill in the lower tax brackets and then use tax-free accounts to avoid the next tax bracket.
Of course, this all assumes that you have investments in multiple types of tax accounts. Otherwise, it doesn’t really apply to you. But if you do, you might want to consult with a qualified and unbiased financial planner to help you sort it out and come up with the right strategy. If your employer offers that as a free benefit, it might be a good place to start.