Retirement Withdrawal Strategies: How to Make Your Money Last

One of the most consequential -- and least discussed -- retirement decisions is the order in which you withdraw money from your various accounts. Get it right and you can significantly reduce your lifetime tax bill, lower your Medicare premiums, and make your money last years longer.

Most retirees have assets in three types of accounts, each with different tax treatment:

Taxable accounts (brokerage accounts, savings): You've already paid income tax on contributions. Growth is taxed as capital gains (lower rates). Withdrawals of principal are tax-free.

Tax-deferred accounts (traditional IRA, 401(k), 403(b)): Contributions were pre-tax. All withdrawals are taxed as ordinary income. Subject to Required Minimum Distributions starting at age 73.

Tax-free accounts (Roth IRA, Roth 401(k)): Contributions were after-tax. Qualified withdrawals are completely tax-free. No RMDs during the owner's lifetime.

The traditional advice is to withdraw from taxable accounts first, then tax-deferred, then Roth last (to let the Roth grow tax-free as long as possible).

This approach makes sense in some situations -- but it can result in massive RMDs later in retirement that push you into high tax brackets and trigger IRMAA surcharges on Medicare premiums.

A more sophisticated strategy is to manage your taxable income each year to stay in the most favorable tax brackets.

In your early retirement years (before RMDs begin):

• Take some withdrawals from traditional IRA/401(k) to fill lower tax brackets
• Consider Roth conversions to reduce future RMD burden
• Use taxable account withdrawals to supplement income as needed

The goal: Prevent your traditional IRA from growing so large that RMDs force you into high brackets at 73+.

Converting traditional IRA funds to a Roth IRA in your early retirement years -- before Social Security, before RMDs, when your income is relatively low -- is one of the most powerful tax strategies available to retirees.

Benefits of Roth conversions:

• Reduces future RMDs (smaller traditional IRA = smaller mandatory withdrawals)
• Reduces future taxable income (which affects Social Security taxation and IRMAA)
• Creates tax-free income for later in retirement
• Leaves tax-free assets to heirs

The cost: You pay income tax on the converted amount in the year of conversion. The key is to convert enough to fill your current tax bracket without jumping into a higher one.

Medicare IRMAA surcharges are based on your income from two years prior. Large traditional IRA withdrawals or Roth conversions can push you into a higher IRMAA bracket, increasing your Medicare Part B and D premiums.

2017 IRMAA thresholds: Individual income above $85,000 triggers the first surcharge tier. Plan your withdrawals and conversions to stay below the relevant thresholds.

The "4% rule" suggests withdrawing 4% of your portfolio in the first year of retirement, then adjusting for inflation each year. Research suggests this approach has a high probability of lasting 30 years.

However, the 4% rule:

• Doesn't account for taxes (your actual spendable income is less than 4% of a tax-deferred account)
• Doesn't account for variable spending (most retirees spend more in early retirement, less in middle retirement, more again in late retirement for healthcare)
• Was developed for a 60/40 portfolio in a higher interest rate environment

Use the 4% rule as a starting point, not a rigid rule.

Delaying Social Security while drawing down traditional IRA funds is a powerful combined strategy:

• Reduces traditional IRA balance (and future RMDs)
• Increases Social Security benefit (8%/year from FRA to 70)
• Social Security is partially tax-free (up to 15% is always tax-free)
• Social Security is inflation-adjusted for life

For many retirees, this "bridge strategy" -- living on IRA withdrawals from 62-70 while delaying Social Security -- produces the best lifetime financial outcome.

This article is for educational purposes only and does not constitute financial or legal advice. Consult a financial advisor for personalized guidance.