For retirees with assets spread across various buckets, from taxable investment accounts to Roth IRAs, Fidelity recommends a proportional withdrawal approach that relies on all of your accounts at the start of retirement. Rather than withdrawing assets from one account at a time, Fidelity found that proportionally withdrawing money from each of your accounts simultaneously can extend the lifespan of your savings by reducing the taxes you pay throughout retirement.
A financial advisor can help you withdraw your retirement assets in a tax-efficient manner and provide other retirement advice. SmartAsset can help you find advisors who serve your area today.
This Common Withdrawal Strategy May Be Costing You
As Fidelity notes, tax professionals often recommend withdrawing assets from taxable accounts first, followed by tax-deferred accounts like traditional 401(k)s and IRAs, followed by Roth IRAs last. This strategy allows your Roth assets to continue to grow tax free, since Roth IRAs are not subject to required minimum distributions.
But this approach of withdrawing assets from one account at a time can result in what Fidelity calls a “tax bump” in the middle of retirement.
Consider Joe, a hypothetical retiree with $200,000 in a taxable brokerage account, $250,000 in a traditional 401(k) and $50,000 in a Roth IRA. The retiree must generate $60,000 worth of after-tax retirement income to meet his spending needs. He collects $25,000 in annual Social Security benefits, and as a result, must withdraw approximately $35,000 from his various accounts.
If the retiree relies on the traditional approach of withdrawing assets from one account at a time, starting with his taxable investment accounts, he’ll largely avoid taxes through his first seven years of retirement. That’s because his income will be low enough that he won’t pay long-term capital gains taxes on withdrawals from his brokerage account. But that won’t last.
After exhausting the assets in his brokerage account, Joe begins drawing down his traditional 401(k) accounts. However, he must pay income taxes on these withdrawals. As a result, he’ll pay approximately $66,000 in income taxes over the next 12 years of retirement, according to Fidelity’s analysis. At this pace, Joe’s traditional 401(k)s will be tapped out halfway through his 19th year of retirement. From there, his Roth IRA assets will last him about four more years.
Proportional Withdrawals: A Tax-Savvy Alternative
Fidelity says there’s a more tax-efficient alternative for Joe and retirees like him. Taking withdrawals from all three sources spreads out Joe’s tax liability and slightly extends the life of his portfolio by one year.
Following this approach, Joe would withdraw approximately $15,000 per year from his taxable account in the first 23 years of retirement. At the same time, he would withdraw around $18,000 from his traditional 401(k) each year, while also supplementing those withdrawals with another $4,000 from his Roth IRA.
While this strategy would result in Joe paying taxes practically every year he’s retired, it would dramatically reduce his tax liability compared to the more traditional withdrawal strategy. Instead of paying an estimated $65,988 in taxes during the middle portion of retirement, Joe would pay just $41,398 in estimated taxes throughout his entire retirement. That’s a 37% reduction in his tax bill!
For retirees with assets spread across multiple accounts, including taxable brokerage accounts, traditional 401(k)s and Roth IRAs, Fidelity found that a proportional withdrawal strategy can limit your tax liability and make your savings go farther. This approach relies on making withdrawals from each of your accounts simultaneously based on that account’s percentage of your overall savings.
Retirement Planning Tips
- Planning for retirement can be complicated and overwhelming. A financial advisor can help you make important financial decisions related to your retirement plan. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Tracking your progress toward reaching a savings goal is critical. SmartAsset’s Retirement Calculator can help you estimate how much you’ll have in savings when the time comes to retire and getting a better sense of where you stand.
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