How to Withdraw Savings During Retirement

A lot has been written about how much money Americans can withdraw from their investments to fund their retirement years. The following list, which I call a “Withdrawal Hierarchy”, outlines the order in which money could be withdrawn from various tax-deferred and taxable investment accounts. The idea was first proposed by the Fidelity Research Institute a number of years ago, with modifications made courtesy of other financial planning experts through the years.
1. Take your minimum required distributions (RMDs) from qualified accounts and IRAs. If you are age 70½ or older, make sure you know which of your accounts require such distributions and how large those distributions need to be, and then meet the requirements and deadlines, avoiding the application of the 50 percent income tax penalty that will be assessed if you fail to make timely withdrawals of required distributions.
2. Liquidate loss positions in taxable accounts. Some investments in your taxable accounts may be worth less than their tax basis (what you invested). In addition to offsetting realized (sold) losses against realized gains, at the federal level you can usually use up to $3,000 ($1,500 for married couples filing separately) of net losses each year to offset ordinary income including interest, salaries, and wages. Unused losses can be carried forward for use in future years.
3. Sell assets in taxable accounts that will generate neither capital gains nor capital losses. Such assets generally include cash and cash-equivalent investments (CDs, money market funds, short term bonds under one year) as well as capital assets, which have not increased in value. If your withdrawals from this tier in the hierarchy largely come from cash-equivalent investments, keep sufficient liquid assets intact in order to cover short-term financial emergencies. And be especially mindful of portfolio rebalancing issues.
4. Withdraw money from taxable accounts in relative order of basis (cost). The choice depends on the circumstances. For most retirees, capital gains rates are lower than ordinary income tax rates and generally, liquidating taxable capital assets first would be beneficial. Be aware of accumulating significant capital gains.
5. Withdraw money from tax-deferred accounts funded with deductible (or pre-tax) contributions such as 401(k)s and Traditional IRAs, or tax-exempt accounts such as Roth IRAs. It may not make much difference which account you tap first within this category since all withdrawals from any tax-deferred accounts funded with fully deductible (or pre-tax) contributions are taxed at the same rate. When withdrawing money from tax-deferred accounts funded with fully deductible (or pre-tax) contributions, you may wish to request that taxes be withheld.
Estate planning considerations may also significantly impact the entire hierarchy. Remember, capital assets receive a step-up in basis at death, while qualified and tax deferred assets are considered to contain “income in respect of a decedent” and do not receive a step-up. A number of other issues may also have an effect on the recommended order of withdrawal, such as the retiree’s income approaches the threshold of paying taxes on Social Security income. It may make more sense to leave your Roth account intact if you thought your ordinary income tax rate was likely to rise in later years, increasing the value of the Roth’s tax exemption.
*This article is for general information only and is not intended to provide specific advice or recommendations for any individual. Consult your financial advisor, attorney or tax advisor with regard to your personal situation. Past performance does not guarantee future returns and your actual results may vary.