For clients approaching or in retirement, the order in which money is drawn from different accounts is one of the largest levers available — and it is a decision that has to be made in advance rather than reported afterwards.
The three buckets
- Taxable — brokerage accounts and cash. Withdrawals are not income; only realised gains are, and long-term gains get preferential rates.
- Tax-deferred — traditional IRA and 401(k). Every dollar out is ordinary income.
- Roth — qualified withdrawals are tax free.
Why the conventional order is not always right
The received wisdom is taxable first, then tax-deferred, then Roth. That maximises deferral, and deferral is not always the goal.
The problem it creates: a large tax-deferred balance eventually becomes required minimum distributions, and those are ordinary income whether you need the money or not. A retiree who spent a decade in a low bracket living off taxable accounts can find RMDs pushing them into a much higher bracket later — and taking a surviving spouse into single filer brackets after a death.
The years between retiring and RMDs
These are frequently the most valuable planning years anybody has. Earned income has stopped, RMDs have not started, and taxable income can be unusually low.
That creates room to deliberately fill lower brackets — either by drawing from tax-deferred accounts at a low rate, or by converting some of that balance to Roth and paying the tax at today's lower rate rather than tomorrow's higher one.
Doing nothing in those years is a decision too, and frequently an expensive one.
What else the number affects
Taxable income in retirement does not only drive income tax:
- How much of Social Security is taxable.
- Medicare premium surcharges, which are based on income from two years earlier and which step up sharply at thresholds.
- Capital gains rates, which depend on total taxable income.
- Eligibility for various credits and deductions.
Crossing a threshold by a small amount can cost a disproportionate amount, which is why the planning is worth doing precisely rather than approximately.
What to do
Model it before you need it. The right sequence depends on the size of each bucket, the expected bracket now versus later, whether there is a legacy objective, and health and longevity expectations. It is genuinely individual, and it is not something to work out in the year you need the money.
This article is general information, not tax advice, and tax rules change from year to year. Confirm current-year figures and talk with a professional about your specific situation before acting.
Common questions
Should I always spend taxable accounts first in retirement?
Not necessarily. Doing so maximises deferral but can leave a large tax-deferred balance that produces required minimum distributions at a higher rate later — and pushes a surviving spouse into single brackets. The right sequence depends on the size of each bucket and expected brackets.
What are the best years for Roth conversions?
Frequently the years between stopping work and starting required minimum distributions, when taxable income is unusually low. Converting during those years pays tax at a lower rate than the RMDs would later, and it reduces the future RMD.
Does retirement income affect Medicare premiums?
Yes. Medicare premium surcharges are based on income from two years earlier and they step up sharply at thresholds. Crossing one by a small amount can cost a disproportionate amount, which is why the planning needs to be precise.
Have a question about your situation?
Robert prepares returns for individuals, contractors, and small business owners across Weatherford, Aledo, Willow Park, Springtown, Mineral Wells, and the rest of Parker County. Bring your questions — the first conversation is free.