Retirement Income Tax Planning: Which Accounts to Draw From First

Quick Answer

The optimal withdrawal order depends on your situation, but generally: (1) Taxable brokerage accounts first (capital gains taxes only), (2) Traditional IRA/401(k) (ordinary income tax), (3) Roth IRA (tax-free). This keeps your AGI (affecting Social Security taxation and Medicare IRMAA surcharges) as low as possible in early retirement, then allows larger traditional withdrawals later when other income sources activate.

Why Withdrawal Order Matters

Different account types have different tax consequences:

• Taxable brokerage: Capital gains taxed at favorable rates (0%, 15%, 20%); principal withdrawal is tax-free.
• Traditional IRA/401(k): Fully taxable as ordinary income.
• Roth IRA: Tax-free.

Your withdrawal sequence affects:

1. Federal income tax: Rate depends on account type and bracket.
2. Social Security taxation: Up to 85% of benefits taxable if combined income exceeds thresholds.
3. Medicare IRMAA surcharges: Premiums increase if MAGI exceeds thresholds.
4. State income tax: Varies by state (some don't tax retirement income).

Example: Retiree spending $60,000/year.

• Strategy A (withdraw from traditional IRA): MAGI = $60,000. Social Security taxation applies; IRMAA surcharges triggered.
• Strategy B (withdraw from Roth): MAGI = $0. No Social Security taxation; no IRMAA surcharges. Same $60,000 spending.

Strategy B saves $8,000–$15,000/year in taxes and premiums.

The Three-Account Framework

Most retirees have:

1. Taxable brokerage (regular investment account).
2. Traditional account (IRA, 401(k)).
3. Roth account (Roth IRA, Roth 401(k)).

Optimal withdrawal order: Taxable → Traditional → Roth.

Rationale:

• Taxable first: Capital gains taxes are lower than ordinary income tax; delays Roth for maximum tax-free growth.
• Traditional second: Once you've paid capital gains taxes, use traditional for remaining needs.
• Roth last: Preserve for flexibility in later years; never pay taxes on Roth withdrawals.

Withdrawal Sequencing Example

Retiree, age 70, spending $80,000/year:

• Taxable brokerage: $300,000.
• Traditional IRA: $500,000.
• Roth IRA: $200,000.
• Social Security: $40,000/year (doesn't require withdrawal; automatic).

Year 1 withdrawal plan (age 70):

1. Social Security: $40,000 (automatic).
2. Needed from accounts: $80,000 - $40,000 = $40,000.
3. Withdraw $40,000 from taxable brokerage.
4. AGI: ~$40,000 (capital gains or qualified dividends).
5. Impact: Minimal Social Security taxation, no IRMAA surcharge.

Year 5 (age 75), if taxable account is depleting:

1. Social Security: $40,000.
2. Needed: $40,000.
3. Withdraw $40,000 from traditional IRA.
4. AGI: ~$80,000 (ordinary income).
5. Impact: Some Social Security taxation kicks in (~$15,000 becomes taxable).

This sequencing keeps early retirement taxes low, then accepts higher taxes later.

Special Case: Large Pensions

If you have a pension (which starts automatically), it affects withdrawal sequencing:

Example: Retiree with $50,000/year pension, $30,000 Social Security, need $80,000/year total.

• Pension + Social Security: $80,000 (exactly covers spending).
• Withdraw $0 from retirement accounts initially.
• Delay touching traditional IRA and Roth (maximize tax-free growth).
• At 80, if health costs spike, withdraw from Roth (tax-free).

The pension and Social Security cover living expenses, allowing retirement accounts to grow untouched longer.

Roth Conversion Ladder Withdrawal

Some retirees use Roth conversion ladder strategy:

Years 1–4 (before accessing traditional IRA):

1. Withdraw from traditional IRA → taxable conversion.
2. Move funds to Roth conversion account.
3. Pay tax on conversion (but low income years, so low tax rate).

Years 5+ (5-year rule met):

1. Withdraw from Roth conversion account tax-free/penalty-free.
2. Use for spending.

This lets early retirees access pre-tax retirement money at low tax rates, then withdraw it tax-free after the 5-year seasoning period.

Example: Retire at 50, need $50,000/year from IRAs.

• Ages 50–54: Convert $50,000/year from traditional to Roth at low tax rate (~10% = $5,000 tax).
• Ages 55–59: Withdraw $50,000/year from Roth conversions (tax-free).
• Age 59.5+: Can withdraw from original IRA directly without penalty, or continue conversions.

This strategy is complex but powerful for early retirees.

Tax Bracket Optimization

Withdraw strategically to "fill up" lower tax brackets:

Example: Retiree's taxable income is $47,150 (end of 22% bracket). Can withdraw $10,000 more while staying in 22%, then the next dollar moves to 24% bracket.

• Withdraw $10,000 from taxable account (capital gains taxed at 15% = $1,500).
• Compare to withdrawing $10,000 from traditional IRA (taxed at 22% = $2,200).
• Tax savings: $700 by choosing the right account.

Use tax software or a CPA to model different withdrawal scenarios.

Social Security and Withdrawal Strategy

Social Security is partially taxed if combined income exceeds:

• $25,000 (single).
• $32,000 (married filing jointly).

Formula: Combined income = AGI + 50% of Social Security + tax-exempt interest.

Strategy: Keep AGI below $25,000 in early retirement to avoid Social Security taxation.

Example: Single, age 70, receiving $40,000 Social Security, spending $50,000/year.

• Option A: Withdraw $50,000 from traditional IRA.

  • AGI = $50,000.
  • Combined income = $50,000 + 0.5 × $40,000 = $70,000.
  • Taxable SS = min($40,000, $15,000 × 0.5 + 0.85 × ($70,000 - $34,000)) = ~$34,600 (roughly 86% of SS taxable).

• Option B: Withdraw $50,000 from Roth IRA.

  • AGI = $0.
  • Combined income = $0 + 0.5 × $40,000 = $20,000 (below $25,000 threshold).
  • Taxable SS = $0 (no Social Security taxation).

Tax savings: ~$8,000/year ($34,600 × 24% bracket) by using Roth withdrawal.

Roth withdrawals are powerful for controlling Social Security taxation.

State Income Tax Considerations

Some states don't tax retirement income:

• No tax states (Florida, Texas, Wyoming, Nevada): All withdrawals are tax-free at state level.
• Tax states (California, New York, Illinois): Withdrawals taxed at state rates (5%–13.3%).
• Pension-income-exempt states (Illinois, Pennsylvania, Mississippi): Pensions aren't taxed, but IRA withdrawals are.

If you're in a high-tax state, consider retiring in a low-tax state to reduce withdrawal taxes.

Difference: Retiree needing $80,000/year.

• In Florida (0% state tax): Withdraw $80,000.
• In California (9.3% state tax): Withdraw ~$88,000 to net $80,000.
• Difference: $8,000/year or $240,000 over 30 years.

Moving to a low-tax state in retirement can be very beneficial.

RMD and Forced Withdrawals

At age 73, Required Minimum Distributions force withdrawals from traditional accounts (whether you need the money or not).

Planning implication: To minimize taxes from forced RMDs, convert traditional IRA to Roth in early retirement (when you have a choice), reducing the RMD balance at 73.

Example: Age 65, $500,000 traditional IRA.

• Convert $50,000/year to Roth for 5 years (until age 70).
• At 73, traditional IRA balance is $250,000 (not $500,000).
• RMD at 73 is $250,000 / 26.5 = ~$9,434 (not ~$18,868).
• Tax savings: ~$9,434 × 24% = ~$2,264/year.

Early conversions reduce future RMDs and taxes.

Charitable Giving and Qualified Charitable Distribution

If you're charitably inclined and age 70.5+, use Qualified Charitable Distribution (QCD):

• Withdraw up to $100,000/year from IRA to charity.
• Distribution doesn't count as income (avoids AGI increase).
• Doesn't require itemizing deductions.

Example: Age 72, $50,000 IRA withdrawal to charity.

• Doesn't count as income (AGI stays low).
• Social Security taxation avoided.
• IRMAA surcharges avoided.
• Saves roughly $12,000–$15,000 in taxes/premiums compared to regular withdrawal.

QCD is powerful for retirees with charitable intent and large IRAs.

Sources

• Internal Revenue Service. "Retirement Withdrawal Strategies." IRS.gov.
• IRS Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs).
• CMS. "Medicare Income-Related Monthly Adjustment Amounts (IRMAA)." CMS.gov.
• Internal Revenue Service. "Taxable Social Security Benefits." IRS.gov.
• CFA Institute. "Tax-Efficient Retirement Withdrawal Strategies."