Congratulations on your recent retirement! Since your tax situation has changed significantly, this is an excellent time to review your potential income streams and maximize the tax efficiency of your withdrawals, significantly impacting how long your money lasts.
First, lets discuss how each type of retirement income is taxed:
- Roth (IRA/401(k)): Qualified withdrawals (contributions and earnings) are tax-free. No Required Minimum Distributions (RMDs) during the original owner's lifetime.
- Traditional/Rollover (IRA/401(k)): Withdrawals of pre-tax contributions and earnings are taxed as ordinary income. RMDs typically begin at age 73 (or 75 for certain birth years).
- Taxable Accounts (Brokerage): Withdrawals of original principal are generally not taxed. Earnings and gains are taxed annually as either ordinary income (interest, non-qualified dividends) or at lower long-term capital gains rates (for assets held over a year).
- Social Security: Deciding when to start collecting Social Security is a subject all on it's own! There are options to start collecting as early as age 62, but you will take a permanent decrease in benefits if you start social security before your full retirement age. Likewise, there are options to defer taking social security up until age 70 - by deferring, you will get a permanent increase in your benefits. Your social security benefits can be 0-85% taxable - the amount of taxable social security benefits is based on your filing status and the amount of your income for the year.
A common, tax-efficient strategy used frequently is:
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Taxable Accounts: Tap these first to take advantage of the potentially lower long-term capital gains tax rates, especially if your income is low enough to qualify for the 0% capital gains bracket. This also allows your tax-advantaged accounts to continue to grow.
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Tax-Deferred Accounts (Traditional/Rollover): Withdraw from these second. These distributions are taxed as ordinary income and are subject to RMDs starting at the required age.
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Roth Accounts: Draw from these last. Since qualified withdrawals are tax-free and they have no RMDs, letting them grow for as long as possible provides a valuable source of tax-free income later in retirement.
Note that for 2025 there may be some strategies specific for this year. Since you only worked for about half the year, you may be in a lower tax bracket this year. If that is the case, this low-income year could be a great time to consider converting some of your pre-tax retirement funds to a Roth IRA, paying tax at a lower rate than you might face later.
Although the above is a good starting point, the reality is that no one size fits all in figuring out what is the most tax efficent way of withdrawing retirement funds. I would strongly suggest that you work with a professional to project your annual income, taxes, and cash needs for the next 5-10 years, factoring in when you plan to start Social Security and when RMDs begin. This will determine the best annual withdrawal amounts and sources.
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