The general approach to withdrawal order in retirement is to first spend down taxable accounts, then tax-deferred accounts, and finally tax-free accounts. By delaying withdrawals from tax-deferred accounts, retirees can allow these accounts to continue growing tax-deferred for a longer period, maximizing their potential for compounding growth. While this can be a good starting approach it does not focus on minimizing your overall tax bracket throughout retirement.
IW Retirement Planner uses the below order for withdrawals after first consuming non-investment income like employment, Social Security, and pension income.
Tax-Deferred Investments Taxable Investments Tax-Free Investments Cash & Equivalents
By default, tax-deferred accounts are withdrawn from before taxable accounts, but the Withdrawal Strategy feature lets you switch the order to experiment with the most effective way to lower taxes for your situation. Some reasons to withdraw from tax-deferred accounts before taxable accounts:
- Reduce potential tax consequences of Required Minimum Distributions in the later stages of retirement
- Minimize the tax impact of the 10-year rule for inherited tax-deferred funds. The 10-year Rule requires that beneficiaries receiving Traditional IRAs and 401(k)s, withdraw all funds within a 10 year period, which can have significant tax implications.
- Take advantage of the step-up in basis rule, which raises the cost basis for inheritors to the market value of investments on the date of the previous owner's death, reducing future capital gains taxes.
Additionally, Cash & Equivalents accounts are withdrawn from last to preserve liquidity, ensuring immediate access to funds for unforeseen expenses or emergencies without incurring penalties or tax consequences.