Which Retirement Account Should I Take Money From First?

November 19, 2024 — A number of people are in the fortunate position of having multiple accounts tohat could fund their retirements. They might have IRAs, 401(k)s, 403(b)s, Roths, and/or non-retirement savings and investments. But which one(s) should they tap first when they need money for retirement. Note: We are in no way an investment or financial experts, we are just laying out the issues and providinginformation for you to consider in your planning.

Complications affecting which account to withdraw from first

Before you even get to withdrawal strategies, there are other financial considerations that might apply to your decision. Among others, those include: when to apply for Social Security benefits, Roth conversions, and the state of your finances. In general we believe that in most cases it pays to wait until age 70 to start collecting Social Security, assuming you have enough to live on until then, and you and your spouse have an average life expectancy. But we could write a whole article on whether it is better to delay when you take Social Security by using your savings and investments, or let that money ride, and collect early.

Roth conversions, which allow you to tap retirement money tax free, are another complex subject, but often a worthwhile idea for people with big balances in their regular IRA and 401(k) accounts. These conversions need to thought through carefully, as you will pay taxes on any converted funds as they go in (but if you have low income or big losses you might be able to offset that).

Lastly, sometimes the decision as to which accounts to use is simple – you don’t have much money saved, or few accounts to choose from.

Tax Efficient Retirement Withdrawals

Many experts say that the first principle about retirement withdrawals is to delay having to pay taxes as much as you can (of course you might have different considerations). On the scale of taxability, the worst case is money taken from regular IRAs and 401(ks) – every cent is taxable as ordinary income. That income can add to your tax bill, kick you up to a higher bracket, and increase your Medicare Part B premiums by hundreds of dollars per month.

Next in the tax liability line are the funds taken out from regular savings and investment accounts. They are not taxable, except for any capital gains. As it stands in 2024 the capital gain tax rate of 15% (on joint incomes up to $600,000) is generally less than the ordinary income rates that would apply to other forms of income.

By contrast, all money from Roth and 401(k) IRAs comes out tax free. That is a huge advantage, and what you leave in continues to grow tax free.

Required Minimum Distributions Complicate Things

At a certain age you are obliged to take out a minimum amount from the money in your IRA and 401(k) accounts. So money is going to come out of these accounts whether you want it to or not. From the IRS:

The RMD amounts start out small (for persons turning 73 it is your IRA balance divided by 26.5, or 3.774%). As you age the amount you take out increases, until at age 100 the dividing factor is 6.4 (on a million dollar balance it would be $156,250).

The point is this: you have to start taking money out of your non-Roth retirement accounts at age 73; there is no choice. But one way to minimize your tax bill is to make contributions to qualified charities and minimize your tax bill as part of your RMDs.

Some Example Situations

First, let’s take a person whose assets are evenly split among taxable retirement accounts (IRAs, 401(k)s, Roth accounts, and non-retirement savings and investments. After she takes out their RMD for the year, and accounting for Social Security and any other income, she still needs $50,000 to live on. Which account should she take it from first?

Following the principle of trying to minimize taxes, it would seem that regular savings/investments should be the first pot to dip the ladle in. She might have to pay capital gains on her winning investments, but she could always choose to sell her poorer performing assets first – possible even harvesting some tax losses. Other than perhaps keeping some emergency funds, it is probably wise to drain these accounts (if she needs to) before she moves on to your retirement accounts. The advantage is that she is not adding to her tax bill like she would from IRA withdrawals, and she gets to leave the Roth money to grow with no taxation. When and if she empties out her non-retirement accounts, then the next bucket is probably her Roth accounts. She won’t pay taxes on it, although it will no longer be there to grow tax free. Lastly, if she need it, she should tap her IRA/401(k) accounts beyond your RMDs.

Another example – all or nothing

Another example is someone who either has most of their money in retirement accounts, or most of it in non-retirement accounts. If you agree that the avoid taxation principle we applied in the first situation still applies: tap the non-retirement first, followed by the Roths, and then the regular IRAs.

Thinking about inheritances and retirement accounts

Our last example is someone who is fortunate enough to have more than enough money than they need for their retirement lifestyle. If they have heirs they want to take care of and not give them a big tax burden, two of their account types are usually tax free to the heirs, and one is taxable. Unless the person has more than $13.61 million in assets, none of their non retirement estate is taxable to the heirs on a federal basis (a few states have smaller exemptions). Roth plans are not taxable to the heirs. However, regular IRA/401(k)s are taxable as it is distributed over the years.

So if you don’t care about possibly adding to your own tax burden, but would rather lessen it for your heirs, then perhaps you might want to think about tapping your regular IRA/4019k)s first, maximizing what the heirs will get tax free. That decision we will leave to you.

Bottom line – Which Retirement Account Should I Take Money from First

Like you can see from the above, the answer to the question is personal, and complex. For example, you can minimize the tax bill from your IRAs by giving money to qualified charities. Or, take money out of those accounts early to avoid bigger RMDs in the future. But in general, taking it from the account that causes the least taxation is the principle to keep in mind. Careful planning and research is required. You might be able to minimize your overall tax liability by strategically withdrawing from different types of accounts to keep within a lower tax bracket. To help you in your decision, consult your financial advisor or accountant to make sure you choose the plan that makes the most sense to you.

Comments? Have you got a strategy for which accounts to take money from first? Do you have some different ideas from what is discussed here? Please share your thoughts in the Comments section below.

For further reading:
ChatGBT vs. Human: Retirement Withdrawal Strategies

Estate Plan and Financial Blogs at Topretirements (see separate categories)