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Nobody wants to pay more taxes than they have to in retirement, but if they aren’t careful, they can end up doing exactly that.
That is why it’s important to create a retirement withdrawal strategy that minimizes your potential tax hit. One approach is the “Take That, Uncle Sam” rule of retirement spending.
With this approach, money is withdrawn strategically to limit your tax exposure. Any retiree can use the strategy, but timing is everything. Those who spend more early in retirement must structure their plans differently from those who wait until later.
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Spending in the go-go years
Let’s say you are a retiree who wants to spend a lot of money in your so-called go-go years. To limit your tax burden, you would withdraw from your Roth IRA first to avoid paying taxes. After that, you would tap your brokerage account and then your IRA. Once your spending slows down, you stop withdrawing from your Roth.
Spending in the slow-go years
If you are a retiree who expects to spend more money in the so-called slow-go years of retirement, then you would withdraw from your holdings in the reverse order from the go-go years.
First, you would withdraw from your traditional IRA up to the top of your tax bracket, and if you need more, take it from your brokerage account. The reason to tap your traditional IRA first? Typically, you’re in a lower tax bracket in retirement, so the tax hit is minimal. It also gives you a chance to reduce your Required Minimum Distributions, or RMDs.
The downside: You must pay some taxes on withdrawals. However, you still come out ahead. Follow that pattern year after year and then move to taking withdrawals from your Roth. When it comes time to make large withdrawals later, the money will be tax-free.
Test your retirement tax knowledge
All of this sounds great, but if you don’t understand how each of your retirement accounts works, or what taxes are expected of you at different ages, you won’t be able to pull it off.
So before you tell Uncle Sam where to go, take our quiz to test your retirement tax knowledge.