Understanding the Order of Withdrawals In Retirement

When entering retirement, one of the most important financial questions you’ll face is: What’s the smartest order to pull funds from my various retirement accounts? Getting this order wrong can lead to unnecessary taxes, reduced portfolio longevity, and even higher Medicare premiums.

While there’s no universal rule that fits everyone, there are strategic guidelines that can help most retirees withdraw more efficiently and keep more of what they’ve saved.

1. Use Tax-Deferred Accounts (Traditional IRA / 401(k))

For clients who have both after-tax brokerage accounts or cash reserves as well as pre-tax retirement accounts, they are often surprised to find out that there are large tax advantages to taking distributions from pre-tax retirement accounts in the early years of retirement.  Since all Traditional IRA and 401(k) distributions are taxed, retirees unknowingly will fully deplete their after-tax sources before turning to their pre-tax retirement accounts.

I’ll explain why this is a mistake.

When most individuals retire, their paychecks stop, and they may, tax-wise, find themselves in low to medium tax brackets. Knowing they are in low to medium tax brackets, by not taking distributions from pre-tax retirement accounts, a retiree could be wasting those low-bracket years.

For example, Scott and Kelly just retired. Prior to retirement their combine income was $300,000.  Scott and Kelly have a cash reserve of $100,000, an after tax brokerage account with $250,000, and Traditional IRA’s totaling $800,000.  Since their only fixed income source in retirement is their social security benefits totaling $60,000, if they need an additional $20,000 per year to meet their annual expenses, it may make sense for them to withdrawal that money from their Traditional IRAs as opposed to their cash reserve or brokerage account.

Reason 1:  For a married couple filing a joint tax return, the 12% Federal tax bracket caps out at $96,000, that is relatively low tax rate. If they need $20,000 after tax to meet their expenses, they could gross up their IRA distribution to cover the 12% Fed Tax and withdrawal $22,727 from their IRA’s and still be in the 12% Fed bracket.

Reason 2: If they don't take withdrawals from their pretax retirement accounts, those account balances will keep growing, and at age 75, Scott and Kelly will be required to take RMD’s from their pre-tax retirement account, and those RMDs could be very large pushing them into the 22% Fed tax bracket. 

Reason 3:  For states like New York that have state income tax, depending on the state you live in, they may provide an annual state tax exemption for a certain amount of distributions from pre-tax retirement accounts each year.  In New York, the state does not tax the first $20,000 EACH YEAR withdrawn from pre-tax retirement accounts.  By not taking distributions in their early years and retirement, a retiree may be wasting that annual $20,000 New York state exemption, making a larger portion of their IRA distribution subject to state tax in the future.

For client who have both pre-tax retirement accounts and after-tax brokerage accounts, it can sometimes be a blend of the two, depending on how much money they need to meet their expenses. It could be that the first $20,000 comes from their Traditional IRA to keep them in the low tax bracket, but the remainder comes from their brokerage account.  It varies on a case-by-case basis.

2. After-Tax Brokerage Accounts and Cash Reserve (Brokerage)

For individuals who retire after age 59 ½, the distribution strategy usually involves a blend of pre-tax retirement account distributions and distributions from after-tax brokerage accounts.  When selling holdings in a brokerage account to raise cash for distributions, retirees have to be selective as to which holdings they sell.  Selling holdings that have appreciated significantly in value could trigger large capital gains, adding to their taxable income in the retirement years.  But there are typically holdings that may either have minimal gains that could be sold with very little tax impact or holding that have long-term capital gains treatment taxed at a flat 15% federal rate.  Since every dollar is taxed coming out of a pre-tax retirement account, having after-tax cash or a brokerage account can sometimes allow a retiree to pick their tax bracket from year to year.

There is often an exception for individuals that retire prior to age 59½ or in some cases prior to age 65.  In these cases, taking withdrawals from after-tax sources may be the primary objective.  For individual under the age of 59 1/2 , if distributions are taken from a Traditional IRA prior to age 59 1/2, the individual faced taxation and a 10% early withdrawal penalty.

Note: There are some exceptions for 401(k) distributions after age 55 but prior to age 59 1/2.

For individuals who retire prior to age 65 and do not have access to retiree health benefits, they frequently have to obtain their insurance coverage through the state exchange, which has income subsidies available. Meaning the less income an individual shows, the less they have to pay out of pocket for their health insurance coverage. Taking taxable distributions from pre-tax retirement accounts could potentially raise their income, forcing them to pay more for their health insurance coverage.  If instead they take distributions from after-tax sources, they could potentially receive very good health insurance coverage for little to no cost. 

3. Save Roth IRA Funds for Last

Roth IRAs grow tax-free and offer tax-free withdrawals in retirement. Because they don’t have RMDs and don’t increase your taxable income, Roth IRAs are ideal for later in retirement, or even as a legacy asset to pass on to heirs. To learn more about creating generational wealth with Roth Conversions, watch this video.

Keeping your Roth untouched early in retirement also gives you flexibility in higher-income years. Need to take a larger withdrawal to fund a home project or major expense? Roth distributions won’t impact your tax bracket or Medicare premiums.

4. Special Considerations

Health Savings Accounts (HSAs):
If you have a balance in an HSA, use it for qualified medical expenses tax-free. These can be especially valuable in later years as healthcare costs increase.

Social Security Timing:
Delaying Social Security can reduce taxable income in early retirement, opening the door for Roth conversions and other tax strategies.

Sequence of Return Risk:
Withdrawing from the wrong accounts during a market downturn can permanently damage your portfolio. Diversifying your income sources can reduce that risk.

5. Avoid These Common Withdrawal Mistakes

Triggering higher Medicare premiums (IRMAA): Large withdrawals can push your income over thresholds that increase Medicare Part B and D premiums.

Missing Roth Conversion Opportunities: Processing Roth conversions to take advantage of low tax brackets and reduce future RMDs.

Tapping after-tax accounts too early: Maintaining a balance in a brokerage account can provide more tax flexibility in future years, and when it comes to estate planning these asset receive a step-up in cost basis before passing to your beneficiaries.

Final Thoughts

The order you withdraw your funds in retirement can significantly affect your taxes, benefits, and long-term financial security. A smart strategy blends tax awareness, income needs, and market conditions.

Every retiree’s situation is unique and working with a financial planner who understands the coordination of retirement income can help you keep more of your wealth and make it last longer.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What is the best order to withdraw funds from retirement accounts?
The “best” withdrawal strategy truly varies from person to person. A common mistake retirees make is fully retiring and withdrawing money first from after-tax sources, then, once depleted, from pre-tax sources. Depending on the types of investment accounts someone has and their income needs, a blended approach can often be ideal.

Why might it make sense to take IRA withdrawals early in retirement?
Early retirement years often come with lower taxable income, allowing retirees to withdraw from pre-tax accounts at favorable tax rates. Doing so can reduce the size of future RMDs and help avoid being pushed into higher tax brackets later in life.

How do after-tax brokerage accounts fit into a retirement income strategy?
After-tax brokerage accounts offer flexibility since withdrawals are not fully taxable—only gains are. They can help retirees manage their tax brackets from year to year, especially when balancing withdrawals from pre-tax and Roth accounts.

When should retirees use Roth IRA funds?
Roth IRAs are typically best reserved for later in retirement because withdrawals are tax-free and don’t affect Medicare premiums or tax brackets. They also have no required minimum distributions, making them valuable for legacy or estate planning.

How can withdrawal timing affect Medicare premiums?
Large distributions from pre-tax accounts can raise your income and trigger higher Medicare Part B and D premiums through the Income-Related Monthly Adjustment Amount (IRMAA). Spreading withdrawals over multiple years or using Roth funds strategically can help avoid these surcharges.

What are common mistakes to avoid when withdrawing retirement funds?
Common pitfalls include depleting after-tax accounts too early, missing Roth conversion opportunities, or taking large taxable withdrawals that increase Medicare costs. Coordinating withdrawals with tax brackets and healthcare needs can help prevent these costly errors.

How does delaying Social Security affect retirement withdrawal strategy?
Delaying Social Security reduces taxable income in early retirement, which can open opportunities for Roth conversions or strategic IRA withdrawals. Once benefits begin, managing income sources carefully helps minimize taxes and maximize long-term income.

Multi-Generational Roth Conversion Planning

With the new 10-Year Rule in place for non-spouse beneficiaries of retirement accounts, one of the new tax strategies for passing tax-free wealth to the next generation is something called the “Next Gen Roth Conversion Strategy”.  This tax strategy works extremely well when the beneficiaries of the retirement account are expected to be in the same or higher tax bracket than the current owner of the retirement account.  

Here's how the strategy works. The current owner of the retirement account begins to initiate large Roth conversions over the course of a number of years to purposefully have those pre-tax retirement dollars taxed in a low to medium tax bracket. This way, when it comes time to pass assets to their beneficiaries, the beneficiaries inherit Roth IRA assets instead of pre-tax Traditional IRA and 401(k) assets that could be taxed at a much higher rate due to the requirement to fully liquidate and pay tax on those assets within a 10-year period.  

In addition to lowering the total income tax paid on those pre-tax retirement assets, this strategy can also create multi-generational tax-free wealth, reduce the size of an estate to save on estate taxes, and reduce future RMDs for the current account owner.

10-Year Rule for Non-Spouse Beneficiaries

This tax strategy surfaced when the new 10-Year Rule went into place with the passing of the Secure Act.  Non-spouse beneficiaries who inherit pre-tax retirement accounts are now required to fully deplete and pay tax on those account balances within a 10-year period following the passing of the original account owner.  In many cases when children inherit pre-tax retirement accounts from their parents, they are still working, which means that they already have income on the table. 

For example, if Josh, a non-spouse beneficiary, inherits a $600,000 Traditional IRA from his father when he is age 50, he would be required to pay tax on the full $600,000 within 10 years of his father passing. But what if Josh is married and he and his wife still work and are making $360,000 per year?  If Josh and his wife do not plan to retire within the next 10 years, the $600,000 that is required to be distributed from that inherited IRA while they are still working could be subject to very high tax rates since the taxable distribution stacks on top of the $360,000 that they are already making.  A large portion of those IRA distributions could be subject to the 32% federal tax bracket.

If Josh’s father had started making $100,000 Roth conversions each year while both he and Josh’s mother were still alive, they could have taken advantage of the 22% Federal Tax Bracket I in 2025 (which ranges from $96,951 to $206,000 in taxable income). If they had very little other income in retirement, they could have processed large Roth conversions, paid just 22% in federal taxes on the converted amount, and eventually passed a Roth IRA on to Josh. Utilizing this strategy, the full $600,000 pre-tax IRA would have been subject to the parent’s federal tax rate of 22% as opposed to Josh’s tax rate of 32%, saving approximately $60,000 in taxes paid to the IRS.

Tax Free Accumulations For 10 More Years

But it gets better.  By Josh’s parents processing Roth conversions while they were still alive, not only is there multigenerational tax savings, but when John inherits a Roth IRA instead of a Traditional IRA from his parents, all of the accumulation within that Roth IRA since the parents completed the conversion, PLUS 10 years after Josh inherits the Roth IRA, are completely tax-free. 

Multi-generational Tax-Free Wealth

If you are a non-spouse beneficiary, whether you inherited a pre-tax retirement account or a Roth IRA, you are subject to the 10-year distribution rule (unless you qualify for one of the exceptions). With a pre-tax IRA or 401(k), not only is the beneficiary required to deplete and pay tax on the account within 10 years, but they may also be required to process RMDs (required minimum distributions) from their inherited IRA each year, depending on the age of the decedent when they passed away.

With an Inherited Roth IRA, the account must be depleted in 10 years, but there is no annual RMD requirement, because RMDs do not apply to Roth IRAs subject to the 10-year rule.  So, essentially, someone could inherit a $500,000 Roth IRA, take no money out for 9 years, and then at the end of the 10th year, distribute the full balance TAX-FREE.  If the owner of the inherited Roth IRA invests the account wisely and obtains an 8% annualized rate of return, at the end of year 10 the account would be worth $1,079,462, which would be withdrawn completely tax-free.

Reduce The Size of an Estate

For individuals who are expected to have an estate large enough to trigger estate tax at the federal and/or state level, this “Next Gen Roth Conversion” strategy can also help to reduce the size of the estate subject to estate tax.  When a Roth conversion is processed, it’s a taxable event, and any tax paid by the account owner essentially shrinks the size of the estate subject to taxation. 

If someone has a $15 million estate, and included in that estate is a $5 million balance in a Traditional IRA and that person does nothing, it creates two problems.  First, the balance in the Traditional IRA will continue to grow, increasing the estate tax liability that will be due when the individual passes assets to the next generation.  Second, if there are only two beneficiaries of the estate, each beneficiary will have to move $2.5 million into their own inherited IRA and fully deplete and pay tax on that $2.5M PLUS earnings within a 10-year period.  Not great.

If, instead, that individual begins processing Roth conversions of $500,000 per year, and over a course of 10 years can fully convert the Traditional IRA to a Roth IRA (ignoring earnings), two good things can happen. First, if that individual pays an effective tax rate of 30% on the conversions, it will decrease the size of the estate by $1.5 million ($5M x 30%), potentially lowering the estate tax liability when assets are passed to the beneficiaries of the estate. Second, even though the beneficiaries of the estate would inherit a $3.5M Roth IRA instead of a $5M Traditional IRA, no RMDs would be required each year, the beneficiaries could invest the Inherited Roth IRA which could potentially double the value of the Inherited Roth IRA during that 10-year period, and withdraw the full balance at the end of year 10, completely tax free, resulting in big multi-generational tax free wealth.

The Power of Tax-Free Compounding

Not only does the beneficiary of the Roth IRA benefit from tax-free growth for the 10 years following the account owner's death, but they also receive the benefit of tax-free growth and withdrawal within the Roth IRA, as long as the account owner is still alive.  For example, if someone begins these Roth conversions at age 70 and they live until age 90, that’s 20 years of compounding, PLUS another 10 years after they pass away, so 30 years in total.

A quick example showing the power of this tax-free compounding effect: someone processes a $200,000 Roth conversion at age 70, lives until age 90, and achieves an 8% per year rate of return. When they pass away at age 90, the balance in their Roth IRA would be $932,191.  The non-spouse beneficiary then inherits the Roth IRA and invests the account, also achieving an 8% annual rate of return. In year 10, the Inherited Roth IRA would have a balance of $2,012,531. So, the original owner of the Traditional IRA paid tax on $200,000 when the Roth conversion took place, but it created a potential $2M tax-free asset for the beneficiaries of that Roth IRA.  

Reduce Future RMDs of Roth IRA Account Owner

Outside of creating the multi-generational tax-free wealth, by processing Roth conversions in retirement, it’s shifting money from pre-tax retirement accounts subject to annual RMDs into a Roth IRA that does not require RMDs.  First, this lowers the amount of future taxable RMDs to the Roth IRA account owner because assets are being shifted from their Traditional IRA to Roth IRA, and second, since RMDs are not required from Roth IRAs, the assets in that IRA are allowed to continue to compound investment returns without disruption. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What is the “Next Gen Roth Conversion Strategy”?
The Next Gen Roth Conversion Strategy involves gradually converting pre-tax retirement assets, such as Traditional IRAs or 401(k)s, into Roth IRAs while the account owner is in a lower tax bracket. This allows heirs to inherit Roth assets that grow and distribute tax-free rather than being forced to pay higher taxes under the 10-Year Rule for inherited pre-tax accounts.

How does the 10-Year Rule affect inherited retirement accounts?
Under the SECURE Act, non-spouse beneficiaries must fully deplete inherited pre-tax retirement accounts within 10 years of the original owner’s death. This often forces distributions during high-income years, which can push beneficiaries into higher tax brackets and increase total taxes owed.

Why is this strategy beneficial for high-earning heirs?
When heirs are in the same or higher tax bracket as the original account owner, converting to a Roth during the parent’s lifetime allows the taxes to be paid at a lower rate. The heirs then inherit a Roth IRA that continues to grow tax-free and can be withdrawn without triggering additional income tax.

How does the strategy create multi-generational tax-free wealth?
After the account owner passes, heirs can keep the inherited Roth IRA invested for up to 10 years without required minimum distributions (RMDs). All investment growth during that time is tax-free, and the full balance can be withdrawn at the end of year 10 with no taxes owed.

Can Roth conversions also reduce estate taxes?
Yes. The taxes paid during the conversion process reduce the overall size of the estate, which may lower exposure to federal or state estate taxes. Converting pre-tax assets to Roth IRAs can therefore benefit both the heirs and the estate itself.

How does this strategy help minimize future RMDs?
By converting pre-tax accounts to Roth IRAs, retirees reduce the balance of assets subject to required minimum distributions. Since Roth IRAs do not require RMDs during the owner’s lifetime, more assets can continue compounding tax-free for longer.

What makes the Next Gen Roth Conversion Strategy so powerful?
It combines proactive tax planning, estate reduction, and multi-generational wealth transfer. Taxes are paid strategically at lower rates, future RMDs are minimized, and beneficiaries receive assets that can grow for up to a decade after inheritance—completely tax-free.