Turning your portfolio into a paycheck

What is a retirement withdrawal strategy?

A withdrawal strategy is the decision about which account you take money from each year. Not how much you spend. Which account it comes out of.

That sounds like a detail and it is closer to the whole game. The accounts are taxed on different schedules, so the same spending can produce very different tax bills depending on where it comes from.

It is also a decision you make roughly thirty times, not once. Most of what follows is about keeping that decision open rather than letting a default make it for you.

You have three buckets, not one

Taxable accounts, tax-deferred accounts like a traditional IRA, and tax-free accounts like a Roth. Each one is taxed on a different schedule, so spending isn’t one decision. It’s a decision about which bucket, every year, for thirty years.

• Taxable accounts are already-taxed money. Only the growth is taxed when you sell, and gains have their own schedule.
• Tax-deferred accounts are fully taxable on the way out, as ordinary income. This is where most people hold most of their money.
• Tax-free accounts come out untaxed, which makes them the most flexible thing you own and the last thing most people should spend.

What is the best order to withdraw retirement funds?

The common rule of thumb says spend taxable first, then tax-deferred, then Roth. It’s a reasonable starting point, and it’s often not the best answer.

Draining taxable accounts first can leave a very large IRA sitting there. It becomes a required withdrawal at 73 if you were born from 1951 through 1958, or at 75 if you were born in 1960 or later, at a rate you no longer control. Birth year 1959 is the one gap: the paragraph of the regulation that would set the required withdrawal age for it is marked reserved and left blank, so it is genuinely unresolved rather than something you have missed.

The rule of thumb optimizes for this year. It defers tax as long as possible, which sounds obviously good. But deferring tax is not the same as paying less of it, and a required withdrawal is what eventually collects the difference.

Mixing accounts beats draining them in order

Pulling from more than one bucket in the same year gives you a dial. It works like the two handles on an old bathroom faucet. Either one on its own hands you whatever temperature it hands you. Running both is what lets you set it where you want it. You can fill the lower brackets deliberately instead of falling into whatever bracket the default order hands you.

That’s the difference between a withdrawal plan and a withdrawal habit.

Is there a safe withdrawal rate?

The best-known rule of thumb says you withdraw about 4% of your portfolio in the first year. After that you adjust it for inflation. You will also find people arguing for more, and people arguing for less.

It came with assumptions, and they matter as much as the number. It was derived for a roughly thirty-year retirement and a particular mix of stocks and bonds, which is why it means something different if you retire at 52 than at 67. It is also a rate on the portfolio, before the cost of running it and before tax. What lands in your bank account is smaller than the percentage suggests, by whatever you pay in advisory and fund fees and by whatever the withdrawal itself is taxed at — and that second part depends entirely on which account the money came from.

The inflation adjustment is an assumption, not arithmetic. Raising the first year’s withdrawal by inflation every year afterwards assumes you will want the same purchasing power at 85 that you wanted at 65. That is a modeling choice the rule makes on your behalf, and it may or may not describe you. Your own spending over the last few years is a better guide to it than any percentage is.

Any single percentage is answering a different question from the one this page is about. A rate tells you roughly how much to spend. It says nothing about which account the money comes from, and that is where the tax is decided.

The rules are useful as a sanity check on the size of the plan. They are not a plan. Two people with the same portfolio and the same spending can pay very different tax over thirty years. No withdrawal rate can see that difference.

A worked example: the same spending, two different tax bills

The argument for blending is much easier to see written down than described.

What people get wrong about withdrawal strategy

Nearly every mistake here is the same mistake in different clothes. Optimizing this year at the expense of the next twenty-nine.

• Pulling from whatever account is easiest. Usually the IRA, because that is where the balance is. It is also the most expensive dollar you own.
• Treating the rule of thumb as an answer. Taxable first, then tax-deferred, then Roth is where the thinking starts.
• Deferring tax as long as possible. Deferring is not avoiding. A required withdrawal is when the deferral ends on someone else’s schedule.
• Spending the Roth early. It is the most flexible account you have, and flexibility is worth the most at the end.
• Selling investments that are down to cover spending. If you have another source that year, that is what it is for.
• Ignoring the taxable account’s cost basis. A large part of a brokerage withdrawal is often not income at all.
• Never revisiting it. Social Security starting, a pension starting and required withdrawals beginning each change the right answer.

When this does NOT apply to you

Blending is powerful when you have something to blend. Plenty of people don’t, and for them most of this page is interesting rather than useful.

• If nearly everything you hold is in one account type. There is no dial to turn, and the plan is simpler.
• If a pension and Social Security cover your spending. The portfolio question may barely arise.
• If your income is low enough that the brackets never bind. Optimizing a tax you are not paying costs effort and returns nothing.
• If you are under 59½ and need the money. Access rules come before tax efficiency, and they are a different conversation.
• If a large charitable gift is in the picture. Giving straight from the IRA can beat every withdrawal order on this page.
• If the complexity would stop you following the plan. A plan you actually run beats a better one you abandon.

How this connects to the other six

This is the page the other six run through, and that is not a filing convention. Every other topic on this site is a version of the same question. Which dollars move this year, and what moves with them.

Read the other six as six views of one decision.

• Roth conversions are the same decision with the money going to a Roth instead of to your checking account. Both fill the same brackets, and you budget for them together or not at all.
• Required minimum distributions (RMDs) and qualified charitable distributions (QCDs) are what happens when you stop choosing. The requirement takes the decision out of your hands, and every year of withdrawal planning before then is about making that future amount smaller.
• Healthcare in retirement is the bill for getting this wrong. Income sets your Medicare surcharge two years later, so a withdrawal today has a price tag that arrives late.
• Social Security timing decides how much of your income is already spoken for. Delaying leaves the low brackets empty, which is what gives a withdrawal plan room to work.
• Estate and legacy is the last line of the same arithmetic. Which accounts you spend down decides what is left, and a traditional IRA is the least tax-friendly thing to leave behind.