2. Understand required minimum distributions
What you should do. For each of your retirement accounts, learn if they are subject to required minimum distributions and how RMDs work. For example, traditional IRAs require you to start taking minimum distributions beginning with the year you turn 72. 401(k)s do, too, unless you’re still working. Roth IRAs don’t require any distributions until the owner dies.
How this strategy save on taxes. If you don’t take RMDs or if your distributions are too small, you’ll owe a tax penalty of 50 percent of the amount you didn’t withdraw — a huge waste of money. Make sure to withdraw the full amount you’re required to each year, which is generally based on your age, life expectancy, and account balance.
You must take your first RMD in the year when you turn 72, but you have the option to delay it until April 1 of the following year. You might want to delay it if your income will be substantially lower the following year—for example, if you’re still working but about to retire. You may also need to make quarterly estimated tax payments on your retirement account distributions to avoid tax penalties.
Bonus tip : Once you are over age 70 ½, you can make a direct transfer of up to $100,000 from your IRA (other than a SEP IRA or SIMPLE IRA) to a qualified 501(c)(3) charity through what’s called a qualified charitable distribution (QCD). A QCD will satisfy part or all of your RMD requirement and reduce your taxable income, even if you don’t itemize deductions on your tax return.
3. Consider proportional withdrawals
What you should do. It’s common to have retirement assets in three types of accounts: taxable brokerage accounts, tax-deferred retirement accounts, such as 401(k)s or 403(b)s, and tax-free Roth accounts. It is important to time the withdrawals in order to potentially avoid getting bumped into a higher tax bracket and also to avoid making Social Security taxable.
How this saves on taxes. Typically, a retiree withdraws a certain amount from their portfolio each year. How much could vary from person to person, but a rule of thumb is 4-5 percent of the overall portfolio value each year.
The traditional approach is to draw down the money in your taxable brokerage accounts first, incurring little to no tax since the only taxable part of those withdrawals is from capital gains, which are taxed at a lower rate than other kinds of earned income. Next would come 401(k) and traditional IRA withdrawals, which will typically incur taxes at ordinary rates. When those accounts are depleted, turn to Roth withdrawals, which can generally be taken tax-free. Overall, this strategy means tax bills are mainly due in mid-retirement years for most people. Also, this overall approach lets money in tax-deferred accounts grow longer.
But a different strategy is emerging where a retiree would withdraw from every account in their portfolio, based on each account’s percentage of their overall savings. So, some money would come from brokerage accounts, 401(K)/traditional IRAs, and Roth accounts each year. This strategy typically incurs a tax bill every year, but the amount can be lower and relatively stable from year to year. And it ultimately may amount to a lower tax bill over the length of your retirement. It could also reduce taxes on Social Security benefits and lower Medicare premiums, since taxable income would be spread out over a greater number of years.
Which strategy makes the most sense will depend on personal circumstances and finances. Many people opt to discuss their options with a financial professional or tax specialist.
Bonus tip : For retirees in the 15 percent to 20 percent capital gains tax bracket, combining the traditional and proportional withdrawal strategy could result in greater tax savings. Again, consulting with a financial professional or tax specialist would probably help see if that option is workable.
Our last two tips are here.