What Retirement Accounts Should I Withdraw From First?

It’s finally time to start using the money you managed to save and invest over the years. But be careful: Taxes are just one of the tricky parts.

Here’s the first thing to remember about withdrawing retirement money: It’s all about the cash flow.

The second thing? You might want to get some help managing it.

America is hitting a phase some experts call Peak 65, with more than four million people turning 65 in 2024, 2025 and 2026. According to one survey, that’s an average of 11,200 people every day each of those years. Whether they’re retiring or getting ready to retire, a huge number of workers will need to significantly change how they think about their finances.

After decades of building a nest egg, retirees must suddenly switch to making sure that money lasts for nearly 30 years — or even longer.

“While you’re working, what we prioritize is building net worth over time, aiming for the highest net worth possible,” said Mike Crews, a certified financial planner and chief executive of North Texas Wealth Management in Allen, Texas. “When you retire, it’s no longer about that, it’s realizing that retirement is all about cash flow. That’s a total mind shift for people.”

It turns out that the accumulation of savings phase is the easier part of retirement, when workers can sock away money in an individual retirement account or workplace account, such as a 401(k). With research and discipline, someone in their 20s or 30s can ride out the ups and downs of the stock market for a few decades and gradually build a seven-figure retirement stash.

When it comes time to create a retirement paycheck, the challenge is to balance withdrawals from taxable and nontaxable money against when and how to claim Social Security, collect any pension, liquidate real estate, sell other assets and how much to leave for any heirs.

Just 22 percent of retirees say they take withdrawals from their retirement accounts using a formal, sustainable strategy while nearly half, according to a recent survey, “take what they need as they go.”

One approach Mr. Crews suggests: Divide your money into four parts, starting with an emergency fund equal to no more than 10 percent of your net worth. This helps you avoid liquidating investments to cover a medical issue or other large, unexpected expense. The second part is your income, which includes Social Security, pensions, annuities, cash and whatever investment withdrawals you take from, say, a 401(k) or 403(b), to pay living expenses.

The third part is for growth and inflation protection. This includes your longer-term investments, which need to include stocks to keep inflation from eroding your nest egg. Mr. Crews advises aiming for a 7 percent average growth rate, enough to provide real growth after inflation. The final part is assets you’re planning to leave for heirs.

Social Security: Important for Everyone

“The first rule of thumb is, don’t take Social Security while you’re still working,” said Jeanne Sutton, a managing partner with Strategic Retirement Partners who’s known on YouTube as #401klady. “With the way Social Security is taxed and the earnings test, if you’re working before your full retirement age, there’s no real advantage to taking Social Security.”

If you claim Social Security early (before ages 66 or 67, depending on your birth year), you’ll be subject to an earnings test, which in 2025 applies to income higher than $23,400. Half of any earnings above that amount are withheld from your benefits. The formula means that, in the case of someone earning $50,000, about $13,000 of Social Security benefits would be withheld. It might account for most of a person’s benefits for a given year.

That withheld money is credited to your account once you reach your full retirement age.

The earnings test lightens up if you have reached full retirement age when you claim benefits. The earnings-test trigger for beneficiaries in the year of their full retirement age is $62,160 for 2025, with a benefit reduction of $1 for every $3 over the earnings cap.

Another consideration is that up to 85 percent of Social Security benefits are taxed for people with certain amounts of additional income, as calculated by a complex formula under a rule set in 1984. Unlike tax brackets, the income trigger doesn’t adjust with inflation, hitting more beneficiaries each year with taxes.

I.R.A.s, 401(k)s and Other Taxable Accounts

When to tap which investments and savings accounts comes down to managing taxes. With IRAs, 401(k)s and other tax-deferred accounts, the I.R.S. allows retirement savers to invest now and pay taxes later.

Once you retire, “later” becomes “now.”

There is a recommended order of priority, Ms. Sutton said, that focuses on prolonging tax-deferred and tax-free growth as long as possible. That means withdrawing money from taxable savings and investment accounts first, followed by tax-deferred I.R.A.s, 401(k)s and similar holdings.

“The last account is your Roth I.R.A. because of the tax-free growth,” Ms. Sutton said. “If you’re going to leave anything to your kids, it’s much better to leave it in a Roth.”

When You’re Forced to Cash Out

Eventually, the I.R.S. demands that you take withdrawals and start paying taxes through the dreaded Required Minimum Distribution, or R.M.D. At age 73, anyone born in 1951 through 1959 must start withdrawing a minimum amount of tax-deferred cash or face a 25 percent penalty on the amount that should have been withdrawn. (Those born after 1960 don’t need to take R.M.D.s until age 75.)

Calculating your mandatory withdrawal involves dividing your total tax-deferred holdings by a factor listed in one of several I.R.S. tables. For a 73-year-old with a $1 million balance in 2025, the minimum would be $37,736, which is less than the 4 percent rule-of-thumb withdrawal rate used in retirement planning. You can estimate your potential R.M.D.s using the calculator at Investor.gov.

An additional wrinkle is that if you have enough money in tax-deferred accounts, the mandatory withdrawal combined with Social Security benefits and other income could push you into a higher tax bracket. Lee Munson of Portfolio Wealth Advisors in New York advises estimating your future R.M.D.s and to delay claiming Social Security if the mandatory withdrawals will be larger than the amount you had planned to withdraw each year.

“If we delay Social Security, we can take money out through 401(k)s or IRAs, pay the lower tax rate and lower the future R.M.D.s,” Mr. Munson said. “The increased Social Security payment from delaying benefits is just a bonus for looking at the numbers.”

Your big withdrawal risk

A final consideration about retirement withdrawals is that there can be times when the best move is to take out as little cash as possible — or none at all.

Taking withdrawals in a falling market, especially near the beginning of retirement, means those losses are locked in, and offsetting them would require bigger gains in the market later. A few years of ill-timed withdrawals could create enough of a hole that a retiree risks running out of money.

An example: With a $1 million portfolio, a first-year retiree withdraws 4 percent, or $40,000. The portfolio then gains 10 percent for the year and grows to $1.056 million. After another 4 percent withdrawal of $42,240 and 10 percent gains in the second year, the balance grows to $1.115 million, even after more than $80,000 in withdrawals.

If the market heads in the opposite direction, the new retiree runs into trouble. After withdrawing 4 percent ($40,000), the market loses 10 percent, dropping the portfolio value to $864,000. If that’s followed by another 4 percent withdrawal of $34,560 in the second year followed and another 10 percent loss, the balance drops to $746,496. The retiree now needs a 34 percent gain just to get back to their original $1 million balance. And that doesn’t account for two years of inflation.

The options for retirees after such a financial wallop can be grim: living on less, selling other assets, drastically downsizing their lifestyles or returning to work. After a wave of Covid-prompted retirements in 2020, the percentage of people 65 and older in the work force fell from a peak of 26 percent in early 2020 to 23.5 percent in January 2022, two months after the S&P 500 posted a record high of 4,700. When stocks dropped by 24 percent in July 2022, older workers jumped back into the work force.

After inflation hit an average of 8 percent in 2022, a survey of retirees by Paychex payroll services found that one in six were considering going back to work.

Balancing the many moving parts of retirement finances with the vagaries of the stock markets and inflation are why retirees may want to consider meeting with a financial planner before and after retirement. As Mr. Crews of North Texas Wealth Management said, retirees have only one shot at getting their finances right.

Just a few down years in the markets can ruin your retirement, he said. “You don’t want to take your 30 or 40 years of investing and have it work against you.”

Let Us Help You Plan for Retirement

The good news is that we’re living longer. The bad news is you need to save for all those future retirement years. We’re here to help.

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