Effectively Managing Retirement Account Withdrawals

October 6, 2018 — 12:23 PM EDT

One of the biggest challenges for retirees is managing withdrawals from their various retirement accounts, which might include 401(k) plans, individual retirement accounts (IRAs), annuities and taxable investment accounts. There are a variety of factors to consider before making withdrawals, one of the most important being tax implications.

Many retirees don’t realize the money saved in tax-deferred accounts is taxed as ordinary income when withdrawn. So that $1 million in your 401(k) plan might only provide $600,000 - $700,000 of income after taxes. Here are some factors for retirees to consider when planning for withdrawals from their retirement accounts.

Look at All Sources of Retirement Income

As you approach retirement it is important to take stock of all of your retirement income sources. Here is a partial list:

Determine the value of these assets and the amount of cash flow you can expect during retirement, keeping in mind the income tax issues associated with tapping some of these sources. (For more, see: Will You Pay Taxes During Retirement?)

IRAs and Defined Contribution Plans

Withdrawals from traditional IRAs and 401(k) accounts are generally subject to income taxes on the full amount is withdrawn. This also applies to other defined contribution retirement plans such as 403(b)s, the federal government’s teacher retirement system (TRS) and 457 plans used by many state and municipal governments. This is certainly the case with any contributions made on a pre-tax basis and the associated earnings on those contributions.

Some defined contribution plans allow for after-tax contributions, which means this income is not taxed when it is withdrawn. This is also true of contributions to traditional IRAs that fall outside the income ranges allowed for deductible contributions. If you have made post-tax contributions, you will need to track them because the pre-tax portion of your withdrawals will be taxed and the post-tax portion won't. 

Contributions to Roth IRAs and Roth 401(k)s are made with after-tax dollars. In the case of Roth IRAs, the money can be withdrawn tax-free as long as your initial Roth IRA contribution was at least five years ago and you are 59.5 or older in age. Additionally there no required minimum distributions (RMDs) as there are with traditional IRAs. A Roth 401(k) is similar but differs in that RMDs must be taken. Rolling an account with RMDs over to a Roth IRA is one way to avoid this issue.

Taxable Investments and Income

Taxable investment accounts are a valid way to save for retirement. The tax implications when using these investments could include capital gains taxes or the taxation of any interest or dividends received. Payments from a defined benefit pension are generally fully taxable as ordinary income. Social Security may also be taxed based on your age and income. (For more, see: Retirement Savings: Tax-Deferred or Tax-Exempt?)


Annuities can be funded with after-tax dollars (non-qualified) or they can be held within an IRA or certain tax-deferred workplace retirement plans (qualified). In the case of non-qualified annuities, your contributions to the account are not taxed but the gains in the underlying investments are. The actual taxation rules will differ based on whether you annuitize the account or take piecemeal distributions at various times. Withdrawals from a qualified account are fully subject to taxation with the exception of any after-tax contributions.

Cash Value Life Insurance

Cash value life insurance is often touted by insurance agents and commissioned financial advisors as a retirement savings vehicle. If structured correctly the policyholder can take what amounts to a tax-free loan from the policy to fund retirement. However, care must be taken to ensure the policy’s cash value does not fall below a certain level that would trigger a taxable event. (For more, see: How Cash Value Builds in a Life Insurance Policy.)

Pulling It All together

Given the information above, the question still remains: Which accounts should you tap for retirement income and in what order? There is no hard and fast answer, but here are some factors to consider. If you retire from your full-time job but work at least part-time during the early years of retirement, you might want to tap tax-deferred retirement accounts later if you have the option of taking money from taxable investment accounts first. Once you reach age 70.5, you have to take required minimum distributions from any tax-deferred retirement accounts. This does not apply to non-qualified annuity accounts and may not apply to a 401(k) with your current employer if you are still working. (For more, see: How Much Should Retirees Withdraw from Accounts?)

Another factor to consider is your Social Security can be adversely impacted by a higher income. In 2018, if your earnings exceed $17,040 and you are younger than your full retirement age (FRA), your benefit will be reduced $1 for every $2 that your earnings exceed this limit. This limit increases to $45,360 during the year in which you reach FRA and disappears altogether in the month you hit FRA and all subsequent years.

Remember the top long-term capital gains rate for taxable investments held for at least one year is 20% for those in the highest income tax brackets. Even with the potential of the 3.8% Medicare surcharge, this rate is cheaper than the ordinary income tax rates charged on withdrawals from tax-deferred retirement accounts if you are in one of the higher income tax brackets.

The best strategy for you may be making withdrawals from more than one type of account. If you entirely deplete your after-tax investments and savings first, you will be forced to tap tax-deferred accounts exclusively, which can be an expensive source of money. It may make sense to keep your tax-deferred income withdrawals within the lowest tax bracket, then tap sources such as a Roth IRA, a savings or money market account, cash value from a life insurance policy, or other non-taxable or low-taxed sources of income for whatever additional funds you need.

The Bottom Line

Effectively managing your retirement account withdrawals can be a complex task, especially if you have accounts of various types. If you are unsure what the proper approach is for you, work with your financial advisor and tax professional on a plan that includes the amount needed to fund your retirement and takes into account your tax situation. (For more, see: Strategies for Withdrawing Retirement Income.)