Compare spendable cash from IRA, Roth and taxable accounts. Review required distributions, basis and future income before choosing a withdrawal order.
September 23, 2024 · Financial Forte Staff
Historical article: prepared retrospectively using information available as of September 23, 2024.
A retirement withdrawal plan may begin with a familiar sequence: use one account first, another later and preserve the Roth account as long as possible. That can be a useful starting question, but a rigid order may miss changes in income, taxes and the purpose of the money.
Review the withdrawal decision each year using the cash you need and the tax characteristics of the actual accounts. Required distributions, cost basis, qualified Roth treatment and other income all matter. The lowest immediate tax is one consideration, but it does not automatically produce the best result over the rest of retirement.[1][2]
Compare spendable cash rather than equal withdrawals
A dollar withdrawn from each account may not leave the same amount available for spending. A traditional IRA distribution may be fully or partly taxable depending on the records. A qualified Roth IRA distribution can be tax-free. Selling an investment in a taxable account can involve both recovery of cost basis and a gain or loss.[1][2]
Keep those categories separate. An account described as taxable does not mean the entire sale proceeds are taxable income. An account described as tax-deferred does not establish that every distribution is fully taxable when nondeductible contributions or other basis exist.
Begin with the amount needed after tax, then estimate the gross transaction required from each possible source. Use the applicable rules and your circumstances rather than the withholding percentage selected on a form. Withholding is a tax payment, not necessarily the final tax cost.
Work through a deliberately simple comparison
Camille needs $10,000 of additional spending cash in this hypothetical comparison. Assume one possible traditional IRA withdrawal would be fully taxable at an illustrative 22% federal rate. A $10,000 withdrawal would create $2,200 of federal tax under that simplified assumption, leaving $7,800.
To provide $10,000 after that assumed tax, the gross withdrawal would need to be approximately $12,820.51. The calculation is $10,000 divided by 0.78. Actual tax brackets, other income, state taxes and income-sensitive provisions are excluded from the illustration and could change the result.
Now suppose Camille can sell investments in a taxable account for $10,000, with $8,000 of basis allocated to the shares sold. The gain is $2,000. At an illustrative 15% federal capital-gains rate, the tax would be $300, leaving $9,700 before fees and other effects. The rate is an assumption, not a statement about Camille's actual eligibility. If additional shares have the same 80% basis ratio and the same assumed tax rate applies, selling approximately $10,309.28 would leave $10,000 after the resulting 3% tax on proceeds.
A $10,000 qualified Roth IRA distribution would provide the stated $10,000 without federal income tax under the assumed qualified treatment. That makes it attractive for this immediate need, but the comparison is incomplete if it ignores the value of retaining Roth assets for a later high-income year or another planning goal.
The three examples explain cash mechanics. They do not recommend that Camille always use the Roth first or always sell taxable assets. Before deciding, she needs to consider required withdrawals, other income this year, future needs and the investment consequences of the transaction.
Look at the current year and the next few years together
A year with unusually low taxable income may create room to examine a traditional-account withdrawal at a lower rate than expected later. A year with a large gain or other income may support a different choice. The relevant comparison is the household's projected tax position, not a permanent label attached to one account.
Future required distributions can also affect the analysis. Preserving every tax-deferred dollar indefinitely may leave larger taxable withdrawals later, while using those assets too quickly can reduce other options. A projection should show the assumptions and allow them to change rather than present one sequence as certain to minimize lifetime tax.
When a required minimum distribution applies, address that obligation as part of the plan. Choosing a qualified Roth distribution for spending does not by itself satisfy an unrelated traditional IRA RMD. Confirm which accounts have requirements and how the permitted distribution rules apply.[1]
Coordinate the investment decision as well. Selling a concentrated position may reduce a risk the portfolio already needs to address. Selling an investment solely because its tax bill is small may leave the overall allocation less suitable. Tax efficiency should support the financial plan rather than replace it.
Preserve flexibility for the expenses you cannot schedule
Camille might choose a combination of sources after reviewing her return and portfolio. For example, a required traditional IRA distribution may already provide some of the needed cash, with a smaller additional sale or qualified Roth distribution filling the remaining gap. Count the distribution's spendable amount after tax, rather than using its gross amount as though it were all available. The exact combination should follow the facts instead of a fixed account hierarchy.
Keep an accessible reserve for upcoming expenses so every repair or medical bill does not force an immediate investment sale. The reserve itself needs to fit the income plan and risk tolerance. Holding more cash can improve access while giving up potential investment returns; neither extreme solves every household's needs.
Document the chosen source, estimated tax, amount expected in checking and reason for the decision. After the transaction, compare the actual proceeds, tax withholding and remaining estimated tax payment with the plan. Update the projection if a later event changes the assumptions.
At the next annual review, revisit the order with fresh balances, income estimates and spending needs. The goal is a withdrawal strategy that can adapt while keeping the household funded. Start with the cash required, understand what each account can provide and make the tax decision in the context of the years ahead.
Related reading
- A Withdrawal Plan Needs Flexibility, Not Just a Percentage
- Create a Retirement Paycheck Before You Leave Work
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Educational information, not personalized investment, tax, legal or benefits advice. Examples use hypothetical assumptions. Verify current rules and your circumstances before acting.
