6 Smart Ways to Withdraw Retirement Funds and Lower Your Taxes

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 Peter Lazaroff By: Peter Lazaroff

The global pandemic has had an enormous impact on all of our daily lives, but it presents a unique set of challenges to recent retirees. As the stock-market volatility continues, uncertainty over the future may leave you wondering the best way to draw down assets going forward. 

While your personal situation can dictate the optimal retirement withdrawal strategy, there is a general order to consider when drawing down assets. If you’re currently in the process of withdrawing to support your spending, consider the following steps:

  1. Spend from Investments with the Lowest Tax Rate
  2. Follow the Required Minimum Distribution (RMD) Rules
  3. Consider Partial Roth Conversions
  4. Donate to Charity
  5. Make In-Kind Withdrawals for Your RMDs
  6. Make the Most of Your Health Savings Account

Spend from Investments with the Lowest Tax Rate

This is the obvious first step to take when you need to pull money from your account because it will reduce your total tax liability. However, some factors can alter the order of your withdrawals.

These include your expected spending at various stages of retirement, your estimated income and tax liability, insight on whether withdrawals from your various retirement accounts will be taxable, and your expected income fluctuation over time. Keep a close eye on your tax bracket year by year to get all you can without paying more tax. Find out how tax projections can be a great tool to help you reduce your tax liability. 

Follow the Required Minimum Distribution (RMD) Rules

Before the SECURE Act took effect on Jan. 1, 2020, the age at which you needed to withdraw required minimum distributions, or RMDs, from your IRA and other retirement plans was 70 1/2. You now are not required to withdraw from those plans until you’re 72, which affords you a few extra years of tax-deferred growth.

If you don’t take RMDs at the required age, you could face issues such as the excess accumulations penalty. This means you’d have to pay a penalty of 50% excise tax for any years that you fail to take your required distributions.

Consider Partial Roth Conversions

If you drop to a lower tax bracket one year but know you will be in a higher bracket in the future, a partial Roth conversion is a good strategy. In this case, you would pay taxes on the IRA withdrawal at a lower rate now than you would in the future — and any future gains in the Roth aren’t taxed.

Remember, too, that you can make small Roth conversions over multiple years. Just remember to avoid some common mistakes, such as paying the conversion taxes with IRA funds or holding the wrong assets in your Roth account.

Donate to Charity

If you’re so inclined, you can leverage qualified charitable distributions, or QCDs, and donor-advised funds, or DAFs, to decrease your taxable income. This allows you to take an even more customized approach when withdrawing your retirement assets.

If you own an IRA and are 70 1/2, you can contribute up to $100,000 to charities without paying taxes as part of the QCD program. If you put money in a DAF, it will grow tax-free in a variety of investments (similar to the money put into an IRA). As it grows, you can decide when and how you’d like to donate that money.

Make In-Kind Withdrawals for Your RMDs

If you don’t want to take RMDs as cash, you can make in-kind distributions from your IRA. This means stock from your tax-advantaged retirement account can move to a taxable investment account (e.g., a brokerage account) without any need to liquidate shares first. Even better, in-kind distributions can potentially lead to capital gains in the future.

There are several reasons you might decide to make in-kind withdrawals. The market could have taken a downturn, you may have decided to hold onto a particular stock, or you just don’t need the cash right now. No matter the reason, you should discuss your situation with an expert before making any final decisions.

Make the Most of Your Health Savings Account

For those medical expenses that are bound to pop up during retirement, a health savings account, or HSA, allows you to withdraw the funds you need. What’s more, if you kept previous receipts from non-reimbursed health expenses, you can also withdraw funds in those amounts. These withdrawals are tax-free, unlike those from an IRA or 401(k).

Everyone has different needs, and optimizing withdrawals is a complex process, so it’s essential to work with an advisor. An expert can help you develop a plan that spends down one account at a time or draws proportionally from different accounts based on your situation. Then, you can better plan for the retirement you’ve always imagined.

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Disclaimer: This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.

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Peter Lazaroff, Co-Chief Investment Officer, first took an interest in investing when his grandmother gave him a single share of Nike stock for his 13th birthday. Today, nearly 20 years later, his investment insights are highly sought after by local and national media. More »