So, you’re ready to retire?

You’ve made it to retirement and are now drawing down your savings after a lifetime of building them up. As you begin to use these funds, you may be wondering from which savings “buckets” to spend first?

You probably have some combination of the following sources of funds:

1. Pre-tax IRA (and/or 401k, 403b, or SEP-IRA)
2. Roth IRA
3. Inherited IRA
4. Social Security
5. Taxable savings

You’ll want to draw down these funds in a manner that minimizes taxes over your lifetime. I’ll offer some general principles that should apply in most circumstances:

1. Pre-tax IRA

Withdraw the required minimum distribution (RMD) if you’re age 72 or older, but don’t withdraw more than that if you don’t need to. If you are under age 72 and can afford to wait and live on other savings, don’t withdraw any of the funds. One exception may be to use these funds to delay claiming Social Security (see below).

To complicate things a bit, in certain circumstances, it makes good sense to convert some of these funds to a Roth IRA. If you do that, you should have sufficient funds in a taxable account to pay the additional taxes you’ll owe on the conversion.

2. Roth IRA

This is the easiest decision — if you can afford to wait, don’t withdraw any funds. A Roth IRA is the most favorable tax shelter so tap it last and let it grow tax-free for as long as possible. Ideally, leave it behind for your kids and they’ll have fond memories of you when they spend it years later.

3a. Pre-2020 inherited IRA

If you can afford to wait, withdraw no more than the RMD.

3b. 2020 (and beyond) inherited pre-tax IRA

This determination is more complicated. If you have one of these, see my explanation here. In short, for most beneficiaries, you’ll need to empty this account within 10 years and it probably does not make sense to do so all at once in year 10.

3c. 2020 (and beyond) inherited Roth IRA

This decision is simple — if you can afford to wait, don’t withdraw any funds until year 10 by which time it must be emptied for most beneficiaries.

4. Social Security

If you have not already claimed your Social Security benefits, it may likely make sense to delay until age 70 and rely on your other savings until then, including tapping IRA withdrawals earlier than is required. Unless your life expectancy is short, delay claiming, especially in our new inflationary era.

5. Taxable savings

That leaves your non-retirement savings.

I usually recommend using these funds before you reach into those other buckets. In some cases, you may pay capital gains taxes and that may change the calculus a bit. However, keep in mind that when withdrawing from a pre-tax IRA, you’ll pay ordinary income tax that will most likely be at a higher rate than long-term capital gains. When you use these funds, pay attention to the capital gains treatment of anything that you need to sell.

The general approach is to spend your savings in the most tax-efficient manner you can. That usually means deferring taxes to the future, unless you have particular circumstances where that may not make good financial sense. Also, ordinary income tax rates (from pre-tax retirement accounts) are higher than your rate on long-term capital gains, so minimize the distributions that trigger ordinary income.