So, you’re ready to retire?

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

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

  1. Pre-tax IRA (and 401k, 403b, or SEP-IRA)
  2. Roth IRA
  3. Inherited IRAs
  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).

2. Roth IRA

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

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.

3c. 2020 (and beyond) inherited Roth IRA

This decision is also simple — if you can afford to wait, don’t withdraw any funds until the end of 10 years.

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, it pays to delay claiming.

5. Taxable savings

That leaves your non-retirement savings.

I usually recommend drawing down 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.

The general approach to these retirement spending decisions is that you want 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.

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