Tax Strategies for Retirement Account Withdrawals

If you're like most retirees, running out of money is likely one of your biggest fears for your golden years. The good news is that careful planning and tax-efficient drawdown strategies can help support the lifestyle you're hoping for in retirement while helping minimize the impact of taxes on your retirement income.

Chances are that your retirement accounts include a 401(k) or IRA. Retirement accounts come with plenty of benefits, such as tax deductions and the potential for investment growth over time. But they can also come with complicated rules that might make it tricky to access your money without incurring heavy taxes. Here are some helpful, tax-efficient retirement account withdrawal strategies to consider.

Avoid the Early Withdrawal Penalty

Taxes are an unfortunate reality for any traditional 401(k) withdrawals. However, there are some ways you can potentially reduce the amount you owe. One of the simplest options is to avoid withdrawing money before age 59½. Early withdrawals are subject to a 10% penalty in addition to the typical income tax on the withdrawn amount.

Roll Over Your 401(k) Without Tax Withholding

If you change jobs before age 59½ and withdraw money from your 401(k), 20% will be withheld for taxes. You then have 60 days to put the entire amount withdrawn, including the 20% withheld, into a new retirement account to avoid an early withdrawal penalty and income tax.

It's possible to avoid the tax withholding and potential penalties with a trustee-to-trustee transfer — transferring money directly from your 401(k) to the trustee of another 401(k) or IRA.

Remember Required Minimum Distributions

To avoid a tax penalty, you need to begin withdrawing Required Minimum Distributions (RMDs) from your IRA and retirement plan accounts annually, starting at age 73. If you miss a withdrawal, you may owe a 25% excise tax on the amount that was supposed to be withdrawn. Correcting the shortfall within the IRS's two-year correction window can reduce that penalty to 10%.

Avoid Two Distributions in the Same Year

Taking two distributions in one year may push you into a higher tax bracket and produce more taxable income. If you're 73 and retired, you can wait until April 1 of the calendar year after you've turned 73 to take your first distribution. After that, distributions must be taken annually by December 31.

If you're tempted to delay your first distribution because you think you might be in a lower tax bracket once retired, keep in mind that delaying means taking two distributions in one year, which can create a greater tax burden.

Take Withdrawals Before They're Mandatory

You may be able to reduce lifetime tax payments on your 401(k) withdrawals by taking them before the mandatory date. Instead of waiting until age 73, some savers choose to start taking smaller withdrawals in their 60s. This approach may help keep you in a lower tax bracket and spread your tax burden over more years — though the right approach depends on your individual income and tax situation.

Donate Your IRA Distribution to Charity

Do you want to continue giving to your favorite charities in retirement? You can potentially reduce your taxable income by donating IRA distributions directly to charity.

If you're at least age 70½, you can contribute up to $111,000 ($222,000 for a married couple, with each spouse using their own IRA) directly from your IRA to a qualified charity in 2026, avoiding income tax on that distribution. All qualified charitable distributions must be made directly from your IRA to the charity. As an alternative, you can donate part of your RMD and withdraw the remaining amount as taxable income.

Consider a Roth Account

Parking some of your savings into an after-tax Roth account may help set you up for tax-free investment growth and withdrawals during retirement. Contributions to a Roth IRA or Roth 401(k) cannot be deducted from your taxable income for that year, but qualified withdrawals of earnings are generally free of income tax. To qualify, you generally need to be at least age 59½ and have held the account for at least five tax years. Early withdrawals for certain qualifying expenses may be exempt from penalties.

Keep Tax-Preferred Investments Outside of Retirement Accounts

An effective tax-efficient investing approach is to consider leaving investments that generate long-term capital gains outside of your retirement accounts. If those investments are held in a retirement account, withdrawals may be taxed at the higher ordinary income rate instead. You might instead consider holding more highly-taxed investments — such as corporate and government bonds, or funds generating short-term capital gains — inside your retirement accounts.

Use Your Funds in the Right Order

Strategic retirement planning includes knowing how and when to draw income from various sources. Several factors matter here, including your age, lifestyle goals, income sources, and the types of assets you hold.

To help manage lifetime income, some retirees consider withdrawing from taxable accounts first, since those gains are often taxed as long-term capital gains rather than ordinary income — typically at a lower rate.

Next, you might withdraw from tax-deferred accounts such as a traditional IRA or 401(k). Withdrawing from these after your taxable accounts may allow the remaining tax-deferred assets more time to potentially grow.

Consider withdrawing from a Roth IRA last, since it has no RMD requirement — letting it continue growing for as long as possible, with qualified withdrawals generally free of tax on investment gains (see the Roth account qualifications above).

Let's schedule a meeting to discuss how strategies like these might apply to your specific situation, so you can make the most of your retirement savings.

For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Registered Representatives of Cetera firms may not give legal or tax advice.

Before deciding whether to retain assets in a 401(k) or roll over to an IRA, an investor should consider various factors including, but not limited to, investment options, fees and expenses, services, withdrawal penalties, protection from creditors and legal judgments, required minimum distributions, and possession of employer stock. Please view the Investor Alerts section of the FINRA website for additional information.

Some IRAs have contribution limitations and tax consequences for early withdrawals. For complete details, consult your tax advisor or attorney. Distributions from traditional IRAs and employer-sponsored retirement plans are taxed as ordinary income and, if taken prior to age 59½, may be subject to an additional 10% IRS tax penalty. A Roth IRA offers tax-free withdrawals on taxable contributions. To qualify for tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59½ or due to death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.

The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value.