Tax-Efficient Withdrawal Ordering in Retirement

The Three Account Types and Their Tax Characteristics

Most retirees draw income from some combination of three account types, each with distinct tax treatment. Understanding these differences is the foundation of any withdrawal strategy.

Taxable brokerage accounts hold after-tax dollars. You have already paid income tax on the money you contributed. Investment gains are taxed as capital gains — either short-term (at ordinary income rates) or long-term (at preferential rates of 0%, 15%, or 20%). Dividends in these accounts may also receive favorable qualified dividend treatment. Because the cost basis has already been taxed, only the gain portion is taxable upon withdrawal.

Tax-deferred accounts (Traditional IRAs, 401(k)s, 403(b)s) were funded with pre-tax dollars, meaning you received a tax deduction when you contributed. Every dollar withdrawn is taxed as ordinary income at your marginal rate. These accounts are also subject to Required Minimum Distributions (RMDs) beginning at age 73, which force taxable withdrawals whether you need the income or not.

Tax-free accounts (Roth IRAs, Roth 401(k)s) were funded with after-tax dollars, but qualified withdrawals — including all growth — come out completely tax-free. Roth IRAs have no RMDs during the original owner's lifetime, making them the most flexible account type in retirement.

The Conventional Wisdom

The traditional approach to retirement withdrawals follows a simple sequence: spend down taxable accounts first, then tax-deferred accounts, and preserve Roth accounts for last. The logic is straightforward — let tax-free assets compound as long as possible while using taxable accounts that generate annual tax drag from dividends and distributions.

This ordering has the virtue of simplicity, and it is better than withdrawing randomly. However, it treats the problem as static when reality is anything but. Your tax bracket, income sources, and the tax code itself change from year to year. A rigid ordering ignores these shifts and often results in paying more tax than necessary over a 25- or 30-year retirement.

Why the Conventional Order Is Not Always Optimal

The fundamental flaw of the conventional approach is that it tends to push large tax-deferred balances into the future, where RMDs force them out at potentially higher rates. A retiree who spends down taxable accounts for the first decade of retirement may find that their Traditional IRA has grown substantially. When RMDs begin, those mandatory distributions can push them into the 22% or 24% bracket — even though they had room in the 10% and 12% brackets during the years they were withdrawing only from taxable accounts.

Additionally, a large tax-deferred balance at age 73 means larger annual RMDs. Those RMDs can increase the taxable portion of Social Security benefits, trigger Medicare IRMAA surcharges, and push long-term capital gains from the 0% rate to 15% or even 20%. The tax cost extends well beyond the marginal rate on the withdrawal itself.

The Dynamic Withdrawal Strategy

A dynamic, or optimized, withdrawal strategy takes a different approach. Instead of following a fixed order, it asks a simple question each year: given my projected income, deductions, and tax brackets, what is the most tax-efficient combination of withdrawals this year?

The core technique is bracket filling. Each year, you calculate your taxable income from all sources — Social Security, pensions, RMDs, and any other income. You then determine how much room remains in your current tax bracket. That remaining space can be filled with tax-deferred withdrawals or Roth conversions at a known, manageable rate, rather than letting that bracket space go unused.

For example, a married couple with $50,000 in Social Security income and $30,000 in pension income has approximately $127,000 of room before they leave the 22% bracket (after the standard deduction). Rather than withdrawing entirely from their taxable brokerage, they could take $80,000 from their Traditional IRA to fill the 22% bracket while paying a known and relatively moderate tax rate on those funds.

Gap Years: The Golden Window for Roth Conversions

The years between retirement and the onset of Social Security and RMDs represent a unique planning opportunity. During these gap years, your taxable income may drop significantly, creating room to convert Traditional IRA assets to Roth at historically low tax rates.

A retiree who leaves the workforce at 62 and delays Social Security to 70 has up to eight gap years where their only taxable income might be from a brokerage account or a small pension. During this window, they can convert substantial amounts from their Traditional IRA at the 10%, 12%, or 22% bracket — rates they will likely never see again once Social Security and RMDs begin simultaneously.

Every dollar converted during a gap year is a dollar that will never be subject to RMDs, will never count toward Social Security taxation thresholds, and will never trigger IRMAA surcharges. The long-term compounding of this advantage is difficult to overstate.

Strategy Comparison: 30-Year Retirement

The following table illustrates three withdrawal approaches for a married couple retiring at 65 with $600,000 in a taxable brokerage, $800,000 in Traditional IRAs, and $200,000 in Roth IRAs. They need $80,000 per year in after-tax income, receive $40,000 combined in Social Security starting at 67, and earn a 6% average annual return. Figures are approximate and for illustrative purposes only.

The dynamic strategy saves approximately $68,000 in taxes and leaves $85,000 more in the portfolio at age 95 compared to the conventional approach. The Roth-first strategy performs worst because it spends down the most valuable asset (tax-free funds) early, leaving the retiree fully exposed to rising RMDs later.

How Withdrawals Affect Social Security Taxation

Up to 85% of your Social Security benefits can become taxable depending on your "provisional income" — which is your adjusted gross income plus tax-exempt interest plus half of your Social Security benefits. The thresholds for married couples filing jointly are $32,000 (where 50% becomes taxable) and $44,000 (where up to 85% becomes taxable). For single filers, those thresholds are $25,000 and $34,000.

Withdrawals from tax-deferred accounts count fully toward provisional income. Withdrawals from Roth accounts do not count at all. Withdrawals from taxable brokerage accounts count only to the extent of the realized gain. This asymmetry is precisely why a dynamic strategy that mixes sources intelligently outperforms a rigid ordering approach.

How Withdrawals Affect Medicare IRMAA Brackets

Medicare Part B and Part D premiums are income-tested using your Modified Adjusted Gross Income (MAGI) from two years prior. This two-year look-back means that a large withdrawal or Roth conversion in 2026 affects your Medicare premiums in 2028.

Coordinating the Moving Parts

Tax-efficient withdrawal ordering is not a set-it-and-forget-it decision. It requires annual recalibration as tax law changes, market returns shift account balances, and life events alter your income picture. The interplay between federal tax brackets, Social Security taxation, Medicare IRMAA, state income taxes, capital gains rates, and net investment income tax creates a web of dependencies that no single rule of thumb can navigate.

This is where working with a financial advisor who understands all the moving parts becomes essential. The right withdrawal decision in any given year depends on your current-year income projection, your multi-year tax forecast, your health and longevity expectations, and your estate planning goals. An advisor can model these scenarios, identify the optimal blend of account withdrawals each year, and adjust the plan as circumstances evolve.

The difference between a good withdrawal strategy and an optimized one can mean tens of thousands of dollars in tax savings and a portfolio that lasts years longer. In retirement, where every dollar counts, that difference matters enormously.

This article is for informational purposes only and does not constitute investment advice. All information should be discussed with a qualified financial advisor before implementation.