Tax-efficient withdrawal order is the sequence in which you draw from taxable, tax-deferred, and Roth accounts to minimize lifetime taxes. The right order can save 10–20% in total taxes over a 30-year retirement — potentially hundreds of thousands of dollars.
Tax-efficient withdrawal order refers to the strategic sequencing of withdrawals from different types of retirement accounts to minimize the total taxes paid over a lifetime. Since taxable accounts, tax-deferred accounts, and Roth accounts are all taxed differently, the order in which you draw from them significantly affects how much of your savings you actually get to spend.
How It Works
The three main account types and their tax treatment:
| Account Type | Examples | Tax on Withdrawal |
|---|---|---|
| Taxable | Brokerage accounts | Capital gains rates (often 0–20%) |
| Tax-deferred | Traditional IRA, 401(k) | Ordinary income rates (10–37%) |
| Tax-free | Roth IRA, Roth 401(k) | None (if qualified) |
The conventional order: Taxable → Tax-deferred → Roth
The logic: let tax-advantaged accounts compound as long as possible. Spend taxable accounts first (lowest tax impact), then tax-deferred, and preserve Roth accounts for last (tax-free growth is the most valuable).
The improved approach: Fill low tax brackets strategically
Rather than rigidly following the conventional order, the optimal strategy adjusts year by year:
- Take enough from tax-deferred accounts to "fill up" low tax brackets (even if you don't need the income)
- Convert additional tax-deferred money to Roth during low-income years (Roth conversion)
- Use taxable accounts to bridge the gap between income needs and tax-bracket-filling withdrawals
- Preserve Roth for last — or for years when you'd otherwise be in a high bracket
Why It Matters for Retirement Planning
The wrong withdrawal sequence can cost retirees tens or hundreds of thousands in unnecessary taxes:
- RMD tax bomb: Retirees who leave large tax-deferred balances untouched until age 73 face large mandatory withdrawals that push them into high tax brackets
- Social Security taxation cliff: Above certain income thresholds, up to 85% of Social Security benefits become taxable
- Medicare IRMAA surcharges: High income in any single year triggers higher Medicare premiums for the following two years
Strategic withdrawals in early retirement — when income is typically lower — can dramatically reduce these future costs.
A Practical Example
A retiree at 65 has: $400,000 taxable, $600,000 Traditional IRA, $200,000 Roth. They need $48,000/year and are in the 12% bracket until Social Security starts at 70.
Naive approach (taxable first):
- Ages 65–72: Drain taxable account, leave IRA untouched
- Age 73: $600,000+ IRA generates $22,000+ RMDs, combined with Social Security pushes into 22% bracket
Strategic approach (bracket filling):
- Ages 65–69: Withdraw $48,000/year from taxable + convert $30,000/year of IRA to Roth at 12% rate
- By age 70: IRA reduced to $450,000, Roth grown to $350,000
- Age 73+: Smaller IRA means smaller RMDs, more tax-free Roth income available
| Naive Approach | Strategic Approach | Savings | |
|---|---|---|---|
| Lifetime taxes (est.) | $185,000 | $148,000 | $37,000 |
The strategic approach pays slightly more tax early (12% on Roth conversions) to avoid much higher taxes later (22%+ on large RMDs).
Frequently Asked Questions
- What is the standard tax-efficient withdrawal order?
- The conventional order is: (1) taxable accounts first (brokerage accounts — withdrawals may benefit from lower capital gains rates), (2) tax-deferred accounts second (Traditional IRA/401k — taxed as ordinary income), (3) Roth accounts last (tax-free growth continues as long as possible). However, this order should be modified based on individual tax bracket management and Roth conversion opportunities.
- Should I always withdraw from taxable accounts first?
- Not necessarily. The conventional order is a starting point, but strategic tax-deferred withdrawals in low-income years (before Social Security or RMDs begin) can reduce lifetime taxes. 'Filling up' low tax brackets with Traditional IRA withdrawals or Roth conversions during early retirement is often more efficient than strictly following the standard order.
- How much can tax-efficient withdrawal order save?
- Studies show optimal withdrawal sequencing can save retirees 10-20% in lifetime taxes compared to naive approaches, potentially translating to hundreds of thousands of dollars over a 30-year retirement. The savings come from managing tax brackets, minimizing RMD-related taxes, and maximizing tax-free Roth growth.