How to Set Up a Tax-Efficient Withdrawal Strategy

Tax Strategies | by Jules Buxbaum | Saturday, February 08, 2025

Tax-efficient withdrawal strategy is critical for retirees who want to make the most of their income. It helps individuals approaching or already in retirement keep more money in their pockets while balancing different account types.

For those who aim to lower taxes in retirement, starting early can be beneficial. If you’re looking for additional tips on keeping your retirement tax burden low, check out our guide on minimize taxes on your retirement income.

Why a Tax-Efficient Approach Matters

Every dollar lost to taxes is a dollar you can’t spend on travel, hobbies, or everyday needs. Striking a balance between withdrawals from taxable, tax-deferred, and tax-free accounts can stretch your nest egg longer.

Retirement withdrawal planning often focuses on sequence: which accounts to tap first, how to handle withdrawals in mid-retirement, and when to rely on tax-free options. By aligning these actions with your personal goals, you can optimize retirement withdrawals and safeguard your savings.

According to a study by Fidelity, drawing from multiple account types proportionally can slash taxes by 40% and boost portfolio life by almost 5%. This figure is a reminder that strategy matters—and that it evolves as you move further into retirement.

1. Evaluate Your Different Account Types

Taxes in retirement hinge on how each account is treated. Taxable accounts (like brokerage or savings) are exposed to yearly taxes on dividends, interest, and capital gains.

Tax-deferred accounts, including Traditional IRAs or 401(k)s, let you postpone taxes until withdrawal. However, you could face higher rates if you remove large sums in the same year.

Roth IRAs offer tax-free potential if you meet the relevant guidelines. You pay taxes upfront, but qualified withdrawals are free of federal taxes later. This combination often gives you more control over your taxable income when you need funds the most.

2. Manage Your Tax Brackets

Tax bracket management means spreading withdrawals to avoid jumping from, for example, a 12% to a 22% band. One year, you might draw from your Traditionals up to a specific threshold, then use Roth funds to fill the gap.

This approach helps minimize taxes in retirement by steering clear of sudden bracket increases. It also prevents a “tax bump” later in life when large Required Minimum Distributions (RMDs) kick in.

Consider the times when you have lower taxable income. In those years, converting part of a traditional account to Roth might deliberately fill a lower bracket. That way, you lock in a known rate now instead of risking higher rates later.

3. Understand RMDs

Required Minimum Distributions (RMDs) begin at age 73 for most tax-deferred accounts. These mandatory withdrawals can push up your taxable income if you’ve accumulated a large balance.

Outline your projected RMDs in advance to sidestep surprises. According to Golden Apple Agency (2023), missing an RMD may lead to a 25% penalty on the undistributed amount.

If you’re curious about the nuts and bolts of RMDs, explore our article on Understanding Required Minimum Distributions (RMDs). It covers how they work and includes tips on avoiding penalties.

4. Roth Conversions: A Balancing Act

Moving money from a traditional account to Roth (a “conversion”) can reduce future RMDs. You’ll pay taxes on the conversion amount now, but subsequent qualified withdrawals are tax-free.

Timing is crucial. Converting a large sum in a single year might lift you into a higher bracket, wiping out the benefits.

Some planners recommend partial conversions for several years. This spreads your tax hit and leaves room for bracket control.

If you’re comparing pre-tax and after-tax contributions, have a look at our resource on Roth IRA vs. Traditional IRA: Tax Implications Explained. It helps clarify which path might best fit your goals.

5. Additional Strategies to Consider

Tax-loss harvesting offsets profits by selling investments that lost value. The resulting capital losses can reduce the taxes on gains or up to $3,000 of ordinary income.

Qualified Charitable Distributions (QCDs) from traditional IRAs can satisfy RMDs without adding to your taxable income. This is especially helpful for those who already donate to causes they support.

For investors who hold both stocks and bonds, asset location can ease tax drags. Placing high-yield bonds in tax-deferred accounts shields interest income from annual taxation, while using taxable accounts for equities lets you benefit from lower long-term capital gains rates.

Remember, strategic timing of Social Security can reduce combined income, possibly preventing up to 85% of your benefits from being taxable. Coordinating these elements can produce tax-smart retirement income.

6. The Role of Personalized Risk Allocation

Your withdrawal strategy should also mesh with the risk level in your portfolio. Some people assume they must “dial down” stocks with age, but that may not apply universally.

At 2Pi Financial, we’ve seen that what matters is how much wealth someone has relative to their future earnings. If you have strong income potential, you may withstand more market swings, even later in life.

Conversely, a younger person with little earnings capacity might prefer less equity risk. It’s about customizing your equity versus fixed-income mix based on personal circumstances, not just age.

Recognizing this relationship helps you blend a tax-smart withdrawal sequence with an allocation that fits your long-term goals. Each piece reinforces the other, allowing you to remain calm even during market dips.

7. Explore Our Financial Planning Engine

Once you understand the building blocks, it’s time for an integrated view. Our team at 2Pi Financial developed a specialized tool to simplify that process.

This tool shows you how to input retirement details, adjust savings rates or retirement dates, and compare multiple possibilities. Try the Two Pi Financial Planner to see these outcomes firsthand.

It also projects the probability of meeting your income targets through different markets. By testing modifications—like retiring one year later or converting a slice to Roth earlier—you’ll see how small tweaks might lengthen the life of your portfolio.

Realizing where your money grows and how you might withdraw it can let you plan confidently. The best solutions balance tax brackets, RMD timelines, and a sensible asset mix.

Wrapping Up

No single method suits everyone, but a carefully structured drawdown process can reduce taxes while preserving your savings. By looking at each account type, managing tax brackets, and coordinating Social Security, you boost the odds of sustaining income over the long haul.

State laws also play a part, especially if you’re considering relocation in retirement. To dig deeper, check out our resource on State-Specific Tax Benefits for Retirees: NY, NC & FL Compared. A tax-friendly state can further reinforce your strategy down the road.

In the end, a measured plan gives you more control of your finances. Take time to evaluate your options, and don’t hesitate to seek professional guidance when needed.

References

Fidelity. (n.d.). “Tax-Savvy Withdrawals in Retirement.” Available at: https://www.fidelity.com/viewpoints/retirement/tax-savvy-withdrawals

Golden Apple Agency. (2023). “Taxes on IRA Withdrawals.” Available at: https://www.goldenappleagencyinc.com/blog/taxes-on-ira-withdrawals

T. Rowe Price. (2022). “How to Get More Out of Your Retirement Account Withdrawals.” Available at: https://www.troweprice.com/personal-investing/resources/insights/how-to-get-more-out-your-retirement-account-withdrawals.html