3 Things Retirees Must Do Before Taking Their First Retirement Account Withdrawal
Written by
Kerra Bolton
Edited by
Jenna Klaverweiden
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Making the first retirement account withdrawal is like achieving most other financial milestones; it requires organization and planning.
Planning ensures retirees withdraw with the intention to minimize taxes and avoid penalties. Preparing ahead also helps preserve savings, reduce tax burdens and make the most of retirement income.
Here are three things retirees must do before taking their first retirement account withdrawal.
Plan Ahead
Retirees should start by understanding their income needs, tax bracket and the timing of required minimum distributions (RMDs). Regular withdrawals offer flexibility, while RMDs are mandatory after a certain age and follow specific rules.
Tyler Meyer, CFP, founder of Retire to Abundance, said retirees should prepare by establishing a spending plan, consolidating and simplifying accounts, and creating a cash reserve.
“Streamlining finances by rolling over old 401(k)s into IRAs can make managing withdrawals easier,” Meyer said. “Maintain 12 to 24 months of living expenses in cash or a cash equivalent to avoid selling investments during a market downturn.”
Create a Withdrawal Strategy
Next, you’ll want to make sure you have a withdrawal strategy set up. Experts at U.S. Wealth Management, a financial advisory firm, said one of the strategies retirees could consider is withdrawing 4% of their savings during the first year of retirement.
In subsequent years, retirees could use the 4% as a baseline and scale the amount to account for inflation. The advantage of this “4% rule” is that it works in most markets for most people and it’s a financial goal that is easy to understand and achieve.
However, there could be drawbacks to the 4% rule if other factors, such as anticipated retirement longevity or investment allocation, require a more customized plan.
“Estimate life expectancy and adjust withdrawal rates accordingly, keeping in mind that many people underestimate how long they’ll live,” Meyer said.
In addition, Meyer recommended overlaying retirement income guardrails and running a stress test of the withdrawal strategy.
“Guardrails dynamically adjust withdrawal amounts based on portfolio performance and spending needs,” Meyer said. “They provide structure while reducing the risk of running out of money. Run a stress test to model withdrawals under various market conditions to see how long the portfolio will last.”
Consider Tax Implications
Withdrawing from your retirement account for the first time has significant tax implications based on the account type and your age.
“Many people are seeking ways to help reduce the taxes that they will pay over the course of their retirement,” said Andrew Bachman, director of financial solutions at Fidelity Investments, in an article about the topic. “Timing is critical. So how and when you choose to withdraw from various accounts — 401(k)s, Roth accounts, and other accounts — can impact your taxes in different ways.”
Traditional IRAs and 401(k)s are generally taxed as ordinary income. However, retirees under the age of 59 1/2 could pay an additional 10% penalty unless there are certain exemptions, such as disability or a court-ordered withdrawal to a former spouse or dependent.
Roth IRA withdrawals are tax-free if the account is at least five years old and the retiree is over 59 1/2. If the timing of the first withdrawal doesn’t meet these conditions, retirees can expect to pay taxes and penalties.
For retirees born after 1950, mandatory withdrawals begin at age 73 from traditional accounts and are taxed as ordinary income. If retirees aged 73 and over don’t withdraw from their accounts, they could pay 25% in penalties. Roth IRAs are exempt from RMDs during the account holder’s lifetime.
Meyer said retirees should start withdrawing from taxable accounts and then move to tax-deferred accounts.
“Save Roth IRAs for last to allow tax-free growth,” he said. “Adjust the order based on your tax bracket and income needs for the year.”
Finally, Meyer suggested checking Medicare premiums and Social Security thresholds before the first retirement withdrawal. He said withdrawals could affect taxable income, which could increase Medicare costs or incur more taxes on Social Security benefits.
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