The Secret to Keeping More Money in Your Pocket

Taxes can significantly diminish your hard-earned retirement savings, but a strategic approach called tax-efficient drawdowns can help you keep more of your money. 

Each retirement account has its own tax rules, and withdrawing from the wrong account at the wrong time leads to unnecessary tax liabilities. Understanding these rules and implementing a thoughtful withdrawal plan is essential for maximizing your retirement income and ensuring financial security throughout your golden years.

Understanding Retirement Drawdowns 

Retirement drawdowns refer to the process of withdrawing money from retirement accounts to fund living expenses after you stop working. Planning this aspect of your retirement is crucial because how you access your funds directly impacts how much you ultimately have available to spend. A well-defined plan can help you avoid unnecessary taxes and extend the life of your savings.

The Importance of Tax Efficiency in Retirement 

Taxes can take a significant bite out of your retirement income. Every dollar you pay in taxes is one less you have for living expenses and enjoying your golden years. 

“In my experience, retirees hate taxes, and oftentimes, avoiding some taxes today means paying substantially more taxes later,” said David Rae, a Los Angeles- and Palm Springs-based financial planner and president of DRM Wealth Management. 

A tax-efficient withdrawal strategy minimizes this impact by carefully considering which accounts to tap and when, potentially extending the life of your savings and maximizing your money. In fact, research has found that proper withdrawal planning can extend retirement savings by three years or more, essentially giving you “free money” through tax savings.

Types of Retirement Accounts

Understanding the tax treatment of different retirement accounts is fundamental to developing an effective withdrawal strategy.

Traditional IRAs and 401(k)s: Contributions are often made with pre-tax dollars, meaning you don’t pay taxes on the money you contribute in the year you contribute. However, withdrawals in retirement are taxed as ordinary income.

Roth IRAs and Roth 401(k)s: Contributions are made with money you’ve already paid taxes on. The primary advantage is that qualified withdrawals in retirement are completely tax-free.

Taxable investment accounts: These are brokerage accounts where you invest with after-tax dollars. You pay taxes on any profits, including capital gains and dividends. However, the tax rates on long-term capital gains are often lower than ordinary income tax rates.

Traditional vs Proportional Withdrawal Strategies

Traditional

The traditional approach involves a specific sequence of withdrawals: taxable accounts first, then tax-deferred accounts (such as traditional IRAs and 401(k)s), and finally, tax-free Roth accounts. The underlying principle is to delay paying taxes on tax-advantaged accounts as long as possible, allowing those investments more time to potentially grow.

Proportional

In contrast to the sequential approach, the proportional strategy involves withdrawing a certain percentage from each account type (taxable, tax-deferred, and tax-free) each year. This method aims to maintain a relatively consistent ratio across your accounts, which can help manage your overall tax liability more evenly throughout retirement.

Kayla R. Fernandez of California Financial Advisors highlighted the benefits of this approach, particularly for those with substantial pre-tax accounts. 

“A proportional withdrawal strategy can be especially effective for retirees with sizable pre-tax accounts like 401(k)s, 403(b)s, or IRAs,” she said. “The core benefit is that this approach can allow retirees to optimize tax efficiency by utilizing lower income tax years and reducing the risk of larger, bracket-accelerating distributions in future years.” (Examples include a new car purchase or a big home repair.)

Strategies To Minimize Taxes on Withdrawals 

Capital Gains Management

One tactic to help minimize your taxes is planning around capital gains. Capital gains—the profit from selling investments in taxable accounts—are taxed at different rates depending on how long you held the asset and your overall income. Strategically timing your sales can allow you to take advantage of lower tax rates on long-term capital gains and potentially keep you within a lower tax bracket. 

Hilary Hendershott, a financial advisor and the founder of Hendershott Wealth Management, emphasizes the importance of proactive planning. “Many retirees don’t realize they have more control over their capital gains taxes than other forms of retirement income,” she said. She recommends thinking of retirement income in three buckets:

• Bucket A: Traditional IRAs, 401(k)s, and some pensions (taxed as ordinary income)
• Bucket B: Roth IRAs or Roth 401(k)s (tax-free)
• Bucket C: Taxable investment accounts (gains are taxable, offering more control)

Hendershott suggested withdrawing from taxable investment accounts first for that third bucket. 

“Only the gains portion is taxable, which means you have room to maneuver and reduce that tax–or avoid it entirely,” she said.

You should also opt to gift or donate appreciated assets in taxable accounts. “Giving your child appreciated shares from your taxable account shifts the gains from selling from your tax return to their return,” said Hendershott. “If they’re under the 15% capital-gains bracket, the tax owed could be zero.”

Tax Loss Harvesting

Tax-loss harvesting is another technique for minimizing taxes, especially during market volatility. “Tax loss harvesting can be extremely valuable when markets get bumpy,” Rae said. “With some savvy trading, retirees could minimize or eliminate capital gains over the next few years.” 

This involves selling losing investments to offset capital gains, potentially reducing your overall tax liability.

Required Minimum Distributions (RMDs)

The IRS requires you to start withdrawing from your tax-deferred accounts at a certain age (currently 73 for most people), which is also known as required minimum distributions.

Hendershott emphasizes the importance of early planning for RMDs. “For most people, RMDs kick in the year they turn 73, and you must take the first one by April 1 of the following year and every December 31 after that,” she said. “At our firm, we start estimating those payouts a decade, sometimes more, before they hit because early planning can prevent your taxes from snowballing later on.”

Waiting until you are forced to take RMDs leaves you little wiggle room to minimize taxes on your retirement income, and you’ll be overpaying them, according to Rae. “If you ignore RMDs until you are required to take them, you will be overpaying taxes in retirement,” he said. 

Roth Conversions

Converting funds from traditional IRAs to Roth IRAs can be particularly valuable in the early retirement years before receiving Social Security benefits or being subject to RMDs. “These years can often represent a tax trough where income is temporarily lower, creating an ideal environment for paying taxes on conversions at reduced rates,” Fernandez said.

Hiliary adds that when projections show excess RMDs, she often recommends converting funds from a traditional IRA to a Roth. “You’ll pay the tax up front and must wait five years before touching the converted dollars, but shrinking the IRA now can save more in forced taxable withdrawals down the road,” she said.

Charitable Giving

Fernandez, Rae, and Hendershott all highlighted charitable giving as a strategy. Qualified charitable distributions (QCDs) allow those over 70½ to donate up to $108,000 annually (for tax year 2025) directly from IRAs to qualified charities. This satisfies all or part of an RMD and excludes the donated amount from taxable income, which is especially beneficial for those taking the standard deduction.

Considerations for Different Income Levels 

Your income level during retirement significantly influences your tax rates on withdrawals and capital gains. If you anticipate being in a lower tax bracket in the future, delaying withdrawals from your tax-deferred accounts might be advantageous. 

Conversely, if you expect your tax bracket to be higher later, it might be prudent to draw down some of those funds earlier, potentially at a lower tax rate. 

Common Mistakes To Avoid 

Avoiding tax-related mistakes is as crucial as implementing sound withdrawal strategies.

One frequent issue that Fernandez said she sees is not coordinating account withdrawals for tax efficiency. Withdrawing from just one type of account without considering a blend of taxable, tax-deferred, and Roth resources can lead to inefficient tax outcomes. She noted that sometimes drawing from a Roth account earlier is beneficial, especially during temporary income spikes.

According to Fernandez, another common mistake is inefficient asset allocation across account types. Examples include allocating CDs in taxable accounts, overlooking Treasuries, or placing tax-efficient investments like municipal bonds in retirement accounts.

Another pitfall is rolling over 401(k) assets to an IRA before considering net unrealized appreciation (NUA). Under specific conditions, Fernandez said this strategy allows gains on employer stock within retirement plans to be taxed at typically lower long-term capital gains rates. 

The Bottom Line

Having a plan for withdrawing retirement money can save you thousands in taxes and help your savings last longer. What matters is knowing how each account type is taxed, choosing withdrawal methods that minimize your tax burden, and paying attention to RMDs and capital gains. Of course, the right approach comes down to your specific financial situation, income, and goals.