When you retire, you’ll likely draw your income from several sources—such as retirement accounts, taxable investment accounts, and Social Security Benefits. Each of these sources is taxed according to its own rules. So, in order to accurately plan for your retirement, you need to know what these rules are, whether (and when) you’re required to make withdrawals, and how paying taxes on distributions will impact your overall financial goals.
Here’s a breakdown of the most commons sources of retirement income and how they’re taxed:
Traditional IRA and traditional 401(k)
Making a withdrawal plan
Once you understand how your retirement income is taxed, you can make a tax-efficient plan to support you in your retirement years. You might consider a plan that looks like the following:
- Taking withdrawals from traditional IRA and traditional 401(k) accounts first to satisfy annual RMDs.
- Next, take withdrawals from taxable accounts.
- Take withdrawals from Roth IRAs, and Roth 401(k) accounts last. The longer you can avoid drawing down these plans, which aren’t subject to RMDs, the longer they can benefit from tax-free growth.
A careful withdrawal plan—and keeping your money in tax-exempt accounts as long as possible—can help you maximize your investment returns while minimizing the taxes you’ll owe.