Retirement drawdown strategy

Prepare yourselves for a long winded article with no meaningful conclusions about the best way forward! You have been warned!

To expand on that, there are an absolute ton of factors involved in finding the right path forward. Just to name a few: how much you've saved, where you've saved it, your expenses, and (morbidly) how "long you'll need to draw funds for" (ahem, aka die).

This article will hopefully get you thinking about how to define your investment strategy as it relates to when you get to retire! It will only focus on optimizing for taxes, as that's where my knowledge is focused (i.e. there may be insurance options that help avoid a particular expense) and the only one I can really discuss as it relates to your unique spending situations (i.e. if you have a paid off mortgage already). It's just a small subsection of a big picture!

• Retirement drawdown strategy
  • Basic premises
  • Your expenses
  • Non-taxable income
  • Taxable income
  • Prioritizing tax treatments while saving
  • Withdrawal order
    • "Filling buckets"
    • Not overdrawing important tax treatments
    • Early retirement
    • RMDs
  • When to withdraw?

Basic premises

This part should be part "of course" mixed with (hopefully) already established knowledge from other areas of this blog.

You're going to likely lean on a "safe withdrawal rate" to determine two factors: how much you need to save before retiring as well as how much can you pull from your retirement funds. The math behind this & personal perspective on this is worthy of its own article, but for now, if you want to read more on it, start with this article. I'll use 4% as an example, as it's a widely accepted target.

Now, as for where the money is drawn from...that's the purpose of this article! There are a few pre-requisites to understand prior to this:

• Roth & traditional
• HSA

These items are going to be mentioned in this article and the caveats are important for drawing down funds in retirement. The Roth/Traditional piece applies to most accounts (401k, IRA, 457 etc). There are nuances of these accounts that I'll generalize, but the HSA rules are especially interesting in the early retirement conversation.

What we'll want to understand is: how can we minimize our taxes (an expense needing to be funded from investments now!) while coming up to that safe withdrawal rate. Now, let's get into some details...

Your expenses

Your expenses dictate a good amount of how you'll want to draw your funds. The math is really, really stupid...but if your expenses are low enough (aka your need for income is low, too), you could have a negative tax liability! As an example:

You & your spouse's expenses are $35,000/yr. You sell $35,000 worth of VTSAX and have no other forms of income (let's pretend no dividends exist this year). Your tax liability? $0, if you include the standard deduction? -$27,700. That's because you can have up to $89,250 in long term capital gains (I emphasize gains because you would also have principal as a part of that sale, too). If you are under that $89,250, it would be a good idea to do tax gain harvesting.

If you have higher expenses due to healthcare and other forms of expensive end-of-life services (think long term care, nursing home, etc), this becomes more difficult to do. Additionally, very few people will have such low expenses where $875k in a brokerage account would suffice. Don't worry, there are other ways to keep that tax picture low!

Non-taxable income

Capital gains taxes are based on your taxable income. There are other ways of achieving the necessary funds while also keeping your taxable income low. An example, is using your HSA to recoup incurred medical expenses. This can be current medical expenses, or, as highlighted in the HSA article, past medical expenses. This income is non-taxable (at least federally), and would allow you to still be below that $89,250 of income to be in the 0% bracket of long term capital gains taxes!

This also applies to Roth withdrawals, as well.

Taxable income

Taxable income is somewhat unavoidable. It comes in various uncontrollable forms like dividends, bank interest, social security, etc. Income is great! Some strategies for retirement revolve around building income streams instead of relying on withdrawals (i.e. rentals, high dividend yields, etc). Just remember: if you're paying taxes, it's because you had income that could be used to pay expenses. It may be less efficient than non-taxable income, but it is still good to have rather than not!

Eventually, you may exhaust all forms of non-taxable income and have to rely on your pre-taxed accounts (such as traditional 401ks, IRAs). Additionally, it can be more tax advantageous to pull from traditional accounts in order to not pull from non-taxable income sources and make them last longer.

Prioritizing tax treatments while saving

Up to now, you've probably had a few thoughts: "I could overweight on Roth and just pay all the taxes now, that's the best way to keep tax expenses low in retirement!", or maybe "if I never exceed the capital gains 0% bracket in expenses, then it would be most efficient to just invest in my brokerage!"

Unfortunately, that ignores the bigger picture. Roth & brokerage investments are expensive over that of traditional (remember, when you invest in pre-tax accounts you're saving taxes at the highest tax bracket. So that could be up to 37% less in investment principal). As mentioned in the last section, it's also not a bad thing to have traditional investments because of how our tax brackets work. In 2025, you'd only pay 12% up to $96,950 of income (pre-standard deduction, too!).

It's impossible to know what tax brackets will look like in 30 years, or if HSAs will even be a thing (i.e. universal healthcare?), or if capital gains will be treated in the same way. This is why the premise behind investment diversification applies similarly to taxation treatment.

Withdrawal order

You're now a bajillion words into this article. Hopefully you've learned something in the ramp up to the meat of the article. As a reminder: there is no one size fits all solution. Not everybody has an HSA. Perhaps you didn't have access to a megabackdoor Roth 401k and thus have little Roth savings. Perhaps you were a government employee and have a pension or a lovely 457b which allows early withdrawals without penalty! There are a ton of factors!

"Filling buckets"

The way I look at retirement funding is by looking at the various tax brackets as a form of bucket. An optimal tax picture is to fill the most optimal buckets to the brim, while minimizing the buckets that are less efficient. For instance, 2025 has a tax rate of 10% up to $24,300. If you account for a standard deduction of $30,000, that's $54,300 of income at only 10%. This is the most optimal taxable income bracket. Those "uncontrollable taxable income" items fall under this bucket. Things like a pension payout, social security, etc will likely take a good portion of these items before you even touch pre-tax dollars. Additionally, these brackets may be worth taking advantage of in years where you don't have as much income to do things like traditional -> Roth conversions.

To realize that $54,300 of income, it'll count against the $94,050 of taxable income limit for the 0% capital gains bucket. This means you could get $39,750 of capital gains in for the year and not pay a dime of extra taxes on that income. If you needed even more money, you could look at pulling from your Roth accounts.

For most years, this should be a relatively simple process. Big expenses throw a wrench in the plans. However, the same principals apply. You'll want to maximize the lower tax brackets as much as possible, and compare them with your options. Up to the 22% income bracket? Capital gains are only 15% up to $553k of gains.

Not overdrawing important tax treatments

As mentioned earlier, you may think going 100% Roth is best, and if you did that, this section won't apply to you! However, if you have a mix of tax treatments, you'll want to keep something in mind: tax-free accounts are of massive value for flexibility & optimizing taxes. Have unexpected expenses and already crossed into higher tax brackets? Leverage your Roth. However, it's also important to not over utilize these accounts, especially early in retirement. Every year those funds sit in the market, they (on average) gain value. This gives you future flexibility and a lower tax picture when your expenses will likely start to spiral out of your control (a sad fact of life).

While it may be advantageous to tap your HSA for tax free money before you can access Roth (aka early retirement), that could be a very, very useful account later in life when medical expenses increase substantially.

None of this is to say you're doomed if you decided to leverage one too much, but it can force you to have a higher tax bill in later years when you need to rely more on traditional accounts to fund your expenses. Sometimes it's worth paying 12% income taxes, or 15% capital gains to help preserve your Roth balance.

Early retirement

This is my pursuit. It adds complications to an already complicated picture. Before 59.5 you can face early withdrawal penalties from accounts like 401ks, or penalties on conversions from 401k to IRAs before 5 years. It may make me burn through my entire HSA balance before I really needed it due to present day medical expenses.

The best method I've seen thus far is to essentially use a mix of brokerage accounts, HSA, Roth contributions, and a Roth conversion ladder. I have also had the distinct privilege of being able to leverage megabackdoor Roth 401ks for the last several years (and will max out as much as I can before retirement). These contributions can help us float for (hopefully) many years alone.

Additionally, my wife works for state government and we've been maxing 457b contributions for the last several years, giving us another income source without early withdrawal penalty.

Other options include deferred compensation plans, where your employer manages your pay in a deferred account and pays it out over a schedule after your employment has been terminated.

All of these methods act as bridges to the 59.5 magic number where you can start avoiding the penalties for early withdrawals. The points above in "Filling buckets" apply, with a very watchful eye on where the money is coming from.

RMDs

Required minimum distributions is the IRS's way of getting their due taxes. They force distributions of traditional dollars from tax advantaged accounts based on a formula of age and balance. This could mean a bigger tax picture if you didn't draw down from these accounts early enough. It's possible to avoid these by doing conversions to Roth, withdrawing them before the RMD kicks in, or just biting the bullet and accounting for it in your taxable income amount for the year.

When to withdraw?

This section is a pretty minor point in the big picture, but I felt it was worth typing out. There are some folks who recommend pulling a full year's expenses out at the beginning of the year. Others recommend withdrawing monthly. I'm somewhere in the middle. The truth is, it's up to you. You can choose what works best for you, with the following considerations:

• The more times you withdraw, the more taxable events you'll likely have (aka more paperwork)
• The same mantra of "time in the market beats timing the market" applies to withdrawals. It's beneficial to have your money grow (aka stay in the market)
• It's easier said than done to know how much you'll need for the year

As a result, I think my plan would be to withdraw quarterly, relying on an overflow bucket to help cover unforeseen expenses.