Happy Friday Reader ☀️
Welcome back to Safe Money Weekly, where I share retirement income planning strategies, case studies, and ideas to help you retire with more confidence and less uncertainty.
One of the most common questions I get is “Where do I spend money from first in retirement?”
It’s a great question because the order in which you spend your money can have a massive impact on your lifetime tax bill.
And minimizing that tax bill means more money to spend, or leave behind to loved ones.
Of course, this takes us into the “tax planning” realm of financial planning, which can quickly become overwhelming. Between RMDs, IRMAA surcharges, and Roth conversions, a straightforward question starts to feel complicated.
But I think there’s a simpler way to approach it. At the very least, a good rule of thumb.
Let’s start with Roth IRAs.
You don’t get an upfront tax benefit for contributing to a Roth IRA… so why put money there?
Simple, because that money can grow tax-free for the rest of your life. It also transfers to your loved ones tax-free and often allows them to leave inherited money growing tax-free for another 10 years (before being forced to withdrawal).
So what’s the point?
The point is that the benefit of Roth IRA’s is almost entirely on the back end.
That’s why it often makes sense to spend your Roth money last!
Now, brokerage accounts are a different story.
You funded these accounts with money you already paid taxes on. So when you take money out, your original contribution isn’t taxed again (only the growth in the account).
That can make brokerage money an efficient place to start, helping keep your taxable income lower in the early years of retirement.
But that doesn’t mean you should ignore your other accounts until the brokerage money runs out.
That brings us to tax-deferred retirement accounts.
These are your traditional 401(k)s, IRAs, TSPs, 403(b)s, etc.
Their tax benefit usually came on the front end: you received a tax break when you put money in.
But withdrawals of those pre-tax dollars and their earnings are 100% taxable as ordinary income.
Conventional wisdom might say to delay those withdrawals, kicking the proverbial “tax can” down the road as long as possible.
But that’s not always wise.
It often makes sense to supplement your brokerage money with retirement account withdrawals, especially if you can take them at favorable tax rates.
And that doesn’t mean you have to spend the money.
You might instead move some of it into a Roth IRA. That’s called a Roth conversion. You pay taxes now on that money, but it moves into an account that will grow tax-free for the rest of your life.
And we already discussed why Roth money can be so valuable so valuable in the long run.
So here’s a useful starting point for spending in retirement:
- Spend brokerage/after-tax money first to help manage your taxable income in the early years
- Strategically withdraw from tax-deferred accounts (or convert to Roth) along the way, taking advantage of lower tax brackets when available
- Preserve Roth assets when practical for tax-free income later in retirement or money for loved ones
The right mix will depend on your situation, but this gives you a framework for a question that often becomes much more complicated than it needs to be.
And as always, if you have questions, just reach out.
— Matt
P.S. As always, here is some new content I made this week