For most Americans, your tax bracket is largely out of your control during your working years. It’s determined by your salary, and taxes are automatically withheld from each paycheck.
But in retirement, the script is flipped. You may have multiple income sources — like withdrawals from brokerage accounts, IRAs, and Social Security benefits — all taxed differently and often within your control.
Many retirees don’t realize that withdrawing funds in the wrong order or at the wrong time can cost them tens of thousands of dollars in unnecessary taxes over time. A poorly timed move could push you into a higher tax bracket or trigger hidden penalties tied to programs like Medicare.
Here’s why managing your retirement tax brackets can save you real money — and how to take advantage of this oft-overlooked strategy.
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A common retirement withdrawal strategy is to draw from taxable accounts first, then tax-deferred accounts like traditional IRAs and 401(k)s, and save Roth accounts for last, according to T. Rowe Price. (1)
On paper, this seems smart: early in retirement, you’re likely in a lower tax bracket, so withdrawals from taxable accounts are taxed at a favorable rate. However, this approach can backfire over time, potentially increasing your lifetime tax bill.
Consider Jane, who retires at 62 with $1.5 million: $1 million in a 401(k), $300,000 in a brokerage account, and $200,000 in Roth IRAs. If she delays tapping into her 401(k), it could grow to $1.6 million by age 73 — when required minimum distributions (RMDs) begin.
At that point, large (RMDs) may push Jane into a higher tax bracket, cause up to 85% of her Social Security benefits to become taxable (2), and trigger Medicare income-related monthly adjustment amount (IRMAA) surcharges.
Because of her wealth, Jane could also have additional tax burdens, including Net Investment Income Tax (NIIT), and, in rare cases, the Alternative Minimum Tax (AMT), depending on her income and deductions. (3)
In short, while the conventional withdrawal order may seem tax-efficient early on, it can lead to higher taxes and penalties later. The good news is that there is a more strategic approach.
