Why Withdrawal Strategy for Retirement Tax Planning Matters

Many retirees spend decades saving and investing for retirement. But what some may not realize is that how you withdraw the funds can cost or save you thousands in taxes over time. Today we’re talking about tax planning and specifically what it means in your retirement plan.

Let’s chat.

My name is Gina DiGirolamo. I’m here with Adam Larkin. Adam, let’s jump right into it. Many retirees have saved and invested into different accounts throughout their career. Tell me a little bit about the different accounts someone might have going into retirement. Got it. So we’re going to break this down into kind of three buckets I’ll call it.

The first one is going to be what’s called a pretax or traditional qualified account. The second is a Roth qualified account. And we’ll get into some of the differences or what makes something qualified versus non qualified. But the third would be that after tax non-qualified, you might hear of this as a a taxable or a brokerage account.

So those are kind of the three buckets primarily that people are saving into while they’re putting away for retirement. Okay. So the two difference is there is a qualified and non qualified. Let’s start with qualified. Tell me about the tax consequences of those types of accounts. Yeah. So very simply the way that I like to describe this is that something is qualified, which means that you get some sort of tax advantage by contributing to these accounts.

So in the case of either pre tax or traditional qualified account, you’re getting this tax advantage upfront. When you make contributions in the form of a deduction against your income for the year that you make the contribution. That money then grows tax deferred. And the money is then taxed on the back end. When you take withdrawals or distribution from that account.

So this could be a pretax or traditional either IRA or your for one K through work or for three B whatever you might have through your employer sponsored plan. And just a quick caveat on that specifically taking distributions after age 59.5. That’s right. Yeah. So the trade off of getting this, you know, in this preferential tax treatment or you know, the the deduction up front in the case of the pretax, is that you are able to trade freely in that account without recognizing any capital gains along the way.

But yes, you’re you are supposed to wait until you’re age 59.5 before you start withdrawing without, recognizing any penalty. So then the second type so the Roth account is making the opposite decision, which is to say I’m willing to pay tax on these dollars. Now then any growth on those dollars is going to grow tax free.

And when I take distributions at the end those distributions are also going to be tax free. So what happens now tax wise in the other type the non-qualified account. Yep. Okay. So a non-qualified account. So the difference here is that there is not that restriction of the 59.5. Right. So the trade off there though is that if you are trading inside of those accounts, you know, but between the time that you’re contributing and when you reach age 59 and one half is that you might have to pay what are called capital gains taxes.

So again, you buy a stock inside of a taxable account, or this non-qualified account. Then that stock appreciates from $100 up to 120. You have to pay tax on that $20 worth of growth when you choose to sell it. So you’re, you’re sort of taxed along the way. But the benefit that you get is that, like I said, you don’t have that restriction to wait until age 59.5.

You can have access to those funds as soon as you want to sell them. So shifting into someone that’s in retirement or approaching retirement, they maybe have a pretax IRA or a Roth IRA and this non-qualified brokerage account, they have these three accounts. They they’re stepping away from work. They need to replenish. They need to replace their income.

When we’re talking about distribution strategies. Another piece of that is Social Security. How does Social Security play into all of these other account types?

Yeah. Okay. So we kind of think of Social Security as this, income stream that you’ll have in retirement. So whenever you choose to turn on Social Security, now you have something to satisfy all or at least some portion of your income need for a year. So let’s say in a scenario where you’re somebody that needs $200,000, worth of cash flow for a year to sustain your lifestyle and social Security covers 50,000 of that.

Well, that’s great. So that that limited now down to 150,000 that we need to supplement. So then we have a decision with these other three accounts that we mentioned earlier of, from which accounts should we take and why would we make any one decision rather than another. And the answer to that question is that we’re often looking at your tax bracket and your Medicare bracket, or the premiums that you’ll be paying for your Medicare to drive our decision of which buckets we want to pull from to supplement your Social Security income.

And let’s go a little bit deeper into that. So you mentioned the Medicare premium. Why is this important and what does it mean for someone in retirement.

sum Medicare premium. So part B and part D they come with an annual cost. Right. And at the very basic, you know, first level everybody kind of pays that same amount.

If you have an income level level over a certain threshold, you have to start paying what is called Erma. So an income related monthly adjustment. And what that means is that you would have to pay an amount above what is kind of that base level because your income is too high.

So the Social Security Administration is going to look back at your prior two years tax return, meaning, for them to determine whether or not you need to pay Irma and which level of Irma that you need to pay.

They’re going to look back for 2026. They’re going to look at your 2024 tax return to determine what your income level was then. Which sets what what your Medicare premiums will be for this year. And if you think about the financial life cycle of a person, their their later years in their career approaching retirement are typically their highest earning years.

Also, you know, we’ve had clients that have sold a business or had a big cash inflow in those years leading up to retirement. What does someone do if they have their biggest income year a year or two before retirement, and then they have this two year lookback period? Yeah. So you can file it’s form SSA 44. It’s kind of a redetermination of your Irma premiums.

You’re essentially reaching out to the Social Security Administration and saying, hey, I understand that my income looks this way from two years ago, but something has materially changed in my life. Namely, I’ve retired. So there is a meaningful life change that has now reduced my income. And what you would do is you fill out this form, you essentially send to them, you know what your expectation for your AGI for the year will be AGI plus any any tax exempt interest that you might have, in investments.

You submit that to them, they will respond and let you know if they’re going to reduce your, your premiums. But the good news is, if you’re not willing to go through that process or you didn’t get around to it, you might have those elevated premiums for two years. So let’s say in this example, you sold a business, you know, this year in 2026.

Now when you’re applying for Social Security and 27, they’re looking at your 25 and 26 returns for the next two years. So you’re going to pay this elevated level of premium for those two years until you’ve reached a year where that that income has gone away. So because you’ve in a way, you’ve wrongly paid this elevated premium, the Social Security Administration will reimburse you for anything that you have overpaid.

Once they recognize that, hey, there was some kind of life changing event that has meaningfully reduce your income once you started taking, Medicare. And this is a great explanation, Adam, if you kind of tie a bow on this, we talked about the different types of investment accounts. We talked about Social Security income and Medicare premium thresholds. Generally speaking, what types of conversations are you having with clients around distribution planning?

What’s something that they should be thinking about? So the first thing that you have to understand is what is the mix of what clients have available to them? How have they saved over their lifetime? Do they have all pretax assets, which really limits our ability to kind of make decisions about where we want to be from a tax bracket standpoint, or do they have a mix of pretax assets in after tax and Roth, which then allows us to sort of play this game of, okay, which tax bracket do we want to be in?

And at what level of Medicare premiums are you comfortable paying? And so that’s what we’re looking at. And I think there’s, you know, the first thing is to kind of look at it on a year by year. So meaning I’m trying to plan so that you are in the optimal tax bracket this year. And you’re paying the optimal amount of premiums for Medicare this year.

And the reason I use optimal is that less is not not always more. If, you know, I wanted and I had a client who had both pretax money and Roth dollars, and we exhausted all of their Roth dollars in the first two years of retirement, just so we had the lowest tax impact and the lowest Medicare premiums for those two years.

Well, now, every year beyond that, every dollar that we withdraw from their retirement accounts will now be fully taxable. And they’re going to see their tax brackets jump, and they’re going to see their Medicare premiums jump. So when I say this optimal level that we’re looking at for clients, it is we need to have a longer term view of where do we think you’re going from a tax perspective.

And how can we kind of manage what you have now so that we can kind of keep that level steady over the long term? And that’s such a great point of balancing the yearly decisions with the long term vision and plan, and why it’s so important to work with an advisor to be able to take that Up-Close view, to plan for that tax year, but also zoom out and say, what’s our longer term goals and strategies and how we want to make that work over time.

So to tie a bow on this, what is the key takeaway or key message for folks that are approaching retirement or in retirement? Yeah. So I’ll start with people that are in retirement. So the takeaway here is that, you know, you’ve done a great job saving. You’ve reached retirement. Now, you may have multiple buckets to choose from to withdraw from and supplement that Social Security income that you may have.

And the point that we’re trying to make here is that you want to come up with a targeted approach to doing it, rather than just to withdraw from those accounts without knowing exactly how that’s going to impact your overall tax picture and your Medicare premiums. And and while it’s important to look at this, certainly on a year by year basis, it’s also important to understand kind of the longer term vision of, you know, where do we expect you to be from a tax standpoint in the long term?

And what does that mean for your Medicare premiums in the long term? So I think that’s kind of how it applies to people in retirement. For those that are approaching retirement, you know, we talk a lot about, helping clients have have this flexibility. You want to have, assets saved into multiple buckets. And depending on your income situation at the time, that will probably drive your decision for whether or not you’re contributing pretax or Roth into your company sponsored for lunch.

Or whether or not you’re saving after tax assets. But the point is, if you are able to bolster all three of these buckets now we have flexibility where we can determine, hey, you know, we’re comfortable distributing pretax assets, meaning we’re going to be taxed on these dollars that we distribute up to a certain level. And once we’ve reached that level now we’re going to turn on either after tax or Roth assets that are not going to be taxed.

Dollar for dollar the same way that pretax assets are. So you can you can set yourself up for future flexibility by making sure that you have contributed to, you know, I would say 2 to 3 types of different buckets here that we’ve talked about. Absolutely. And this can sometimes be overwhelming when you’re ready to take those distributions. And there’s so many areas to manage, which is why we said it’s so important to work with an advisor when you have that flexibility in those options to make sure that you’re managing it as best as you can.

So if this is something that you think may apply to your situation, reach out to our team at blue Chip partners. We’re always happy to help.

And thanks so much for joining me today, Adam, and thanks for having me.

Thanks so much for watching. Can’t wait to chat again soon.