The Smartest Retirement Withdrawal Strategy Most People Get Wrong

Smart withdrawal strategies can make or break your retirement plan. In this video, Ed Mahaffy breaks down how using taxable accounts first could significantly reduce your tax burden.

• Why withdrawal order matters in retirement planning

• How taxable accounts can help minimize taxes

• Real example showing how to pay $0 in federal income tax

• The risks of withdrawing from IRAs too early

• How sequence of return risk impacts your retirement 

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Transcript

Retirement Withdrawal Strategy: Important Disclaimers

Before starting today's video, I've got two disclaimers. The first is, all the information you're about to hear should not be considered to be investment nor tax advice. I'm not a CPA. The second disclaimer is, this has to do with taxes. This stuff is dry as a bone, folks. If you want to click off now, no hard feelings. But if you want to stick around for three minutes and just see what happens, let's go.

Why Withdrawal Order Matters in Retirement

Knowing which accounts to draw from and in what order can be the difference in retirement planning success or failure. Spending down taxable accounts first can dramatically improve outcomes.

Tax Benefits of Using Taxable Accounts First

This approach can reduce exposure to ordinary income, take advantage of long-term cap gains treatment, and potentially keep more of your income in the 0% bracket.

Example of a Tax-Free Retirement Income Strategy

Here's a quick example. Jack and Diane are 56 and both retired at the end of 2024. In 2025, they sold $160,000 in assets from their brokerage account with a cost basis of $80,000. And let's assume they take the standard deduction of $31,500. Here's a breakdown of total income for 2025. Don't worry, I'm not going to stand here and read all these line items. Let's just go to the adjusted gross income of $97,500 and apply the $31,500 standard deduction and arrive at a total taxable income of $66,000. Federal income tax liability, zero.

How Taxable Withdrawals Reduce Taxes

When you withdraw from taxable accounts first, non-qualified dividends are often offset by the standard deduction and the qualified dividends may fall in the 0% long-term cap gains bracket.

The Cost of Withdrawing From a Traditional IRA Too Early

In contrast, let's look at John. By the way, folks, John's about to blow it. (I first named him Fredo and then changed it.) John, also age 56, draws $80,000 from a traditional IRA, thus triggering ordinary income as well as a 10% early withdrawal penalty. The ordinary income can force qualified dividends from the 0% bracket up to the 15% bracket and force non-qualified dividends from zero into the 10%, 12%, or 22% brackets. I told you John was going to blow it.

Sequence-of-Return Risk in Early Retirement

Tax savings realized by tapping taxable accounts first can also reduce one of the biggest retirement risks to early retirees. It's known as sequence-of-return risk. This is the risk of poor investment returns early in retirement to retirees with identical circumstances. But different retirement dates can experience vastly different results depending on the market conditions experienced a few years before and after retirement.

The Retirement Transition Trap

The period I call the retirement transition trap where increased spending coupled with poor market returns can wreck your retirement plan. This is where you can really dig a hole.

How to Reduce Early Retirement Risk

Reduce expenses early in retirement to mitigate this risk because the fewer sales that early retirees have to make, the less exposure they have to market downturns and withdrawing from a declining portfolio, which is akin to eating the seed corn of your future growth.

Exceptions: Inherited IRA Rules

There's one exception to the general guideline of spending taxable accounts first. It's when an inherited IRA with a substantial balance is involved as you may be required to distribute the entire balance over a 10-year period, which of course creates significant ordinary income pressure and you have to plan around that.

Estate Planning and Step-Up in Basis

And finally, depending on your legacy goals, you may wish to preserve highly appreciated assets in your taxable account to take advantage of the step-up in basis when you pass.

Conclusion and Call to Action

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