Do you draw from your Traditional 401(k)/IRA or from your Roth 401(k)/Roth IRA first?

[CSdot]

Assumptions:

(A) You have reached 59.5 so you can access your retirement accounts penalty fee.

(B) You have a sizable Traditional 401(k)/IRA and a sizable Roth 401(k)/Roth IRA.

Question 1: Which do you draw from first?

I have a number of years to think this one through as I am only 51 and probably won't be drawing on these accounts before 59.5 (if even then), but is it better to first draw down funds that are taxed on distribution like your traditional 401k and traditional IRA, or to first draw from funds that you can take tax free like your Roth 401k and my Roth IRA?

My gut feeling is you pull from your taxed on distribution retirement accounts (traditional 401k and traditional IRA) and leave the Roths to grow tax free until you are forced to use them.

Question 2: Are Roth distributions included in your income calculation?

As a side thought, and as a possible reason someone might look at drawing from the Roth first is to keep their income low for Obamacare purposes, assuming a Roth distribution is not included in annual income calculation while a traditional 401k or traditional IRA distribution would be. Even then, I suspect the value of maintaining the additional years of tax free growth in your Roth for yourself and heirs exceeds any Obamacare savings for the years between 59.5 and 65 while you are awaiting Medicare eligibility.

 

[qwerty3656]

I would love to get peoples perspective on your last point (even with ACA you think its better to not draw from Roth). My plan is to retire at the end of this year (I'm 58) and start ACA in January. I was planning to limit my draw from TIRA to something like 50k (I haven't looked at the precise numbers) and draw the rest from my Roth (maybe another 50k) so as to keep my ACA costs reasonable.

 

[TimSF]

I may be oversimplifying but I think of it as a tax question. If I think my taxes will be going up in the future - e.g., because of new income (social security/pension/rmd's) or increasing tax rates - then I should draw from tIRA first and pay tax on that income now rather than later. If I think my taxes will be going down in the future, then I should draw on Roth first.

 

[Bruceski44]

The correct answer for you will depend on your tax situation (and tax laws) when the time comes, but I will share my thinking which only pertains to my situation at the current time.

I'm 62 and retired at 58.

Our plan is to reserve the Roths so they go to our heirs after our deaths. They will also inherit our Traditional IRAs and according to current tax law, they must withdraw all the money in a few years (Can't recall exactly how many years, but do know that Congress killed the "stretch IRA" in the latest tax law, which would have permitted the IRA to continue growing indefinitely). As they withdraw all the money from the tIRA, they will be liable for taxes and may be forced into a higher tax bracket, both of which may induce a hardship on them. Conversely, the Roth IRAs, being tax-free will not require them to scrape up tax payments, although they may still force a higher tax bracket. This is the least painful method given the current tax situation and hopefully they'll use the money wisely to provide for their own retirements.

A better inheritance (from the heir's point of view) would be to inherit life insurance or better yet, real estate. The LI inheritance is tax-free and the RE receives a stepped-up basis, so all prior gains are forgiven at that point. The RE will provide income and preferential tax treatment due to depreciation and deductions.

For these reasons we are performing annual Roth conversions and increasing our exposure to RE. All bets are off after Congress decides to change the tax law again, coming after tax shelters benefitting real estate investors. I have LI until age 65 and may then look into a new policy.

I do not take advantage of health care subsidies. The risk of going over the cliff (if your income pops above the cut-off) or losing the subsidy altogther are too great, plus I personally don't like the idea of wealthy people keeping their income artificially low in order to reap an [unfair] advantage. Now I can complain about government excess with a clear conscience and I maintain my income high enough to pay all my bills, plus my $1100 monthly Silver PPO plan.

 

[RunningBum]

I don't think there's a "one size fits all" answer. Generally speaking you are best off spreading out taxable income over your lifetime, but there are also income levels you may want to stay short of. So it's a matter of figuring out when taking tax-free Roth distributions help most:

- Before 65, to help with ACA subsidies and to keep from going over the ACA cliff if that comes back
- After 65, to avoid or limit IRMAA
- After starting SS, which could limit how much of SS is taxable. Also taking more income early and less after starting SS helps level out income.
- If married, it's better to take income while you are MFJ and save the tax free Roth for when one of you is filing single. Since this is unpredictable it seems like it could be a tie-breaker.

These factors will vary for people. You could try to model it in a spreadsheet. You might find that it's taking some from each account.

 

[Markola]

We have 100% stock allocation in our Roths and plan to spend them last. However, I imagine they will also serve as tax-free slush funds along the way for this and that major purchase, when needed to keep us under the next bracket.

 

[RetireBy90]

As mentioned above and many other threads, TIRA vs Roth is really about 2 questions. They both applyto where to draw and also to Roth conversions. First is pure speculation, that is what will the tax laws be in the future. Everyone has an informed opinion but nobody knows. If taxes are adjusted higher in the future, then it makes sense to pay them now at a lower rate. If they go down then wait and pay lower rate later.
Second question is what will your income be in the future? If higher then pay now, if lower then pay later.
These 2 can overlap so you may assume that your income will decrease and tax rates will rise so then you have to not only be directionally correct with 2 guesses but also correct with the degree or amount of changes.
Mix this unknown with various other costs that depend on taxable income like IRMAA and you have a real question that is very specific to your situation and assumptions.
Given that I’m not able to discern all the unknowns here, I’m leaving the Roth untouched and doing Roth conversions until RMDs kick in and we plan to use QCDs for any RMDs at that time.
Bottom line, it all depends on one’s specific situation so you have to make the call based on your specifics including risk tolerance and plans for anything you leave behind.

 

[pb4uski]

Assumptions:

(A) You have reached 59.5 so you can access your retirement accounts penalty fee.

(B) You have a sizable Traditional 401(k)/IRA and a sizable Roth 401(k)/Roth IRA.

Question 1: Which do you draw from first?

I have a number of years to think this one through as I am only 51 and probably won't be drawing on these accounts before 59.5 (if even then), but is it better to first draw down funds that are taxed on distribution like your traditional 401k and traditional IRA, or to first draw from funds that you can take tax free like your Roth 401k and my Roth IRA?

My gut feeling is you pull from your taxed on distribution retirement accounts (traditional 401k and traditional IRA) and leave the Roths to grow tax free until you are forced to use them.

Question 2: Are Roth distributions included in your income calculation?

As a side thought, and as a possible reason someone might look at drawing from the Roth first is to keep their income low for Obamacare purposes, assuming a Roth distribution is not included in annual income calculation while a traditional 401k or traditional IRA distribution would be. Even then, I suspect the value of maintaining the additional years of tax free growth in your Roth for yourself and heirs exceeds any Obamacare savings for the years between 59.5 and 65 while you are awaiting Medicare eligibility.

Do you have taxable account money also? If so, I would use that and then do Roth conversions... especially if the taxable account money is cash-like.

Another option that I considered a actually did for a while was to leave appreciated stock in the taxable account alone (because of step-up in basis those gains would be tax-free), then do a targeted level of Roth conversions and withdraw from the tIRA for spending. Any Roth conversions later withdrawn and spent in the same year are effectively the same as a tIRA withdrawal.

I think in most cases ACA subsidy benefits exceed the value of tax-free growth in the Roth but it is very situational.

 

[enjoyinglife102]

When considering tax ramifications, remember to consider state taxes as well. I'm in NJ and at 62, if one's gross income is under $75,000 ($100,000 for a married couple), retirement account withdrawals are tax free from NJ state taxes.

 

[BubbaChris]

I would love to get peoples perspective on your last point (even with ACA you think its better to not draw from Roth). My plan is to retire at the end of this year (I'm 58) and start ACA in January. I was planning to limit my draw from TIRA to something like 50k (I haven't looked at the precise numbers) and draw the rest from my Roth (maybe another 50k) so as to keep my ACA costs reasonable.

We're 60% tIRA, 10% ROTH, and 30% taxable accounts, started on ACA last year and are age 60. My current strategy/logic is to do smallish ROTH conversions to stay in the ACA bracket we're targeting. We'll use the taxable account to pay any income taxes and cover our expenses.

The ACA premium tax credits are the main reason we feel we can ER, so preserving them is my top priority until Medicare. The ROTH conversions are aimed at lowering RMDs when the time comes. This is because we expect SS plus RMDs to exceed our spending budget by a decent margin.

We have no children, so the ROTH will be our go-to for unplanned or large expenses if I want/need to avoid tax complications.

Best regards,
Chris