Tax-Efficient Withdrawal Planning

The Tax Drag on Retirement Income

🔄 Quick Recall: In the previous lesson, you audited your investment portfolio — reducing fees, eliminating overlap, and aligning your allocation with your timeline. Now let’s address the other silent wealth destroyer: taxes. The difference between a tax-efficient withdrawal plan and a random one can be $100,000+ over a 25-year retirement.

Most people think about retirement in terms of gross numbers: “I have $1 million, so I can withdraw $40,000/year.” But you don’t spend gross dollars — you spend after-tax dollars. A $40,000 withdrawal from a traditional 401(k) might leave you with $32,000 after federal and state taxes. The same $40,000 from a Roth IRA leaves you with $40,000.

The withdrawal sequence matters. A lot.

The Withdrawal Optimization Prompt

Help me plan a tax-efficient retirement withdrawal strategy.

My accounts at retirement:
- Traditional 401(k)/IRA: $[X] (withdrawals taxed as income)
- Roth IRA/401(k): $[X] (withdrawals tax-free)
- Taxable brokerage: $[X] (capital gains tax applies)
- HSA: $[X] (tax-free for medical expenses)

Income sources:
- Social Security: $[X]/month starting at age [X]
- Pension: $[X]/month (if applicable)
- Other: [rental income, part-time work, etc.]

Annual spending need: $[X] (in today's dollars)
State of residence: [state — for state tax calculation]
Filing status: [single / married filing jointly]

Model a 25-year withdrawal plan that:
1. Minimizes total lifetime taxes (not just year 1)
2. Accounts for Social Security taxation thresholds
3. Avoids Medicare IRMAA surcharges where possible
4. Manages RMDs starting at age 73
5. Preserves Roth accounts for maximum tax-free growth

Show: Year-by-year withdrawal amounts by account, projected tax bill,
and cumulative tax savings vs. a simple "pro-rata" withdrawal approach.

Understanding the Tax Interactions

Social Security Taxation

Your Social Security benefits can be taxed at 0%, 50%, or 85% depending on your “combined income”:

Why this matters for withdrawals: Taking $50,000 from a traditional 401(k) adds to your combined income, potentially pushing up to 85% of your Social Security benefits into taxable territory. Taking $50,000 from a Roth IRA does NOT count toward combined income. Strategic mixing of account types can keep Social Security taxation low.

✅ Quick Check: Why does minimizing this year’s taxes sometimes increase your lifetime taxes? Because keeping traditional account balances high to avoid paying taxes now means larger Required Minimum Distributions later (starting at age 73). Those forced withdrawals could push you into a higher bracket than the tax you would have paid by voluntarily withdrawing or converting earlier. AI models the full timeline — showing you that paying some tax now at 12% can prevent paying tax later at 22% or higher.

The Roth Conversion Ladder

The most powerful tax optimization tool for many retirees:

Model a Roth conversion strategy for me.

Current situation:
- Traditional IRA/401(k) balance: $[X]
- Roth IRA balance: $[X]
- Age: [X], retirement age: [X]
- Current marginal tax bracket: [X]%
- Expected retirement income (before withdrawals): $[X]

Model annual Roth conversions that:
1. Fill up the current tax bracket (convert just enough to stay
   in the same bracket — don't push into the next one)
2. Account for the impact on Social Security taxation
3. Stay below Medicare IRMAA income thresholds
4. Reduce the traditional balance enough to minimize future RMDs

Show: Optimal annual conversion amount for each year,
tax cost of conversions, and cumulative tax savings
vs. doing no conversions.

Medicare IRMAA Thresholds

Income above certain thresholds triggers Medicare premium surcharges. For 2025:

A single large withdrawal or Roth conversion can push you over a threshold and cost $840-$4,620/year in extra premiums. AI flags these cliffs in your withdrawal plan.

The RMD Strategy

Starting at 73, you must take Required Minimum Distributions from traditional accounts. The amount is calculated by dividing your account balance by a life expectancy factor.

Model my RMD obligations:

Traditional account balance at age 73: $[X] (projected)
Annual growth assumption: [X]%

Show:
1. Projected RMD for each year from 73 to 95
2. Cumulative income tax on those RMDs
3. What if I reduce the traditional balance through Roth
   conversions before 73? Show the RMD reduction.
4. Identify years where RMDs push me into a higher bracket
5. Suggest QCD (Qualified Charitable Distribution) amounts
   if I typically donate $[X]/year to charity

✅ Quick Check: Why is starting Roth conversions 10-15 years before RMDs begin so important? Because every dollar you convert to Roth before age 73 is a dollar that doesn’t generate a required distribution later. A $500,000 traditional IRA at age 73 requires roughly a $19,000 first-year RMD that grows annually. Converting $200,000 to Roth in your 60s reduces that to roughly a $11,500 first-year RMD — a $7,500/year income difference that affects your tax bracket, Social Security taxation, and Medicare premiums for decades.

Key Takeaways

• Withdrawal sequence across account types can save $100,000+ in lifetime taxes — AI models the optimal order for your specific situation
• Social Security benefits are taxed based on “combined income” — Roth withdrawals don’t count, making them ideal for managing the taxation threshold
• Roth conversions during low-income years (between early retirement and Social Security) lock in low tax rates before RMDs begin at 73
• Medicare IRMAA income cliffs can add $840-$4,620/year in premiums — AI flags these thresholds in your withdrawal plan
• Qualified Charitable Distributions (QCDs) let you satisfy RMDs while avoiding income tax on the donated amount

Up Next: You’ll build your Social Security claiming strategy and healthcare funding plan — the two biggest wild cards in retirement planning.