Understanding Taxes and Retirement Drawdown

A smart retiree’s guide to keeping more of what you’ve saved

When most people think about retirement, they focus on how much they need to save. That’s important, but it’s only part of the story. What often gets overlooked is just as critical: how you withdraw that money once you retire. Poor planning can lead to unexpected tax bills, lost benefits, and reduced legacy potential.

Many retirees are surprised to learn, for example, that up to 85% of their Social Security benefits could be subject to federal income tax.[1] Or that Required Minimum Distributions (RMDs) can suddenly boost their taxable income in their 70s. And what happens if your income unexpectedly pushes you into a higher tax bracket? This can increase your tax bill and even affect your Medicare premiums.

The sequence and strategy you use to pull money from your accounts, what we call a retirement drawdown strategy, can have a significant impact on how much tax you’ll pay throughout retirement.
 
In this article, we’ll walk through the fundamentals of retirement income tax planning — including withdrawal order, income smoothing, and the role of Roth conversions — along with a real-world example to bring it all together.

Why withdrawal order matters

To understand how withdrawals affect taxes, you first need to understand the three main types of retirement accounts:

• Taxable accounts: These include brokerage accounts where you pay taxes on dividends, interest, and capital gains in the year they’re realized.
• Tax-deferred accounts: Think traditional IRAs and 401(k)s. You don’t pay taxes until you withdraw money, at which point it’s taxed as ordinary income.
• Tax-free accounts: Roth IRAs fall into this category. Qualified withdrawals are tax-free, and you’re not required to take RMDs.

A common rule of thumb is to withdraw from these accounts in the following order: taxable → tax-deferred → tax-free
 
This approach allows your tax-advantaged accounts (especially Roths) to keep growing, while managing your taxable income over time. However, like most rules of thumb, this one isn’t universal. In certain cases, such as when your tax rate is temporarily low, it may make sense to tap tax-deferred or even Roth accounts earlier than expected.

What is a Roth conversion?
A Roth conversion involves moving money from a traditional IRA or 401(k) into a Roth IRA. You pay taxes on the converted amount now, but future withdrawals are tax-free. This strategy can be particularly useful during years when your income is lower than usual.

Smoothing income to avoid tax surprises

When your income jumps in retirement, so can your tax bill. These jumps, called income spikes, can happen if you sell a large asset, take substantial RMDs, or start drawing from Social Security while also taking withdrawals from your IRA.
 
That’s where income smoothing comes in. This means intentionally managing how much income you recognize each year to avoid bumping into a higher tax bracket.
 
Some income smoothing strategies might include:

• Partial Roth conversions during low-income years
• Pulling from a mix of account types to spread out your taxable income
• Harvesting capital gains in years when you’re in a lower tax bracket

Knowing when to apply these strategies often comes down to timing and personal circumstances. Watching for changes in income sources, reaching key milestones like age 63 or 73, or anticipating a one-time event (like selling a home or business) can all signal a good time to plan. Tools like tax projection software or retirement income calculators can provide a useful starting point; however, we always recommend working with a financial advisor or tax professional to tailor the approach to your specific situation.
 
The goal is to stay ahead of the “tax cliffs” that catch many retirees off guard.

Social Security and RMD timing

It’s true: Your Social Security benefits can become taxable based on your other income. The more you make, the more of your benefit gets taxed — up to 85%.
 
That’s why when you claim Social Security matters. Delaying benefits until age 70 not only increases your monthly payment, but it also gives you more time to do Roth conversions or draw down tax-deferred assets at lower tax rates.
 
At age 73, required minimum distributions (RMDs) begin. These are government-mandated withdrawals — even if you don’t need the money — from your traditional IRA or 401(k), and they can significantly increase your taxable income.
 
You can manage the impact of RMDs by:

• Taking early withdrawals from tax-deferred accounts
• Making qualified charitable distributions (QCDs) directly from your IRA to a charity, which satisfy RMDs and aren’t taxable
• Doing proactive Roth conversions before RMDs kick in

Tax bracket management and Roth conversions

Your tax bracket in retirement may be lower than during your working years, but not always. RMDs, Social Security, pensions, and other sources of income can add up quickly and unexpectedly if you aren’t watching for them.
 
If you retire before age 73, you may have a period when your income is relatively low. This is often an ideal time to intentionally convert some of your pre-tax assets into Roth accounts. By doing this, you can:

• Lock in today’s lower tax rates
• Reduce future RMDs
• Create a source of tax-free income later in retirement

It’s often best to think of Roth conversions as a multi-year strategy. You don’t need to convert everything at once. The goal is to convert just enough to “fill up” your current tax bracket without exceeding it.

A tale of two retirees

Let’s bring this all together with a simple, real-world example.
 
Tom: Taking the traditional path
Tom retires at age 62 and, like many people, begins collecting Social Security right away. He’s eager to preserve his tax-advantaged retirement accounts, so he lives off his taxable brokerage account for the first several years. He puts off doing any Roth conversions, figuring he’ll address taxes later.
 
At age 73, Tom is hit with his first RMD from his traditional IRA. The mandatory withdrawal is large and unavoidable. It pushes him into a higher tax bracket and increases the portion of his Social Security benefits that are subject to taxation. He also faces higher Medicare premiums due to the spike in his income.
 
Over time, Tom ends up paying significantly more in taxes than he expected. Unfortunately, because most of his remaining assets are in tax-deferred accounts, his heirs will also eventually face a tax bill.

Linda: Taking the strategic path
Linda retires at the same age as Tom but takes a more proactive approach. For the first few years, she lives off her taxable account — just like Tom — but she also takes advantage of her temporarily lower income to begin making small, manageable Roth conversions each year.

Linda chooses to delay Social Security until age 70, which increases her monthly benefit and gives her more time to shift money from her traditional IRA to her Roth IRA at a favorable tax rate.
 
By the time Linda turns 73, her tax-deferred balance is smaller, which means her RMD is smaller, too. Her taxable income stays below key thresholds, helping her avoid higher taxes and surcharges on Medicare premiums. She also has a growing Roth account she can withdraw from tax-free whenever she needs flexibility or leave to her heirs with no income tax owed.
 
The difference between these two approaches isn’t just academic. It can translate into tens of thousands of dollars in tax savings over the course of retirement.

Tax planning is for everyone

You don’t need to be ultra-wealthy to benefit from a smart retirement drawdown plan. In fact, thoughtful tax planning can be even more critical for middle-income retirees who want to make the most of what they’ve saved.
 
As financial advisors specializing in retirement planning, we help our clients develop tax-smart, sustainable withdrawal strategies that align with their goals.
 
If you’d like help reviewing your retirement income plan or exploring whether strategies like Roth conversions make sense for you, we’d love to talk.


[1] https://www.kiplinger.com/taxes/retirement-taxes-and-the-irs