If you need money, you are usually better off taking it out of your non-IRA accounts before touching your IRA. That’s because when you take money out of your non-IRA accounts, you don’t usually trigger any tax. But every dime you withdrawal from a traditional IRA is taxable income my friend. On top of that, you forgo all those wonderful years of tax-deferred growth when you tap into your IRA. That means you stop using Uncle Sam’s money to make money before you really have to. Bad scene.
That said, there are a few instances when tapping your IRA makes sense. Obviously, if you need the money and you have no other sources, you have no choice. And if you are over 70 ½ you also have no alternative; you must take your RMDs.
But there are other situations where withdrawing from your IRA is smart. For example, let’s say you probably won’t pay any income tax this year because you either have write-offs or because you have very little taxable income.
If that’s the case, take money out of your IRA my friend and enjoy. It’s really tax-free. Just be careful not to take out too much and thereby push yourself out of that cozy zero tax bracket. Talk to your tax preparer just to make sure.
It can also make sense to take IRA money if you find yourself in an unusually low tax bracket one year. Even if your IRA withdrawals will be taxable, it might be smart to use the low-tax situation to get money out of your IRA that particular year.
The thing about this strategy is that you have to stay alert and change your withdrawal strategy if your tax bracket shifts. In other words, this is a decision you have to make each year. If your tax bracket rises, switch back and take your withdrawals from the non-IRA once again.
And if you have a high net-worth, using up retirement bucks before
you kick the bucket can be very clever. That’s because when you take the money out of the retirement account, you reduce your net worth because you take a tax bite. This doesn’t impact many people but it can save some serious dollars if your estate is large enough.
And beyond the tax consequences, there are other considerations. Consider Nancy. She needs an extra $1,000 a month ($12,000 a year) out of her accounts in order to make ends meet. She has $100,000 in an IRA and $100,000 in non-IRA accounts. From a tax standpoint, she would be wise to take the entire $12,000 from the non-IRA but there is a problem.
If she does that, her withdrawal rate will be 12% per year and that’s way too high. At that rate she’ll blow through all her non-IRA money in just a few short years.
If instead she takes $500 a month out of each account ($6000 a year) the withdrawal rate drops to 6% which is still high but more manageable.
If she splits her withdrawals by taking half of what she needs from both accounts, she’ll draw down more equally on the accounts. There are pros and cons to this of course. But all things being equal, I think it’s wise to draw down as evenly as possible for as long as possible. That way, you’ll have both non-IRA and IRA accounts available rather than spending down the entire non-IRA and then be left with only the IRA.
Other than satisfying your RMD, are you taking money out of your IRA? Why?