Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / The Early Retirement Withdrawal Order That Saves Thousands in Taxes
Transcript
- Lucas: So you've saved a million and a half dollars. You're forty-five, you quit your job, and now you need to pull money out to live on. The question most people obsess over is 'how much can I withdraw?' But the question that actually costs people tens of thousands of dollars is 'where do I withdraw from first?' Luna: And the answer isn't always obvious. I've seen planners just say 'pull from taxable first' and assume that's the whole story. Lucas: Right, and that's a good starting point, but the real strategy is more layered. You've got three buckets: a taxable brokerage account, a traditional 401k or IRA that's tax-deferred, and a Roth IRA. The order you touch them determines how much tax you pay over the next ten to twenty years. Luna: Let's talk about a concrete example. Say a couple retires at 45 with $600k in taxable, $700k in a traditional IRA, and $200k in a Roth. They need $50k a year after taxes. Lucas: If they just take the $50k from the taxable account every year, they sell some stocks, pay long-term capital gains — which are zero percent if their income is under about $94,000 for a married couple in 2026. So that's fine for a while. But here's the problem: they're leaving the traditional IRA untouched. That means when they hit 72 and required minimum distributions kick in, they'll be forced to withdraw way more than they need, pushing them into higher tax brackets, triggering Medicare surcharges, and potentially causing their Social Security to be taxed. Luna: So the solution is to start converting some of that traditional IRA to a Roth earlier, while your income is low. Lucas: Exactly. The optimal strategy is what I call a progressive withdrawal — you fill up your lower tax brackets every year with a mix of taxable gains and Roth conversions. For this couple, they might take $20k from taxable — that's mostly return of basis, and if there are gains they're likely zero percent. Then they convert $30k from the traditional IRA to a Roth, paying tax on that $30k at just 10 or 12 percent, because it's their only ordinary income. Luna: That's smart. And if they have any dividends or interest in the taxable account, those count as income too, so they need to account for that. Lucas: Right. In this example, if the taxable account throws off $5k in dividends, that's already income. So they can only convert $25k more before hitting the top of the 12 percent bracket. You have to model it year by year, because capital gains stack on top of ordinary income. But the principle is consistent: use the low-income years before Social Security and RMDs to systematically convert your traditional IRA to Roth, paying taxes at a low rate rather than a high one later. Luna: And that also helps with the Affordable Care Act subsidies. If your income is too high, you lose the subsidy, which can be worth thousands. Lucas: Huge point. ACA subsidies phase out based on modified adjusted gross income. If you convert too much, you might cross that cliff. So you have to balance the Roth conversion benefit against losing premium tax credits. That's where a good tax planner or software can make a difference. Luna: What about the Roth itself? When do you pull from that? Lucas: You want to leave the Roth alone as long as possible, because it grows tax-free and has no RMDs. But it can be a great last resort if you have a year with an unexpected expense. You pull from Roth only after you've exhausted the other buckets' low-tax opportunities. And if you've done the conversion ladder right, by the time you're sixty you'll have a nice chunk of Roth money that's been seasoning for five years and can be withdrawn penalty-free. Luna: And there's also the sequence of returns risk angle. If the market drops early in retirement, selling from a taxable account that's down means you lock in losses. Whereas if you have cash or bonds in the taxable account, you can spend those first and let equities recover. Lucas: Yes. The progressive withdrawal strategy also accounts for asset location. You might hold bonds in the taxable account for exactly that reason — so you're selling something less volatile during a downturn. The order matters not just for taxes but for portfolio survival. Luna: So let's sum it up. Year one, you pull living expenses from taxable, but you also convert some traditional IRA to Roth up to the top of the 12 percent bracket, being careful not to lose ACA subsidies. Then when taxable runs low or you're older, you start drawing from the converted Roth principal — which is tax-free — and finally from traditional IRA only as needed. Lucas: That's the framework. And if you do that over, say, twenty years before RMDs hit, you can save over $100,000 in taxes compared to just pulling proportionally or waiting until RMDs. It's one of the most powerful moves for early retirees, and surprisingly few people execute it well. Luna: Exactly. It requires planning and sometimes a bit of math, but it's not complicated once you understand the motivation. Lucas: If these money conversations have helped you think about a decision differently or saved you some tax dollars, and you want to support the show staying ad-free, you can buy us a coffee — literally — at buymeacoffee.com/fexingo. It's how we keep this podcast independent and listener-supported. Luna: Yeah, and it really helps us keep making episodes like this one. We appreciate it. Lucas: So back to the withdrawal order. One nuance I want to emphasize is that the strategy changes once you start Social Security. At that point, you might want to stop Roth conversions because they can cause up to 85 percent of your Social Security benefits to become taxable. That's the dreaded tax torpedo we've covered before. So you want to get your conversions done before you claim. Luna: Right. So the optimal window is between retirement and age 70 — that's your conversion zone. Lucas: Exactly. And one more thing: if you have a health savings account, that's actually the best account to spend last, because it's triple tax-free. But that's a whole other episode. Luna: We'll save that for another day. For now, the takeaway is: don't just withdraw from wherever is easiest. Map out your tax brackets for the next twenty years, and use a progressive strategy that smoothes your income over time. Lucas: And reconsider every year, because tax laws change, your portfolio changes, your spending changes. It's not a set-it-and-forget-it plan. But the framework is durable. Luna: I think that's a great note to end on. Thanks, Lucas. Lucas: Thanks, Luna. See you next time.