We face some important financial decisions over the course of our lives. One of the most challenging things is deciding how to manage withdrawals in retirement. The decisions involved are among the most consequential and most complex — and come once we have diminished ability to make up for any mistakes.

We no longer have work income to add to our savings pile and regroup. We can no longer take a few years off from spending to let the market regain its feet. We’re in it. The only way forward is through. Taking withdrawals that are too large or selecting the wrong accounts to withdraw from can deplete otherwise sufficient retirement funding.

It’s complex. And it’s important. But it’s also manageable. There are ways to manage retirement distributions to optimize the probability of having your best outcome.

Unfortunately, there’s no one-size-fits-all, or even a one-size-fits-most. The optimal way to manage distributions depends on your need for income, how you have positioned your assets (both from an investment and tax standpoint), and factors beyond your control. Inflation, for instance, is a factor but not one we get to select in advance. We need to adjust to what happens, keeping flexibility to allow for that to work.

Size of Withdrawals

The amount of money that you can take from your retirement funds and have them last is not a simple thing to calculate. There are too many variables. We can’t know what the market will do and we can’t know what the economy will do, and we can’t say how long we will live.

But we can make reasonable assumptions. And we can make our assumptions conservatively, allowing room for inevitable variations.

This is easier if retirement is at least adequately funded.

If your retirement is not adequately funded, there are additional complications.

If you have a well-funded retirement, you can assume capital retention. With capital retention, you never deplete your assets. As long as you live, you can have retirement income coming in. That’s the ideal place to be.

If your retirement is not adequately funded, you may be forced to use an assumption of capital depletion. With capital depletion, you plan on eventually depleting your asset pool. Typically, you would try to target this beyond your life expectancy. That’s not always possible.

Fixed percent method

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The most common methods for determining the amount to withdraw are the fixed percent method, the 4 percent rule, interest only, and the fixed dollar amount method.

The fixed percent method has you taking a fixed percentage of your assets each year. The amount is established annually, often using your December 31st balance for calculations for the coming year. If, for example, you were to take withdrawals of 4 percent annually, each year you would calculate 4 percent of your December 31st balance and take one-twelfth of that each month.

The amount of money you get each month could go up or down from year to year depending on investment performance. The downside is that your income is not predictable far in advance; it depends on each year’s investment performance.

4 Percent Rule

The 4 percent rule may seem similar, but it’s not. With the 4 percent rule, you take 4 percent of your portfolio in the first year. In the second year, you adjust that amount — not based on investment performance but based on inflation. The upside is that your spendable income stays level in real terms; your income increases at the rate of inflation.

The potential downside is problematic.

Periods of high inflation may coincide with periods of weak investment performance, resulting in distributions that are too large relative to the size of the portfolio. This is especially problematic if it happens early in retirement.

Taking interest only allows your core investment portfolio to remain intact. Typically, with this method, you’re taking all forms of income, not just interest. You would also take dividends or other income; interest is just its name — it’s not the actual rule. Your core portfolio is preserved; you’re not spending out of assets. But your income can vary from year to year and may not keep pace with inflation.

The fixed dollar method has you taking a level income from your investments on an ongoing basis. Any adjustments for inflation or for other reasons would need to be determined as needed. This method doesn’t automatically keep pace with inflation or even provide a scheduled annual step up in income. It would be most appropriate with a retirement that is significantly underfunded.

Tax Buckets

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Most people come into retirement with investments in at least two different tax buckets. Sometimes people have all three.

The three tax buckets are non-qualified investments, such as bank accounts and regular brokerage accounts; tax qualified investments, such as 401(k) plans, 403(b) plans, and most traditional IRAs; and tax-free accounts, such as Roth IRAs or Roth 401(k)s.

Non-qualified investments may be taxed in several ways. Spending cash, such as from a bank account, has no tax implications. Spending investment assets does have tax implications; the gain on the sale of an asset is taxable as either a short-term or long-term capital gain depending on the holding period. We can consider this a favorable tax treatment; we get our initial investment back without tax consequences and can have favorable treatment on long-term gains.

Distributions from tax qualified investments are taxable as ordinary income.

There’s no favorable treatment. The amount of the distribution is includable as income for federal tax purposes.

Distributions from tax-free investments are tax free, the caveat being that you’ve met holding requirements, have reached age 59½, etc.


The most common strategy people employ is not so much a strategy as it is hopeful thinking. Many retirees spend the assets that have the least tax implications first. Sometimes they do this even though they get no tax savings by doing so.

The logical basis for this is that postponing taxes should allow your assets to grow and you should maximize your spendable assets by deferring taxes.

Not bad logic, except that things aren’t that simple.

The tax rate that you pay is a function of your taxable income; you fill up the lowest rate tax brackets first, then pay higher and higher rates as you move up the income ladder. That’s why it’s complicated.

The totality of a retiree’s income determines how much they pay in taxes. In a typical case, a retiree will have more money in the long run by taking distributions proportionally from each type of account they have. In most cases, this will result in less total taxes and more assets remaining for the retiree.

And it’s still not optimal. To determine the optimal method, you need to figure out how to minimize taxes over time, considering the size of each source and all of your incomes to optimize your distribution strategy from a tax standpoint.

In doing so, you’ll determine the optimal amount to fill up your lower tax brackets with distributions from tax qualified plans, then supplement that with tax favored income from other plans. Optimization looks a lot like the opposite of what people tend to do instinctively. You may pay more taxes now but will pay less over your lifetime.

The Legacy Complication

Let’s throw one more little complication into the mix. Let’s say you also have an interest in passing wealth onto your heirs. This can alter your optimization strategy.

Heirs benefit from inheriting two types of assets. They avoid taxes when they inherit assets that come to them tax free, such as Roth accounts. And they can avoid taxes when they inherit assets that have a step-up in basis, such as investments in a non-qualified brokerage account.

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The worst thing to inherit from a tax standpoint is tax qualified accounts, such as 401(k)s and Traditional IRAs. These are generally fully taxable to the beneficiary. And most people are spending the assets their heirs would most benefit from receiving, even if it saves them a minor amount in taxes.

If you wish to maximize your legacy, you should consider your heir’s tax situation. You may want to spend more of your tax qualified assets at your lower tax rates and leave the tax favorable assets to children or other beneficiaries who may be in a higher tax bracket.

Final Thoughts

It can be complicated — but it’s not a bad problem to have. If you have no retirement savings, you don’t have a distribution problem; you have far larger problems. This set of problems comes only with the opportunity to have a comfortable retirement. It’s really a question of continuing to do the best for yourself or yourselves after having built something worth protecting and maximizing. Truly not a bad set of problems.

The set of problems that go with this is setting up your assets for funding distributions — setting up a bucket strategy to be able to select assets for distribution without having to worry about what the market is doing.

It can make sense to work with an advisor on these issues. Not everyone in or approaching retirement has the desire to do this themselves. Some people have other plans for how to spend their time. Whether you walk this road alone or solicit assistance, optimizing your retirement distribution strategy can help your assets last your lifetime, or longer. Oftentimes, that’s what people wanted when they set these funds aside in the first place.

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