Brokerage Account vs. IRA: Which Should I Tap First in Retirement?

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Have retirement savings in multiple places? Read on to see which account to access first. [[{“value”:”

The average American today has $88,400 in retirement savings, according to Northwestern Mutual. Ideally, you’ll be starting off your retirement with more savings than that. But you may have your retirement savings spread among more than one account.

The nice thing about retirement plans like IRAs and 401(k)s is that they let you save in a tax-advantaged manner. But they also come with annual contribution limits. This year, if you’re under age 50, those limits are $7,000 and $23,000, respectively. So it’s conceivable that you might have some retirement savings in a regular brokerage account if there were a few years when you wanted to contribute more than what your IRA or 401(k) allowed for.

But now that you’re retired, which of those accounts should you withdraw from first? Here are a couple of strategies you can use to maximize your savings.

Let your tax-advantaged accounts keep growing

Generally speaking, it’s best to leave an IRA or 401(k) alone for as long as possible during retirement and first turn to a brokerage account for income. This especially applies to a Roth IRA or Roth 401(k), because investment gains in these accounts are completely tax-free.

Of course, in time, you’ll be forced to start withdrawing from your IRA or 401(k) if you don’t have a Roth account. The age when that happens is 73 or 75, depending on when you were born (older retirees had to start taking required minimum distributions at an even younger age). But until then, it pays to turn to your taxable brokerage account and leave your IRA or 401(k) alone.

You can tap your Roth account first if money is very tight

While the above advice is optimal for many retirees, you may be an exception if you’re only looking to withdraw a small amount and need every dollar of it. And if you have a Roth IRA, you may want to turn to it before another account — even a brokerage account that isn’t tax-advantaged.

The reason? Roth IRA withdrawals are tax-free. With a brokerage account, you don’t pay taxes on withdrawals per se, but you pay capital gains taxes.

It’s possible to take a tax-free withdrawal from a brokerage account in the sense that if you bought a stock 20 years ago for $1,000 and it’s still only worth $1,000, there’s no gain to tax you on. Otherwise, you have to pay capital gains taxes when you liquidate investments in a brokerage account that are worth more than what you paid for them initially (unless your income is low enough to exempt you from those taxes).

Similarly, traditional IRA or 401(k) withdrawals are subject to taxes. The amount of tax you’ll pay will depend on your tax bracket.

If you don’t have a lot of savings and can therefore only take a very small withdrawal from a retirement account as a new retiree, then you may want to use your Roth for the simple reason that it’s the only option that gives you all of your money without having to worry about the IRS getting a cut.

For example, if you’re in the 22% tax bracket, a $5,000 traditional IRA or 401(k) withdrawal will cost you $1,100 in taxes. If you withdraw $5,000 from a brokerage account and half of that is long-term capital gains, you’re generally looking at paying 15% on that $2,500, or $375. But if you take a $5,000 withdrawal from a Roth IRA or Roth 401(k), you lose $0 of that to taxes.

It’s important to be strategic when managing your retirement savings if you have money in multiple places. If you’re not sure what to do, you may want to speak to a financial advisor who can give you some guidance based on your personal situation.

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