How to Handle Your Retirement Account Withdrawals

If you have multiple options of various different kinds of accounts to choose from, such as an IRA, a Roth IRA, a qualified retirement plan (such as a 401(k) plan), also known as a QRP, and perhaps an inherited IRA; you may be asking yourself, which one should I take a withdrawal from first?

Age-Related Considerations

If you’re under age 59½, some of the options include considerable penalties – withdrawals from either the traditional IRA or the QRP will incur a 10% penalty for early withdrawal unless you meet one of the exceptions.  So this leaves the Roth IRA or the inherited IRA.  Each of these can be taxable to some degree, although partly non-taxable, depending upon the circumstances.

If the inherited IRA was subject to estate tax upon the passing of the original owner, you may be able to take a portion of your withdrawal in credit against the estate tax, due to the IRD tax deduction.  In today’s world, this is less and less likely due to the increased estate tax exemption of $5 million, but it’s still something to consider in your quest.

If you’re age 59½ or older, the 10% penalty will not apply to any of your accounts, but that doesn’t mean that your choice is completely unlimited. There are still tax issues to consider, as well as other affects that the law places on you as the owner of these accounts.

At any age, your contributions and conversions more than five years old can be withdrawn from your Roth IRA without tax or penalty.  Any growth in the account will be subject to tax and penalty, and any conversions that were completed less than five years ago will also be subject to the 10% penalty.

Account-Related Considerations

Since you’re required to take a distribution from the inherited IRA (if you’re not the surviving spouse), this is where you’ll be taking a withdrawal no matter what other circumstances are occurring.  If your need for money is greater than the Required Minimum Distribution (RMD), then the next most tax efficient option is to take a withdrawal of your contributions to the Roth IRA.

After those choices, you also could take a loan from your 401(k) plan (as long as this is available).  This would be another option that is tax efficient (in general) but you would need to pay back the loan, and this is a good way to derail your retirement savings.  This could also result in taxation of your loan amount if you leave employment.

Lastly, you can always take money from your IRA and pay the taxes and penalties.  This is probably the least desirable of all the options, as it is the most costly.

Additional Considerations

If you have an inherited IRA and you’re not the surviving spouse: you’re required to take the RMD from the account each year, and this can often be a nuisance to keep track of.  If you’re in need of money you can take extra from the inherited account and this will reduce future RMDs or perhaps eliminate them if you drain the account.

The other thing that makes the inherited IRA the better choice (over your other retirement accounts) is that you can defer use of these accounts until you reach age 70½ (for your entire lifetime for the Roth) – and the rate of withdrawal will be less than with the inherited IRA.

In addition, for your owned accounts (non-inherited) your beneficiaries of those accounts can stretch payments over their lifetimes as well.  With the inherited IRA, the account must be distributed over your single life expectancy, with no opportunity to stretch beyond that timeline.


IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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2 Comments

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  • Hi, Ellen –

    I don’t know of a legal way to do this, other than to give the money away to someone else – and even then there is a five-year lookback for gifts you’ve made, before Medicaid begins to kick in. It’s a tough situation, but that’s the way the system works.

    Sorry I couldn’t be of more help –

    jb

  • Jim, is there a way to shield at least a part of a savings account
    from Nursing Home stays if a person finds they must enter there? I don’t mind paying some amounts, but at some point in time, every penny you have tried to save for your children would be gone in a short time. ($100,000. would be gone in about two years at today’s home charges).

    I’m an average person, not a millionaire or 1/2 millionaire.

    Thanks,
    Ellen

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