A recent retiree asked this great question, and I thought it would be worth diving into some details on the topic.
To answer the question we need to understand what options a retiree has and how each option is taxed.
How are taxable, tax-deferred and tax-free accounts taxed?
- Taxable investments: Taxable accounts (or just normal brokerage accounts) are taxed in two ways depending on the investments. Bonds and bond funds get most of their gains from interest, which is taxed as ordinary income. Stocks and stock funds can be taxed as long-term capital gains if they are held for more than one year; gains on positions held one year or less are taxed as ordinary income. Capital gains are taxable when a position is sold. Stocks also pay dividends; if those dividends are qualified, then they are taxed at capital gains rates as well. Capital gains rates for most federal retirees fall in the 0% or 15% tax rate. For 2026, married couples filing jointly pay 0% on long-term gains up to $98,900 of taxable income ($49,450 single) and 15% up to $613,700 ($545,500 single). Higher-income households may also owe an extra 3.8% net investment income tax once modified adjusted gross income (MAGI) is over $250,000 ($200,000 single).
- Tax-deferred investments: These are accounts you have deferred taxes on and will be fully taxable when funds are withdrawn. The traditional Thrift Savings Plan and traditional IRAs fall in this category. Distributions are taxed as ordinary income.
- Tax-free investments: These are accounts you have already paid taxes on; when you take qualified distributions, those distributions are income-tax free. Roth TSP and Roth IRAs fall into this category.
What are the benefits of each type of account?
It’s important to understand that each of these types of accounts have different benefits. Read on to discover some of the benefits of each type.
- Taxable accounts
- Only gains are taxed when you sell a position. If you don’t have any gains, then there aren’t any taxes to pay. If you bought a position for $8 and it is worth $12 when you sell it, then you only pay taxes on the $4 gain. You can also do tax loss and gain harvesting with your taxable accounts.
- The biggest everyday advantage of a taxable account is liquidity. You can get to the money at any time and at any age, and there are no early-withdrawal penalties. You may have taxes to pay on gains, but not penalties. Tax-sheltered accounts are much harder to tap before retirement age.
- Another big benefit to taxable accounts is that assets pass on to beneficiaries with a step up in basis. For example, if you put $50,000 into a taxable account and it grows to $400,000, then your beneficiaries receive a step up in basis to the value at your death.
- Tax-deferred accounts
- The main benefit of tax-deferred investments is that you don’t pay taxes on the contribution when the investment is made. Retirees continue to receive tax deferral, but any distributions are 100% taxable.
- Tax-deferred accounts also have required minimum distributions, which start at age 73 (75 if you were born in 1960 or later) and wouldn’t be considered a benefit. The benefits of tax-deferred accounts are realized during your working years and the tax-deferred growth.
- Tax-free accounts
- The benefits of tax-free accounts are realized in retirement when distributions are income-tax free. If you are 59½ or older and have had the account for five years or longer, then any distributions are not taxed or penalized. Roth TSP and Roth IRAs also have no required minimum distributions for the original owner.
Having investments in each of the three categories above would give retirees some flexibility over the income tax they pay. Tax planning is a hot topic that can help you keep more of your money in retirement, and I cover the full picture in How to Avoid Getting Crushed by Taxes in Retirement.
How can you make a taxable account more tax-efficient?
A taxable account shouldn’t be a substitute for the TSP or IRAs, but there are a few ways to greatly improve its tax efficiency:
- Invest for long-term gains. Index funds and other funds with low turnover hold investments longer, which increases your chances of paying long-term rates instead of short-term rates.
- Perform annual tax-loss harvesting. Losses offset gains, and you can deduct up to $3,000 of net losses a year from your other income and carry the rest forward. For example, if you have $11,000 of losses in a year and no gains, you can deduct $3,000 on your tax return and carry the other $8,000 forward. Watch the wash sale rule: if you buy the same or a substantially identical investment within 30 days before or after the sale, you don’t get to deduct the loss. Buying a similar, but not identical, fund keeps you invested.
- Give appreciated investments instead of cash. If you gift shares you have held more than a year, you don’t pay tax on the appreciation, and if you itemize you can generally deduct the full value (subject to IRS limits). More ideas are in Reduce Your Retirement Tax Bill by Strategic Giving.
So which account should you withdraw from first in retirement?
The answer is, once again, it depends! My recommendation is to look at your taxable income for each year and process the data. Pulling funds from your brokerage account first would likely lead to paying lower taxes today, which means your tax-deferred accounts are going to continue to grow, but that also could result in higher taxes when any withdrawals are taken. The decision of where to withdraw from first is going to come down to several factors.
- What is your taxable income today?
- What is your taxable income in the future?
- Is lowering taxes today a priority?
- Is lowering future taxes a priority?
- Are you married or single?
- Do you have a desire to pass assets on to beneficiaries?
Withdrawal scenarios by tax bracket
Consider these scenarios that demonstrate what your withdrawals might look like in a given year. For reference, for 2026 the 12% bracket for married couples filing jointly covers taxable income up to $100,800 ($50,400 single), the 22% bracket up to $211,400 ($105,700 single), and the 24% bracket up to $403,550 ($201,775 single).
The retiree is currently in the 12% tax bracket and is expected to be for the next five years until they start collecting Social Security.
In this scenario, it is likely beneficial to withdraw from tax-deferred accounts. At a minimum, the retiree should withdraw (or convert) enough to cover the remaining gap in the 12% tax bracket if they expect to be in the 22% tax bracket in the future. Since January 2026, that conversion can be done inside the TSP; see Roth TSP Conversions.
The retiree is currently at the higher end of the 12% tax bracket and expects to remain there.
In this scenario, the retiree might want to do a small conversion to fill up the rest of the 12% tax bracket. A married retiree should consider the widow’s penalty and how that would affect the survivor.
The retiree is currently in the 22% tax bracket and expects to remain there until Required Minimum Distributions (RMDs) start.
This retiree has options since there don’t appear to be any big changes in the future. One consideration should be withdrawing from tax-deferred accounts to reduce future RMDs. Withdrawing from a brokerage account would keep taxable income lower today.
The retiree is currently in the 22% tax bracket and expects to be in the 12% tax bracket in the future.
This situation is very rare; the only time I’ve seen it happen is when one spouse is still working. This retiree may want to take withdrawals from a brokerage account or even tax-free accounts to reduce taxes today.
The retiree is currently at the higher end of the 24% tax bracket.
In this scenario, it may make sense to withdraw funds from tax-free accounts once you hit the top of the 24% bracket. The next tax bracket is 32%.
Your choice of where to withdraw funds from in any given year of retirement comes down to your priorities for your current and future taxable income. Once you identify your criteria, it becomes easier to pinpoint the account you will withdraw from. I specialize in these federal retirement planning details at Bobb Financial. Schedule a call today if you would like help on your retirement journey.
Brad Bobb, CFP®, Bobb Financial, is an expert in federal benefits and retirement planning for federal employees.
This article is for educational purposes only and is not individualized financial advice. Figures are illustrative.