Smart Ways to Tap Your Retirement Accounts

1. Set up a cash pool that will cover two to five years' worth of expenses. This simple step will alleviate much of your anxiety about cash flow. If you always have several years' worth of expenses covered in cash or short-term bond accounts, you'll always know where to go to take your next withdrawal.

2. As a general rule, make withdrawals from taxable assets before tax-deferred assets. Just don’t deplete your cash pool. As you sell assets in taxable accounts, you’ll need to be conscious of built-up capital gains and losses. To the extent you can net capital gains with capital losses, you can try to minimize the tax you’ll pay. You may also want to consider a strategy of selling over a period of years to lessen the tax payments owed in any one year.

Following the new tax law, it may make sense to start tapping retirement assets before age 70 1/2. If you are in a low tax bracket, you may want to withdraw just enough from your deferred accounts to take you up to the top of--but not beyond--the 15% bracket. By withdrawing some money before age 70 1/2, you will have smaller required minimum distributions down the road. (This does not apply to Roth IRAs.)

3. If you’re in your late 50s, take distributions from your company retirement plan. If you are at least age 55 and separated from service, you generally can take distributions from your company plan without paying a 10% early withdrawal penalty. Once you’re over age 59 1/2, you can roll over the company plan to a traditional IRA for greater investment choices. There is no early withdrawal penalty after age 59 1/2 from a traditional IRA.

4. Consider cashing in company stock (not rolling it over) and paying tax on the basis. If you have company stock in a company retirement plan, you’ll pay capital-gains tax on the appreciation over the basis when you sell the shares (called net unrealized appreciation or NUA). If you roll over the shares into an IRA, you’ll pay ordinary income tax on the distributions.

5. Use substantially equal periodic payments (SEPPs) to avoid the 10% early withdrawal penalty. Do this only if you have no other options. You don't want to lock yourself into these restrictive payments unless there is no other alternative.

SEPPs allow you to avoid the 10% early retirement penalty by taking distributions from your traditional IRA or qualified plan over the greater of five years or until you're age 59 1/2. You calculate the payment amount using one of three methods outlined in IRS Publication 590.

Be careful that you withdraw exactly what the calculation tells you to withdraw. If you take any more or any less, you'll be penalized. Last year a new revenue ruling came out that allows you to change the method of calculation, but only one time. Other than that, if you change the amount or the calculation method, you'll not only trigger the 10% penalty for each year you've been taking SEPPs, but interest on the penalties, too!

You can break your traditional IRA into several smaller IRAs and use SEPPs on only one (or more) of the smaller IRAs. This tactic may be beneficial if you want to match the SEPPs to an expense you have to meet, such as covering college costs, repaying a loan, or paying insurance premiums.

6. Tap your Roth IRA last. Because they have no minimum distribution requirements, leave assets in a Roth IRA to grow the longest. If you won’t be making withdrawals for a long time, consider investing in stocks.

A version of this article appeared Oct. 9, 2003.