Article of the Week  

Jason Schneider

For retirees, not all savings are created equal. When retirees get ready to draw down their nest eggs, few realize that the order in which they tap their accounts influences how much they keep and how much they pay in taxes.

Increasingly, people retire with more than one type of investment or savings account. There are taxable accounts, such as a regular brokerage account or bank account. Then there are tax-deferred savings, like 401(k) plans and traditional individual retirement accounts. There are also Roth IRAs, which allow withdrawals tax free.

The inclination is to take money from whatever account is most convenient, or to take cash out of investments based on an opinion about where markets are heading.

However, retirees who consider the tax consequences of withdrawals from various accounts "can add a lot of value," says Matthew Kenigsberg, a member of the global asset-allocation team at Fidelity Investments. He likens it to "extra credit" on a test.

Underlying the tax questions is a fact that many retirees either forget, or don't realize, until it's too late: They pay income tax on money pulled from traditional IRAs and 401(k)s. As a result, for retirees in their 60s, the first stop for withdrawals usually should be taxable accounts, experts say. The thinking: Cash withdrawn from these—despite the name—isn't subject to income tax.

While capital-gains taxes can take a bite out of savings, the damage is small compared with ordinary-income tax rates, which run from 10% to 39.6%.

For most people, capital-gains taxes will be 15% on long-term investments. They're as low as zero for those in the lowest tax brackets and peak at 20% for the wealthiest. While capital-gains taxes can take a bite out of savings, the damage is small compared with ordinary-income tax rates, which start at 10% and rise to 39.6%.

Another reason to hold off tapping tax-deferred accounts: "The tax-free growth advantage of an IRA is something that you want to preserve as long as you can," says Adam Ochlis, senior client adviser at Ballentine Partners in Waltham, Mass.

When looking at tax implications, don't forget dividends. Many investors automatically reinvest dividends as an easy way to expand savings. But even when reinvested, so-called qualified dividends paid by stocks are taxed at 15% (except for the wealthiest individuals, who pay 20%). As a result, experts suggest ending the automatic reinvestment plans and instead using dividends as a source of cash.

The calculation changes, however, at age 70½, when the federal government requires all holders to take minimum distributions from IRAs and retirement plans. The dollar amount of those distributions is based on your age and the value of the accounts.

Taking those required distributions "is almost always going to be the very first item on the withdrawals list," says Fidelity's Mr. Kenigsberg. If not, "there are pretty stiff penalties."

Roth IRAs, which are funded by after-tax contributions, should generally be last in line for withdrawals. Because withdrawals from Roths are made free of both income and capital-gains taxes, it makes sense to allow money to grow as long as possible in those accounts.

There are nuances and exceptions to these rules. One exception involves those whose income sources land them at the upper end of the 15% tax bracket—and withdrawing money from an IRA or 401(k) would bump them up to the 25% tax bracket.

Instead, those retirees can try to avoid that bump either by tapping a Roth IRA, where withdrawals aren't taxed. In some cases, retirees can turn to taxable accounts. For example, if an investment is sold at a loss, no capital gains or income taxes will be levied on the proceeds.

"That's a huge difference," says Fidelity's Mr. Kenigsberg. "They could save themselves quite a bit."

Individuals who are several years from retirement should keep these strategies in mind, says Maria Bruno, a senior investment analyst at Vanguard Group. That could mean channeling more money into tax-advantaged accounts, especially a Roth. Or else sitting down with an accountant and looking at when it might make sense to convert a traditional IRA to a Roth, which has tax implications of its own.

Says Ms. Bruno: "You can think about building that future tax diversification."