Most Retirees Are Making This 401(k) Mistake: Draining Taxable Accounts First

Financial planner Julia Lembcke laid it out plainly on a recent episode of Thoughtful Money with Adam Taggart: most retirees have their retirement savings backwards. “What I see most of the time is that the pre-tax accounts, whether they’re 401(k)s or IRAs, self-employment retirement accounts, that they’re the dominating share of the tax type.” Her typical client holds 60% to 70% in pre-tax accounts, 20% in taxable brokerage, and 10% or less in Roth. In the worst cases, “the pretax is 90% or more of a person’s net worth, and that’s going to create a big issue, especially if you’re maybe a higher spender and especially when RMDs are due.”

The problem is not the balance. The problem is the order in which retirees spend it down. Conventional wisdom says drain your taxable accounts first, then your traditional IRA, then your Roth. That sequence is tax poison. Every dollar pulled from a traditional 401(k) or IRA counts as ordinary income. Pull too much in one year and you jump into a higher bracket, trigger Medicare IRMAA surcharges, lose access to the 0% capital gains rate on brokerage assets, and potentially face the 3.8% Net Investment Income Tax. The math is uglier than most people realize, and the window to fix it closes fast.

Why withdrawal order determines lifetime tax

Lembcke’s central point is arithmetic: “the way that they withdraw those funds, the sequence with which they withdraw the funds, has a huge impact on their total lifetime taxes.”

A 62-year-old couple with $2 million needs $100,000 a year to live. Split the portfolio 80% traditional IRA ($1.6 million), 15% taxable brokerage ($300,000), and 5% Roth ($100,000). Under the conventional rule, they drain taxable first. That brokerage account lasts three years, taxed at 0% or 15% on long-term gains. At 65 they start pulling $100,000 annually from the IRA. All ordinary income, stacked on top of Social Security.

By 73, when required minimum distributions kick in, the IRA has compounded back to nearly $2 million. The RMD formula forces withdrawals whether the couple needs the cash or not. That mandated income can push them into the 24% bracket, trigger IRMAA, and subject capital gains and dividends to the 3.8% surtax.

The smarter sequence blends sources from day one. From 62 to 70, pull $40,000 from the IRA (staying in the 12% bracket) and $60,000 from the brokerage. Simultaneously convert another $30,000 to $50,000 per year to Roth, filling up the 12% or lower 22% brackets before RMDs start. By 73, the traditional IRA balance is materially lower. RMDs stay manageable. Lifetime tax drag drops by six figures for a household of this size, and the portfolio retains more flexibility to absorb market downturns or unexpected expenses.

The IRMAA lookback is a hidden tax multiplier

Medicare does not care what you earned last year. It looks back two years. Income at 63 sets your Part B and Part D premiums at 65. Lembcke calls these “hidden taxes in retirement,” and the impact is concrete. For 2026, the base Medicare Part B premium is $202.90 per month. Cross the first IRMAA threshold at $109,000 (single) or $218,000 (joint) and your total monthly premium jumps to $284.10, an extra $81.20 per month or $975 per year. The top tier hits $689.90 per month, more than triple the standard rate.

That is why she flags the window between retirement and age 63 as the cleanest conversion opportunity you will ever have. No wages, no RMDs, and no IRMAA penalty for one year of elevated income. A large Roth conversion at 64 can pull capital gains, dividends, and interest into Net Investment Income Tax territory and lift Medicare premiums for two consecutive years.

The Net Investment Income Tax adds 3.8% on investment income for joint filers above $250,000 of modified adjusted gross income. That threshold is not indexed to inflation, and with CPI running at 3.8% year over year as of April 2026, more households cross into NIIT exposure every year without any real increase in purchasing power.

Lembcke is direct about the constraint: “The reality is you don’t have enough cash on the side to do significant conversions” when 90% of assets sit in pre-tax accounts. You need liquid taxable cash to pay the conversion tax bill. Paying the tax from the IRA itself defeats most of the benefit.

What to do now

Inflation makes the timing urgent. CPI hit 3.8% in April 2026, the highest level since May 2023. Core PCE, the Federal Reserve’s preferred inflation gauge, sits at 3.3% annually. IRMAA thresholds and tax brackets adjust for inflation, but RMD withdrawal percentages do not. Rising prices against frozen withdrawal math accelerates bracket creep.

1. Calculate your pre-tax share. Add every traditional 401(k), traditional IRA, and self-employment retirement account. Divide by total investable net worth. If the result exceeds 70%, you have a sequencing problem that compounds every year you delay.
2. Map your IRMAA window. If you are between 59 and 63, every dollar of Roth conversion completed now avoids the two-year lookback that sets Medicare surcharges starting at 65. This is the last clean runway before penalties layer in.
3. Model two scenarios. Run one assuming you defer the IRA until 73 and one assuming you blend withdrawals plus annual conversions starting immediately. Use SSA.gov for Social Security projections and any RMD calculator for the traditional IRA. Compare the projected RMD at 73 under each path.
4. Hold enough taxable cash to pay conversion taxes. Paying the tax out of the IRA itself erases most of the long-term benefit. If you lack sufficient taxable funds, scale conversions to match available cash.

Taggart summarized the core insight on the podcast: “If you plan your withdrawal sequence well, you end up being able to save on taxes and have more money left over.” The sequence is the strategy. The conventional rule costs tens of thousands of dollars in unnecessary taxes, and the longer you wait to fix it, the fewer options remain. Pick wrong and the IRS claims a larger share of the portfolio you spent forty years building.

Editor’s note: Inflation figures and 2026 IRMAA income thresholds were updated to reflect current Bureau of Labor Statistics and Centers for Medicare & Medicaid Services data published through May 2026.