Which Account Goes First? The Question Every Couple With $1.4 Million Should Answer Before 65

A 63-year-old married couple with a $1.4 million investment portfolio must decide which retirement account to draw from first before reaching age 65. This decision is crucial because Medicare's two-year Modified Adjusted Gross Income (MAGI) lookback period means that withdrawals or conversions made in that two-year window will impact their future Part B premiums.

Failing to address this issue could result in an effective marginal tax rate near 40% when Social Security benefits, Medicare surcharges, and potential survivor's tax status are all factored in. The couple should begin by utilizing the taxable brokerage account for cash flow, as long-term gains in this account are taxed at 0% or 15%, which is more favorable than ordinary income withdrawals from their traditional 401(k).

They should also reserve two years of spending in short-term Treasury bills with yields around 4.4% to cover expenses without touching retirement accounts. Next, they should execute partial Roth conversions from their 401(k) each year until they reach age 72. By converting $80,000 annually, they can push income into the 12% and lower end of the 22% tax brackets, reducing their traditional 401(k) balance before Required Minimum Distributions (RMDs kick in at 73.

This strategy can lower their tax burden significantly, as withdrawals from a Roth IRA do not affect Social Security taxation or Medicare Part B premium calculations. Delaying Social Security benefits until age 70 could amplify this strategy, as the benefits will grow approximately 8% per year beyond the full retirement age, and the 2027 Cost of Living Adjustment (COLA) forecasts a 3.3% increase.

Once their combined income surpasses the threshold where 85% of Social Security becomes taxable, along with IRMAA (Individuals with Income Over $103,000 single or $206,000 joint MAGI), the effective marginal tax rate on the next dollar of their 401(k) withdrawal could approach 40%. To minimize this risk, they should model a conversion ladder to the top of the 22% tax bracket, ensuring that their MAGI remains below the first IRMAA tier.

Starting this conversion process before turning 63 is essential, as this return will determine their Medicare premiums for the year they enroll at 65. Additionally, they should build a two-year Treasury reserve to fund their living expenses during the conversion period, ensuring that they do not inadvertently pull extra taxable income from their 401(k).

Finally, they should coordinate their Social Security claims with the conversion window. By delaying benefits until age 70, completing conversions by 72, and allowing RMDs at 73 to be calculated on a smaller pre-tax balance, they can potentially minimize their tax liabilities. If their MAGI is projected to exceed the $206,000 threshold, a fee-only financial advisor may prove invaluable in avoiding IRMAA penalties.