How Does a Pension Affect My 401(k)/RRSP Withdrawal?

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Pensions. Remember those things?

No? Well then gather round, young Millennials. It’s Story Time!

You see, back in the days of yore (i.e. the 60’s), companies had these magical things called “pensions” that they offered to their employees as part of this other magical thing called “benefits.” I know, I know, it sounds crazy but it was a different time. I also think cars worked by sticking your feet through the bottom and running on the pavement back then.

ANYHOO, here’s how these things worked. The employer would automatically take a small contribution off their employee’s paycheck (pre-tax, of course). Then a professional money manager would make all the investing decisions for them. Finally, when the employee retired at 65, this “pension” would pay a part of their salary to them for the rest of their lives. This all happened automatically, of course, with no effort needed by the employee! Retirement planning was, for the most part, just taken care of for them.

I know, I know. Stop laughing. It was a different time!

In case it isn’t glaringly obvious, pensions have gone the way of the dodo, along with “stable employment” and “work-life balance.” Nowadays, defined-benefit pensions mostly exist in government jobs. The private sector, having realized how bloody expensive it is to run a pension, has mostly switched from a defined-benefit system, where your income in retirement is guaranteed by the company, to a defined-contribution system, where they MIGHT provide some 401(k) contribution matching, but the onus of properly investing and managing your retirement income falls onto you, the employee.

So if pensions by and large no longer exist, why am I talking about them at all?

Well, for some strange reason, we’ve recently gotten a string of emails from readers who a) are Baby Boomers with pensions, b) are retired or nearing retirement, and c) wondering how our 401(k)/RRSP withdrawal strategy would work for them.

I never turn away a good question, so despite the fact that we’re mostly concerned about millennials and the issues we face, I thought it would be interesting to MATH SHIT UP on a Boomer facing regular retirement.

How to Withdraw From Your 401(k)/RRSP

So first things first, what 401(k) withdrawal strategy are these Boomers talking about?

Obviously, we wrote about this before, but let’s do a brief recap here.

When you’re working, it pays to contribute money from your paycheck into your 401(k) or RRSP. These are both pre-tax retirement savings accounts, and allow you to defer your taxes by reducing your taxable income by the amount that you contributed.

Note that I said defer, not eliminate. When you later withdraw money from your 401(k) or RRSP, that amount withdrawn gets added back to your taxable account, and could potentially cause you to pay taxes on that withdrawn amount.

So in early retirement, our 401(k)/RRSP withdrawal strategy is to withdraw from these tax-deferred accounts in such a way that you pay no taxes at all. For RRSPs (which are Canadian), this means withdrawing from your RRSP accounts each year the value of your personal exemption, which is a tax credit that every Canadian gets automatically that offsets your tax liability to 0. Americans with 401(k)’s (or similar accounts) have to jump through additional hoops because they’re restricted from accessing their accounts penalty-free before the age of 59 1/2, so to get around this they have to construct what’s known as a 5-year Roth IRA Conversion Ladder. Click that link to learn exactly how to do this.

But for Americans, the strategy is basically the same: Withdraw/convert as much as your standard deduction, which for some reason as of 2019 is the same amount as the Canadian personal exemption: $12,000 per person. So a married couple filing jointly could withdraw $24,000 from your 401(k)/RRSP accounts, and pay zero dollars in tax!

How Does a Pension Affect This?

OK so how does a Boomer retiring with a pension affect this strategy. Well, first of all, a Boomer who’s close to retiring is likely over the age of 59 1/2, so they can just do a straight withdrawal from their 401(k) accounts without all that Conversion Ladder stuff since the age-based penalties don’t apply to them anymore.

And second of all, the withdrawal strategy I’ve outlined above assumed no other income. After all, you’re retired! You’re supposed to stop earning income from your job! That’s kind of the entire point of retiring.

Except if you have a pension, that breaks this assumption.

I know, I know. Tiny violin.

When you have a pension, you have an automatic, baseline amount of income every year, and that’s great. But it also pushes you into a tax bracket where you can’t get money out of your 401(k)/RRSP anymore for free.

As of 2019, here are the American federal tax brackets for joint married-filing-jointly couples.

Tax Bracketincome
10%$0 to $19,400
12%$19,401 to $78,950
22%$78,951 to $168,400
24%$168,401 to $321,450
32%$321,451 to $408,200
35%$408,201 to $612,350
36%"$612,351 or more

So let’s say that someone has a pension worth $30,000 a year. That means that they’re in the “unfortunate” situation of eating up their Standard Deduction of $24,000 of tax-free income, which leaves them $6000 of income at the 10% federal tax bracket.

The preceding paragraphs has been corrected from an earlier version due to the eagle-eyed observations from reader MikeyB. Thanks!

That means that if this Boomer withdraws even a single dollar, they will have to pay taxes on it. And because this happens consistently each and every year, the option of withdrawing/converting money at the 0% tax bracket, as we advocate, is off the table.

So what do we do? Is our retiree screwed?

The Top Up Method

Of course not. Being forced to pay taxes because you make too much money in retirement is never a bad thing. But it does mean you can’t just blindly take out $24k every year and be done with it. You have to do a little more analysis.

Fortunately, the strategy isn’t that hard. I like to call it The Top Up Method.

Here’s how it works.

  1. Add up you and your spouse’s annual pension payout
  2. Figure out which tax bracket this puts you in.
  3. Take the upper limit for that bracket, subtract it off your pension amount, and that’s how much you should withdraw from your 401(k)/RRSP every year.

So for example, if our Boomer retiree couple had a pension worth $30k each year ($6000 after the $24k Standard Deduction(, by looking at 2019’s tax brackets, this would put them in the 10% tax bracket. The 10% tax bracket has a range of $0 to $19,400. So that means our retiree should withdraw $19,400 – $6,000 = $13,400 each year from their 401(k).

Why is this? Because if your pension by default pays you $30,000 each and every year, then the absolute minimum tax rate you can ever pay on a 401(k) withdrawal is 10%. So as long as you’re stuck paying 10%, you may as well get as much out as you can at that tax rate.

So in other words, whatever tax bracket you happen to find yourself in, Top Up (see what I did there?) the bracket you’re currently in. That way, you will withdraw as much as you possibly can at the minimum tax rate you possibly can. Just don’t cross the boundary into the next bracket.

What About State/Provincial Taxes?

My analysis here is using federal tax brackets, but so far I haven’t mentioned state taxes. Why is that?

To keep the lesson simple.

Wall Street loves to convince people that money management is complicated. They do this so you’ll hire them to manage your money. But the truth is, money management is not complicated. But there isn’t a one-size-fits-all solution. I like to teach the techniques, and trust the reader to apply them to their unique situation.

The Top Up Method is a great example of that.

State/Provincial income taxes add a layer of complexity onto the relative simplicity of the Top Up Method. Some states, like California, have a layer of progressive tax brackets that add on top of the federal tax brackets. Others, like Texas, don’t have a state income tax at all.

However, the technique remains the same.

  1. Add up you and your spouse’s annual pension payout
  2. Figure out which (combined) tax bracket this puts you in.
  3. Take the upper limit for that (combined) bracket, subtract it off your pension amount, and that’s how much you should withdraw from your 401(k)/RRSP every year.

And We’re Done

So there you have it. If you’re lucky enough to have a pension, figure out the minimum tax rate you can pay, then maximize the HELL out of that tax bracket you happen to be in.

That’s how a pension affects your 401(k)/RRSP withdrawal.

Questions? Comments? Let’s hear it in the comments below!


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43 thoughts on “How Does a Pension Affect My 401(k)/RRSP Withdrawal?”

  1. Might want to fix a typo or two that could lead to confusion: “401(k) accounts with all that Conversion Ladder stuff since the age-based penalties apply to them anymore.”. I think you meant “withOUT all that…” and “…penalties DON’T apply to them…”‘. Don’t want to be pedantic, but… 🙂

    Good stuff otherwise!

    1. Just start a side hustle and build up your online business, so you can be a side hustle millionaire down the road and potentially make money online 24/7. Nevermind pensions and 401 (k). Your employer will ROB you!

  2. This is day 4 of retirement for me… (no shit, 4 days ago…). I’m 42 wth a small pension and wife who is 9 years younger (millenial).

    My pension is small (19k/yr), which complicates things by only allowing us 5k/yr withdrawal. So what we decided to do was….

    We Allowed ourselves more risk (85/15), by investing in less bonds or ‘safe’ investments, and because my pension pays a steady reliable amount each month. That coupled with your dividend strategy that pays us a little above 4%, provides me with the 40k/year I need.

    … And like you said, if the markets shit, I’m going to Thailand.

    1. Congrats! And yes, pensions absolutely act as a guaranteed Yield Shield so it makes sense to up your equity like you did. Good job!

      And it’s “If shit hits the fan, you’re going to Thailand.” These rules have to rhyme, or it doesn’t count.

  3. I don’t know anyone with a pension anymore… although in the States I hear some government workers still have them. All the rest of us are 401k plebes.

    Congrats to anyone that still has one.

    1. Mr Tako, I have one and you know me! I will say my employer is trying hard to give me a heart attack/severe health problems so I don’t collect it ; )

      1. That’s another reason why I don’t like pensions. TECHNICALLY, it gives the government (or your employer) an incentive for them to kill you. I don’t like them odds.

        1. And another reason that if you win the lottery just take the lump sum payout. No need to create any negative incentives!

    2. We still have pensions in Canada. I am a teacher and my partner works for the government and we both have pretty great pensions.

  4. For those who live in the (once great) state of New Jersey, be careful about pushing your total income (line 27 form NJ-1040) over 100k (not inflation adjusted!). The first dollar might (depending on your 1099-R numbers) cost you about $1300 in additional state tax (I know, hard to believe, but true). My question to the author is, have you considered an IRA conversion (traditional IRA to Roth) instead of withdrawing from the IRA. This is how I have been playing the game and it seems like a good strategy to me. Of course, not nearly as good now since we can’t recharacterize, but still ok.

  5. I benefit from my husband’s pension on which I was remaindered after his death. Trump’s bogus tax cut will not be my friend. Grrrrr.

  6. Millennial with a non-government defined benefit pension here. However, the company went to a hybrid DB/DC plan for new-hires some years ago. Will my pension still be intact in 14 years, the youngest age at which I can start to collect it, let alone to 65? I’m trying not to put all my eggs in that basket.

    This was an informative post. Thank you.

    1. Yeah, FC was the same. Technically, her employer had a DB pension, but they kept tweaking the formulas so that newer employees (like her) got less payout, but still had to pay in the same amount as everyone else. So the younger people were subsidizing the older people.

      So we went “F that noise” and transferred it out as a lump sum when she retired.

  7. Same thing would apply to Social Security income and any earned income from a business, job or side hustle.

    Would you recommend this approach for those pushed into brackets higher than 12%?

    1. It doesn’t matter which bracket you’re in. It’s the same logic. Your pension + SS determines the minimum bracket you will ever be in, which means that’s the minimum tax rate you can possibly pay, so you may as well withdraw as much as you can at the minimum.

      Side hustle income is a little tricker, since it’s not steady or guaranteed. With side hustle income, you can opportunistically take advantage of “dip” years to withdraw more at a lower bracket.

      For example, you and I know that book sales income is very uneven. So if you had an inordinately good year or book sales, I’d hold off on the withdrawal until the year after in the hopes that more “normal” sales will allow me to withdraw more at a lower rate.

  8. Nice write up for us boomers! I have a pension, retired a year ago. I’m trying to roll as much of my 401k into a Roth Ira while taxes are low & before required distributions begin at age 70. Don’t know if I’m following the best strategy, but I don’t need the 401k distributions for expenses right now.
    My pension plus eventual social security for 2 of us will almost fill the 12% bracket. There will be little room for rollover funds before top up.

    Yeah, got a whole tiny string orchestra playing here.

    1. Oh it’s not a bad problem to have, but it’s still a problem that needs solving. Yes, I think you’re doing the right thing. Move to Texas and get as much as you can out at 12% before the RMDs kick in.

  9. $30,000 Pension – $24,000 Standard Deduction = $6,000 of Taxable Income. This puts you in the 10% bracket. Unless I’m missing something here (and it’s quite possible), you might want to rework the math throughout this post.

    1. YOU sir, are correct.

      GREAT catch buddy. This was actually because in Canada, the $24k personal deduction that everyone gets is actually a tax credit, meaning your taxable income doesn’t change but you get credited back any taxes due. In the USA, it’s actually a deduction, meaning it reduces your taxable income. If you earn $24k or less, the effect is the same. But if you earn more than $24k, the US system is better since it lowers the marginal tax.

      Math has been corrected, with credit given to you!

  10. Pensions are a funny thing, they are in fact, an anuity of sorts, it stops when you die (well not quite, depending on your spouce), for me, I want to get out as much as I can up front, damb the taxes, pay them when I am dead. My RRSP, is there no matter what, same with TFSA, which is even better than the RRSP. So, I will leave that as my “cash cushion” and only access if I need it. In Canada, as long as your under 71, you don’t need to withdraw, but after you need to convert to a RRIF, and make minimum withdrawals, but 10 years from now, the basic personal exemption will be up another 10% or so, and that will decrease my tax payable from RRSP money.

  11. “You see, back in the days of yore (i.e. the 60’s), companies had these magical things called “pensions” that they offered to their employees as part of this other magical thing called “benefits.” I know, I know, it sounds crazy but it was a different time.”

    In some commie countries like UK, and a lot of the rest of the civilised world, i.e. not USA, contributing to a workplace pensions are actually a legal requirement. Back in my day (not quite the 60s, but I would probably be considered a Borderline Boomer) they actually weren’t – I had no pension scheme for the first 4 or 5 years of my career. These days it’s actually better for millennials as it’s a legal requirement in the UK – they contribute a minimum % and also the employer must too – so pretty much everyone that has a pension. From April 2019 that contribution will amount to 8% of salary. Sure you *could* opt out, but then you’d lose those employer contribs – free money. Who doesn’t want free money? There are a few exceptions, but things are better than they were in some ways. Sure Defined Benefit schemes are pretty much gone, but Defined Contribution schemes are everywhere.

    p.s. Looking at some of the comments there seems to be a little bit of confusion between a pension and an annuity. You can use the lump sum nestled in your DC scheme to purchase an annuity if you want to – the annuity is basically a fixed income for life. They aren’t that popular these days, but they used to be the only option here in UK. Since various pension scheme rules were relaxed you now have more or less complete control over your lump sum in a DC scheme – you can take 25% tax free lump sum, and/or just drawn down as and when required. I would say controlled drawdown is the popular option these days. Note the 25% tax-free lump sum can be squirrelled away into ISAs (cash, shares) at up to 20K/year.

      1. I only scratched the surface. 😀

        Didn’t get into 25% tax free lumps sums (you can take after age 55) or tax relief.

        Whippersnapper Millennials will get 20% tax relief on payments going into the pension fund, and 40% if they are a high rate tax payer (over £43,651pa). I’ve used this relief to make huge tax efficiencies in my contracting business. You can put in up to 40K a year into your fund and cop that lovely jubbly tax relief. With careful management you’ll gain the 40% going in, but pay 20% max on the way out, and 0% if you’re canny.

        And I didn’t get on to the REALLY big win. Since 2015 private pension arrangements fall outside estate planning for tax purposes, IF you have nominated beneficiaries. UK inheritance tax is 40% on capital gains over 325K so this is a very, very big win – at least for your beneficiaries. 😀

        As I say things are a LOT nicer now in the UK than when I was a “millennial”. 🙂

  12. You could “math this up” a bit more by looking at not taking 401K withdrawals if you don’t need the money. Let it stay in the 401K.

    That way you have a bigger nugget of cash growing tax free inside your 401K. Sure, you’ll pay tax when you eventually take it out but compared to taking it out yearly, having that amount taxed, investing the remainder and eventually paying capital gains tax on those gains, I believe you end up ahead not withdrawing?

    Need to run the numbers with different tax bracket assumptions of course.

  13. Thank you so much for this article! I am a teacher in Vancouver, and as such I do get a pension, thankfully. However, I don’t want to rely solely on that for retirement income, nor do I want to work until the age of 65 in a Kindergarten class. I’m still going to work towards my goal of Financial Independence and once my pension kicks in it will hopefully just be icing on top of the cake. That being said, I’ve only contributed to the fund for two years, so I’ll need a few years to build it up nicely.

      1. Nice to have but are you willing to suffer the hair loss and the stress of raising other peoples kids. I taught for 28 years and loved it. When people found out I was a teacher (grades 7-9), they would often apologize for their kids behavior. When they asked what I taught I would often respond “manners and civilized behavior”. If you ever get a chance to thank the great teachers you have had over the years-please do. It will absolutely make their day and encourage them to continue in a tough job that appears to only be getting tougher over the years.

  14. Great article Wanderer. I am in the situation you describe and am planning to do exactly this. Retired in June at age 56. My Canadian DB teachers pension pushes me into the next tax bracket. I can split 1/2 of this pension with my spouse at tax time and drop a bracket. We were a single income family so her retirement income is small. This allows us to use the top up strategy from any of our four RRSP accounts and move that money into more tax efficient accounts.
    For those with solid DB pensions consider maxing out your tax free accounts first while you are working. RRSP contributions only make sense if you will be in a lower tax bracket when you withdraw the money otherwise it’s a zero sum game. DB pension contributions count towards your annual RRSP contribution limit so the amount you have to contribute can be negligible.
    If you had two DB pensions (two married teachers) consider keeping one intact and withdrawing the other one early, pay the tax hit, move it into self directed investment accounts and invest. This way you have a legacy account and guaranteed income.

  15. This will be my exact situation in a few years. It doesn’t look like this will save me any money (in taxes) over time so my question is why even do this?

  16. My wife has a great DB from her government job. She also has a government 457 and we max that. Due to our combined income IRAs, except for post-tax traditional, are off the table so that 457 is sweet. When we retire at 55 in several years she will have a six figure pension indexed to inflation for life. Makes the “cash cushion” in retirement unnecessary for us so we can be a bit more aggressive in our investments.

    Once in awhile she bemoans the thought she might earn a bit more in the private sector and then I remind her of all her holidays and the fact her employer puts in a match of 30% of her salary to the DB plan. That 30% makes her compensation actually higher than the private sector and it’s like they’re buying her a 4% annuity in the amount of $2.5 million. That always makes her smile.

      1. Wanderer, thanks for the link but it won’t work in our situation, being middle of the pack Gen X’ers and long term savers, we had accumulated a material tranch of traditional IRA investments and 401(k) rollover before this came out. Thanks to the IRS’s IRA aggregation rule and pro-rata rule the numbers don’t work in our case. I wish they did as we’d be doing that big time.

  17. Hello,

    This may be off topic to your recent post but I came across the following link which is mentioning your website and challenging your cash cushion / high yield strategy. We are 2 to 3 years away from retirement or semi and thinking of adding more income driven securities such as preferred shares, REITS etc and following your strategy. What do you think of the article below?

  18. Taken from the canadian revenue agency :

    ”When you withdraw funds from an RRSP, your financial institution withholds the tax. The rates depend on your residency and the amount you withdraw. For residents of Canada, the rates are:

    10% (5% in Quebec) on amounts up to $5,000
    20% (10% in Quebec) on amounts over $5,000 up to including $15,000
    30% (15% in Quebec) on amounts over $15,000”

    So let’s say you withdraw money from your RRSP while being on a pension. You not only have to pay taxes on the difference between your yearly pension (including the added amount withdrawn from the RRSP) and your Personal Deduction, but on top of that, you have to pay taxes on your withdrawal to your financial institution (it’s worse if you live in Quebec)? Is there a way to avoid that withdrawal tax rate? Is that tax rate applicable only if you withdraw BEFORE retiring or it applies everytime you withdraw from your RRSP?

    source :

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