I recently presented “Back to the Future: Is Your FI Journey Stuck in 2017” for the ChooseFI Los Angeles chapter–coming soon to the San Diego ChooseFI chapter!
It struck me that back in 2017, most in the Financial Independence community would have said “let that Roth IRA grow tax free for as long as possible!”
Is that wise in 2026?
I believe that for some early retirees, spending Roth IRAs in early retirement may be the optimal path. Cody Garrett explored this in our recent book, Tax Planning To and Through Early Retirement.
I figure it is good to explore this topic in additional depth on my blog. An example will illustrate just how powerful Roth IRA withdrawals can be for some early retirees.
Funding Year-End Expenses in Early Retirement
Picture Linus and Sally. Both turn 58 in 2026. They are retired, live in San Diego, California, and have no dependents. Linus and Sally are on the “Second Lowest Cost Silver Plan” all year as their ACA medical insurance.
Through November 2026 they fund their living expenses by selling mutual funds in their taxable account. These sales, through November, have triggered $70,000 of capital gains. They also estimate that by the end of the year they will have $10,000 of total interest and dividend income.
Linus and Sally need $10,000 to fund their December living expenses. They are considering two options for getting that $10,000 from their portfolio.
Option 1 is selling $10,000 of mutual funds taxable accounts. This sale would trigger a $6,000 long-term capital gain.
Option 2 is withdrawing $10,000 from one of their Roth IRAs. Due to having previously made annual contributions to Roth IRAs (and/or having done the Backdoor Roth IRA), they have plenty of accessible Roth IRA basis such that the $10,000 withdrawal would be entirely tax and penalty free.
Which option should Linus and Sally choose to fund their December expenses?
The Premium Tax Credit
Linus and Sally are subject to three “taxes” that function like an income tax. They are:
- Federal income tax
- California state income tax
- Premium Tax Credit
To be clear, the Premium Tax Credit is not a tax. Rather, it is a mechanism to run a personal expense (medical insurance premiums) through the Internal Revenue Code.
As a result, the Premium Tax Credit behaves very much like an income tax.
However, there is one feature of the Premium Tax Credit that we must consider in additional detail: the 400% of federal poverty level cliff.
For Americans with income from 138 percent of the federal poverty level up to and through 400% of the federal poverty level, the Premium Tax Credit functions largely like an income tax. As income rises, the Premium Tax Credit is ratably and progressively reduced. However, the second one has income a dollar more than 400 percent of the federal poverty level, the Premium Tax Credit plunges (goes off the cliff) to $0.
For a married couple, this could easily mean the loss of over $10,000 of Premium Tax Credits.
The 2026 return of the 400% of federal poverty level cliff means that Roth IRA withdrawals in early retirement are more important than ever!
Roth IRA Distributions and the Premium Tax Credit
Let’s explore the results when Linus and Sally pursue Option 1. This funds their December expenses with the sale of $10,000 of brokerage account mutual funds. It trips a capital gain of $6,000.
After this capital gain, Linus and Sally have an adjusted gross income (and MAGI) of $86,000, consisting of $70,000 of prior capital gains, $10,000 of interest and dividends, and the December capital gain of $6,000.
At $86,000 of MAGI, Linus and Sally qualify for no Premium Tax Credit, as their MAGI is 407 percent of the federal poverty level.
If, instead, Linus and Sally fund their December living expenses with a $10,000 Roth IRA distribution, their adjusted gross income and their MAGI is $80,000 ($70,000 of capital gains plus $10,000 of interest and dividends). This leaves their income at 378 percent of the federal poverty level.
At this level of income, Linus and Sally qualify for a $15,469 Premium Tax Credit.
Roth Distribution Optimization
Option 2 is a Roth Distribution optimization play.
In Linus and Sally’s 70s and 80s, it may be the case that a Roth distribution avoids a 24% or 32% federal income tax. That’s a good Roth distribution outcome.
But the $10,000 December Roth IRA distribution in 2026 avoids an effective federal tax of 257.82 percent!
Isn’t that the best time to take a Roth distribution?
Maximizing Premium Tax Credits with Roth IRA Distributions
It’s time to start thinking about ways to optimize Roth distributions. Enrollment in an ACA medical insurance plan may be the time to optimize Roth IRA distributions. ACA enrollees are subject to potential federal and state income taxes and potential diminution of the Premium Tax Credit.
What makes the diminution of the Premium Tax Credit issue particularly compelling in 2026 and beyond is the return of the 400 percent of federal poverty level cliff for Premium Tax Credits.
For many of those retired prior to age 65, controlling income to avoid the 400 percent of federal poverty level cliff has become a compelling planning objective. Going off the cliff can easily cost a married retired couple $10,000 or more in Premium Tax Credits.
Having a tax free source to draw upon for living expenses in the early stages of an early retirement might be much more important than having a tax free source to draw upon later in retirement, as Linus and Sally’s example illustrates.
Additional Resources
The taxation of “early” Roth IRA distributions tends to be very favorable. I blogged about the tax treatment of Roth IRA distributions in these two articles.
The Taxation of Roth IRA Distributions
Conclusion
Who doesn’t love a large tax free balance in a Roth IRA? Nevertheless, it is important to remember that balance exists to support retirees.
For many retirees, particularly those on an ACA medical insurance plan, the Roth IRA may best support them in the early part of their early retirement.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
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This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.
Yes! We’ve been doing exactly this. Felt weird at first to pull from Roth in our 50s, but the math makes perfect sense, especially with the ACA cliff now.
I just started working again as a 1099 consultant, and planning to stuff as much into a solo 401k to keep the MAGI below 400% (while still pulling from Roth). As a sole proprietor, my understanding is our health insurance premiums are above-the-line deduction and reduce MAGI, which creates a bit of circular math to figure out exact Premium Tax Credit/MAGI. Have you addressed this in any blog posts/podcasts or know any good resources that address this?
Thanks again for all your great content!