Shifting between saving for retirement and using your savings as retirement income can be difficult and confusing – here’s what you need to know to ensure a seamless retirement transition.
The ultimate goal for most of us is to enter into our retirement years with a low-stress approach to financial matters. After all, we’ve worked hard all our lives to save and invest appropriately – all to ensure that our golden years are well-funded and free from financial calamity. But there is one key piece of the retirement years’ financial puzzle that must be managed quite closely: how to withdraw your retirement funds in the most intelligent way to maximize your retirement years and minimize your tax burden. Keep the following examples in mind as you create your own customized plan:
The Sequence Strategy: To keep it simple, the Sequence Strategy suggests that you liquidate assets from your savings and retirement accounts in the prescribed order as follows:
- Take your required minimum distributions (RMDs) from any retirement accounts. Most RMDs must begin by age 70 ½, with severe penalties if this isn’t followed closely. An excise tax of up to 50% can be levied by the IRS if you fail to take your RMDs, so make this the first step. Roth 401(k)s and traditional IRAs are included here.
- Take distributions from any taxable account next, which can help your tax-deferred investments to grow quicker via compound earnings.
- Then take distributions from your tax-deferred retirement accounts, like 401(k)s, traditional IRAs, 403(b) accounts or a 457.
- Lastly, liquidate your tax-exempt retirement accounts like a Roth IRA or Roth 401(k).
By following this process, you’ll minimize any risk of an excise tax by prioritizing your RMDs.
The Tax Bracket Strategy: This option requires a bit more oversight and involvement in your investment portfolio, but if managed appropriately it will keep you within an advantageous tax bracket and minimize unnecessary income taxes.
- Start by doing a bit of math. Take your forecasted gross income for the year and your living expenses. The difference between these two amounts is called your income gap, and it is an important figure that you’ll need to understand prior to taking any distributions.
- Next, figure out what deductions and exemptions you can expect in the coming tax year, deduct that from your gross income figure, and that’ll provide an estimate as to your taxable income before taking anything from your retirement accounts.
- Then, look at the IRS tax tables and determine how much you can withdraw from your investment accounts without pushing you into the next higher tax bracket. Taking distributions from your tax-deferred accounts up the limits of the tax brackets may make sense in this case.
- If the amount you’ve taken out isn’t enough to cover your income gap, be careful not to liquidate securities for a gain – as this can trigger additional taxes on the transaction. You can take RMDs from a Roth account to make up for the shortfall if you need to.
The 4% Strategy: This philosophy is definitely geared toward those who want a simpler, less intensive method for managing retirement-age funds. In the 4% strategy, retirees will simply withdraw 4% of the account balance during the first year of retirement. Then, do the same the next year but tack on 2% of the distributed amount to account for inflation. Here’s an example:
If you have $500,000 in your retirement account, you would withdraw 4% of $500,000, or $20,000. The next year, withdraw the same $20,000, but add on 2% of the advanced amount, too – or $400. The total during year two would be $20,400. Year three would require a withdrawal of year two’s amount, plus 2%, or $20,808.
This strategy has been in place for nearly 30 years, and is great for those who want a simple and effective means for managing retirement withdrawals. The only risk associated with this option is if the market declines significantly during your retirement – you may find that the account balance drops quickly and your savings could deplete quicker than you anticipated. Nonetheless, it remains a popular option as it is simple and predictable.
Withdrawal of Earnings Strategy: Here’s another moderately simple tactic that does one thing well; it protects your principle investment dollars from erosion. In the withdrawal of earnings strategy, you’ll simply take distributions on the dividends and interest driven by your investments, while keeping the principle balance intact. This is great because it virtually eliminates you running out of money, but it is also less predictable because your annual distributions are 100% tied to the performance of your portfolio.
These are some of the more common retirement withdrawal strategies in place today, but by no means are you limited to just one course of action. In fact, you may want to craft a hybrid distribution option that maximizes your distributions, keeps your principle balance intact, and minimizes your taxable income. Contact the experts today at American Bullion for more information about retirement strategies and the pitfalls to avoid when taking distributions.
Although the information in this commentary has been obtained from sources believed to be reliable, American Bullion does not guarantee its accuracy and such information may be incomplete or condensed. The opinions expressed are subject to change without notice. American Bullion will not be liable for any errors or omissions in this information nor for the availability of this information. All content provided on this blog is for informational purposes only and should not be used to make buy or sell decisions for any type of precious metals.