After decades of planning and putting money away, it would be easy for most people to shift from a savings mindset to a spending mindset. Yet one often overlooked aspect of retirement planning is making a retirement withdrawal strategy.
Retirement Withdraw Strategies
When mapping out your retirement account withdrawal strategy, you must consider factors that include:
Your marital status
- The two significant factors affecting your optimal retirement withdrawal strategies are marital status and state of residence. With a plan to receive the total value of the joint taxable account upon a spouse’s death for a married couple in a community property state, it may be worth holding off withdrawing the funds from the tax-deferred accounts until the event of the step-up.
- A few options are the 4% retirement withdrawal rule, the fixed dollar withdrawals, and the withdrawal buckets strategy.
Your life expectancy
- One of the hardest things to determine is how long you will live. The current average life expectancy for a male is 84 years, whereas a woman is 86.6, says the Social Security Administration.
The kinds of retirement accounts you have
- You will find that there are different rules to consider for IRA withdrawals, Roth IRA withdrawals, and traditional 401 k withdrawals.
What do you think your living expenses will be in retirement?
- According to the Bureau of Labor Statistics, someone aged 65+ spent, on average, a little over 4k a month, coming to almost 49k a year between 2016 and 2020. Keeping this number in mind and paying attention to inflation will keep your withdrawal strategies on target.
Here are six tips that will help you plan a drawdown strategy that accounts for these and other key variables and provides you with a predictable annual income:
1. Plan to Minimize Taxes
Reducing your tax bill will have one of the most significant impacts on your retirement savings. Advanced tax planning that takes advantage of all three tax “buckets” – taxable accounts (savings accounts, investment accounts), tax-deferred accounts (traditional IRAs, 401(k)s), and tax-free accounts (Roth IRA, tax-exempt bonds) – can reduce your taxable income in individual retirement account alone, leaving you with more money after you make your withdrawal (and reducing how much money you need to take out to maintain your lifestyle).
There could also be additional tools, such as trusts, that you could take advantage of to reduce your tax liability. Your tax plan will guide you to a tax-efficient withdrawal strategy that helps you get the most out of your retirement savings.
Bucket withdrawal strategy
The Bucket withdrawal strategy will have you pulling from three buckets. These will be separate accounts that will hold your assets. The three buckets will include a savings account with three to five years of your living expenses, the second is a fixed income security, and the third contains the rest of your investments in equities. As you deplete the first bucket, you can replenish using the earnings from the other buckets. This strategy will allow your savings to grow but is a more hands-on approach to your retirement income and will become more time-consuming.
Remember the required minimum distributions.
Once you turn 73, you must take the required minimum distributions from your tax-deferred accounts. RMD covers all employer-sponsored retirement plans and all traditional IRA variants. You will have to take a distribution based on the amount in each account, modified by a life expectancy factor that the IRS publishes every year. These calculations can be complex, so you will benefit from working with a financial advisor to ensure you take the correct amount (if you don’t, the IRS will hit you with a substantial penalty) and allocate your assets in the most tax-efficient way possible.
Fixed dollar withdrawals
A fixed dollar withdrawal plan will have a fixed amount you withdraw from savings each year. The fixed dollar withdrawal amount can be reassessed every few years, but you leave the amount set for five years.
2. Make the Right Decision About Social Security Benefits
The debate about whether it’s better to take Social Security earlier or postpone it rages on. Your ideal age to start collecting those benefits depends on several factors, including your marital status, how much money you need, and even whether your family has a history of early death or terminal disease.
If you start collecting as early as possible (at age 62), you’ll get 30% less than if you had waited until your full retirement age (based on your birth date). If you can delay taking it until age 70, your monthly benefit may be up to 24% more.
3. Choose the Right Pension Payout
If you’re lucky enough to have a defined benefit plan, you must decide how to withdraw those assets. Should you take a lump-sum payout or annuitize your pension? Each option has benefits and disadvantages. Pension withdrawal strategies can be complex, so it’s best to consult a financial advisor before making any decisions about retirement withdrawals. Your pension withdrawal strategy should also be accounted for in your tax plan.
4. Balance Guaranteed Income and Long-Term Growth
Guaranteed retirement income includes Social Security benefits, payouts from pension plans, and annuities. Variable retirement income comes from earnings on your investments. You’ll need to determine how much guaranteed income you’ll need to cover non-negotiable living expenses (like housing, healthcare, and food).
Once you’ve determined those costs, you can decide how much variable income is required to pay for your discretionary expenses (such as your hobbies, travel, and entertainment). This will help you determine how you allocate your investment portfolio.
5. Plan for Longevity
Lifespans keep rising. Depending on your health, you could be looking at spending between 20 and 30 years in retirement. How can you avoid outliving your retirement savings?
Some options to explore are working longer, maxing out your contributions to retirement plans, and using other financial products, such as an annuity, which can guarantee an income stream for life.
6. Account for Inflation
Most people invest more conservatively as they age. Of course, you shouldn’t put your nest egg at risk by investing too aggressively. At the same time, the earnings on your investments MUST keep pace with inflation. That means they should exceed at least 3% a year. Otherwise, your savings will eventually lose their purchasing power – and you could run out of money.
The challenge with a high inflation rate is that you need more money to maintain your lifestyle. However, if your investments provide a higher rate of return, withdrawing more increases the likelihood of running out of money. At the same time, the 4% rule, a popular retirement withdrawal strategy that provides a more considerable amount of income, is falling out of favor.
What is the 4% rule?
The 4% rule has been around since the mid-1990s. It can also be referred to as the fixed percentage withdrawal strategy. The basic premise of this strategy is that retirees can withdraw 4% of their portfolio savings in their first year of retirement. In each subsequent year, that amount gets adjusted to account for inflation. However, some experts now say that 4% is too much money to withdraw, and recent research from Morningstar suggests that a better starting withdrawal rate would be 3.3%.
Why could withdrawing 4% be too much?
Bond yields, which tend to be a popular investment option for retirees, have been meager in the last decade, while stocks have been costly. These two factors make it unlikely that the 4% withdrawal rate will remain feasible for retirees. With a high rate of inflation and rising interest rates, a lower withdrawal rate would likely mean a reduction in your lifestyle.
However, the assumptions used in the research skew to the more conservative side, based on a 90% probability that a retiree won’t run out within 30 years; a less conservative approach could provide for a higher withdrawal rate. The 4% (or 3.3%) rule does not consider non-investment income sources.
The importance of planning
The combination of high inflation and lower returns makes evaluating retirement withdrawal and investment strategies harder than before. If you plan on retiring soon, now is the time to start narrowing down your options. This challenging task can be made more accessible when working with a professional advisor.
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