You’ve been saving and planning for retirement for decades. It’s been the goal you’re continually striving for – now you’re there and suddenly you have to drop the retirement savings mindset and shift to a retirement spending mindset.
Retirement money management can be a bit complicated; instead of an employer-provided income from which taxes are automatically withdrawn, you may now need to manage multiple potential income streams (such as 401(k)s, pensions, Social Security and other investment accounts) and make decisions about where to pull from to meet your legal requirements, minimize taxes, cover your expenses and leave enough for your future.
Everyone’s retirement income plan looks different, but here are some tips to help you get in the mindset.
Which Accounts Should You Withdraw From First?
Many retirees have multiple different retirement accounts: some are taxable, some are tax-deferred (such as traditional IRAs) and some are tax-free (such as Roth IRAs). When determining your withdrawal strategy, it’s important to balance your sources of income so that you are taking Required Minimum Distributions (RMDs) as required by law, minimizing your tax liability and ensuring that you have enough for the future.
If You Will Not Have an Estate
If you do not intend to leave assets to any beneficiaries, the answer seems to be straightforward: withdraw money from taxable accounts first, then tax-deferred accounts then tax-free accounts. This will leave the most money in accounts with the greatest compounding power, giving you the best growth potential.
However, nothing is that simple. Starting at age 73, you’ll be required to take RMDs from any retirement account that is not a Roth IRA. Failure to take RMDs will result in a penalty, so you’ll need to work those distributions into your plan.
If You Will Have an Estate
If you do plan to leave assets to beneficiaries, you’ll need to coordinate your distribution plan and your estate plan.
You may want to begin withdrawing from tax-deferred and tax-free accounts first if you have appreciated or rapidly-appreciating assets. That’s because tax-deferred and tax-free accounts will not receive a step-up basis at your death (like many of your other assets will), meaning your heirs will owe capital gains taxes on the entire amount upon liquidation.
This approach isn’t necessarily the best path in all situations, though. For example, if you plan to leave your entire estate to your spouse, it may be better to withdraw from taxable accounts first because spouses can receive preferential treatment regarding taxes on retirement plans. If they inherit a traditional IRA or retirement plan, they may be able to roll those funds into their own plan where they can continue to grow tax-deferred.
Your situation is unique; you should talk with an estate planning attorney, CPA and a financial advisor (preferable together) so they can help you map out the best path forward.
Choosing a Withdrawal Rate for Ongoing Needs
For many, their main concern in retirement is outliving their savings. A key factor in determining if your savings will last your lifetime is the rate at which you withdraw funds from your accounts. You don’t want to take too much and dry up your reserve, but taking too little may mean struggling financially, not living the retirement you want or leaving more in your estate (which may be taken out for taxes).
Your withdrawal rate is stated as a percentage of your overall assets. Withdrawals can be from earnings, principal or a combination of the two. For example, if you have $700,000 in assets and decide on a 4% withdrawal rate, the portfolio would need to earn $28,000 a year if you intend to withdraw only earnings. If it doesn’t make that much, you could take $14,000 in interest and take the remaining $14,000 from the principal. A sustainable withdrawal rate is different for everyone – it’s based on many factors including the value of your current assets, your expected rate of return, your life expectancy, your risk tolerance, whether you adjust for inflation, how much your expenses are expected to be and whether you want some assets left over for your heirs.
Fortunately, there are tables and calculators that can provide you with a range of rates that will likely work, and you can work with a financial advisor to help make the right decision for you based on all of the compounding factors.
Determine Your Budget
The first step in knowing how much to withdraw is knowing how much you need. What do your expenses look like in retirement? Be sure to take time to put together a retirement-specific budget, as there may be unexpected expenses that aren’t part of your current budget, such as relocation, travel to visit family and increased entertainment costs. Be sure to also consider the cost of healthcare, estimated to be over $400,000 for a healthy 65-year-old (which doesn’t even account for long-term care costs).
The Impact of Inflation on Retirement Spending
Another consideration as you determine how much to withdraw is the impact of inflation on your purchasing power. When you’re on a fixed income in retirement, high rates of inflation can have an oversized effect on your living standards. Working with a financial advisor can help you prepare for the risk that inflation may have on your savings.
Managing Your Investments in Retirement
When you’re in retirement savings mode, you want to grow your money. As you approach retirement – then transition to retirement – your focus shifts to protecting what you’ve accumulated, since there is no more going into your accounts to replace any losses. Your asset allocation will likely change so that your portfolio is heavier in safer investments, such as bonds, and lighter in riskier growth investments, such as stocks. A financial advisor can help you transition your portfolio and prepare for living in retirement.
Benefiting from Professional Support
Retirement may be the most complicated financial situation of your life, and you don’t have time for trial and error. Talking to a professional can help you manage your money in the way that works best for you and your situation – talk to a Farm Bureau financial advisor today.