For the Baby Boomers close to retirement, and those already retired, one of the biggest challenges is determining how best to turn assets into income.
“Often people don't think about the transition from earning income to spending retirement funds. Many of our clients are not familiar with tax terminology, nor do they understand how their withdrawal decisions affect the amount of taxes they will pay. It is important to look at the assets of the entire household, not just one individual. Putting together a household approach and paying attention to asset allocation will help you reach your retirement goals,” says Charles Weinrich, first vice president, SunTrust Investment Services, Private Wealth Management.
Simply put, picking the right withdrawal rate is critical, says James Heafner, president of Heafner Financial Solutions.
There's no magic trick though, to getting it right. “It's clear. You need a strategy. Pack your bags for retirement with tools to help,” says Michael Fliegelman, a financial advisor with Strategic Wealth Advisors Network.
The experts weigh in on how best to withdraw your money in retirement.
Find the percentage that works for you
As a general rule a 4-5% withdrawal is acceptable. Younger retirees, 55-65, should steer closer to 4% and those older are better positioned for a 5% withdrawal, says Ian Arrowsmith, vice president of investments and retirement advisor with Scarborough Capital Management. “This strategy assumes about a 50%-50% split between stocks and bonds at normal retirement ages and would get more conservative, (increasing the bond allocation), as the retiree ages,” he explains. For example, it's acceptable to be 80% bonds and 20% equities in your 80s.
Remember the basics
However, there is much more to consider than just what percentage to withdraw to successfully manage having your funds outlast you and your spouse on this planet, says Roy Laux, president of Synergy Financial Services.
Stick with some basics of retirement financing. First, he says, establish a liquid source of funds designed for emergencies such as a new roof or furnace. Put the conventional 3-6 months of earning plus any large ticket items you anticipate replacing in the next future. “Cash is still king. Life's curveballs are no means limited to those in the workforce. In fact, the lack of a steady paycheck, puts an even greater premium on maintaining a robust stash of cash. Emergency funds aren't just for your kids,” says JJ Montanaro, a certified financial planner with USAA.
Second, create an essential income account. To do this, you will need to create a monthly budget of expenditures and subtract that amount from fixed sources of income such as Social Security and pension. If there is a shortfall and you have investment funds, place the funds necessary to cover the shortfall into an account that will provide a lifetime guaranteed amount that covers the shortfall.
Thirdly, he says establish an account designed for growth that parallels your risk tolerance. “I am pretty sure that if you retire at 66 and do live to be 80 or 90, what pays the bills today will fall short then, due to inflation and yo will need additional income,” says Laux.
What matters most?
For all the rules, the amount of money you withdraw and where you withdraw it from is largely dependent upon your individual circumstances. What are your goals, priorities?.
But that said, here's an option. First spend all the money from your non-retirement accounts. These funds are not taxed as ordinary income as you spend then, but rather as capital gains, explains Arrowsmith.
“We often have clients who are retired and want to take a $10,000 IRA withdrawal, when they have $50,000 in a savings account at a bank. It is much better to spend the individual accounts first,” he says.
If you take $10,000 from an IRA and have 20% withheld for taxes, you'd net $8,000. But if you leave that in the IRA to continue to grow, and take the same $8,000 from savings, with no tax liability, your net worth will be better served.
Second, withdraw from IRAs and 401k accounts. These distributions are considered ordinary income and taxed as such. Finally, Roth IRAs should be tapped.
To keep it simple, think about the three buckets of wealth you accumulated during your working years – taxable, tax deferred and tax free. When you retire, spend the taxable first, then the tax deferred and the tax free last, it's the best bucket to accumulate long term, advises Wayne von Borstel, president von Borstel and Associates.
Don't ignore reality
No rule is forever golden, says Montanaro. That 4% withdrawal may work today, but life, health and markets all change over time and demand that you periodically assess your strategy to ensure you remain on track.
At age 70 ½ you will need to take a “Required Minimum Distribution” (RMD) from pre-tax or “qualified” accounts, such as traditional IRAs, 401ks, SEPs or Simple IRAs. This is a minimum amount calculated by the IRS that you are required to take annually based on your current life expectancy. You can always take more, and be taxed on that, but this would be the minimum you would need to take or you could face fines or penalties, says Weinrich.
Says Montanaro, “A bury-your-head-in-the-sand approach to retirement income is a recipe for disaster. Small adjustments to income or expenses today, can yield long term results.”