Cracking Open Your Retirement Nest Egg
On par with the importance of building a retirement nest egg is making it last once you start taking distributions. But devising a sound strategy for tapping your retirement savings is not a one-size-fits-all proposition. Your personal and financial situation, goals, age and types of investments will help determine your approach to retirement plan distributions.
Which Comes First: Taxable or Tax-Deferred?
Many financial experts suggest withdrawing from taxable accounts first in order to let tax-deferred accounts continue to grow as long as possible. However, there are instances when taking money out of your tax-advantaged accounts first may make sense:
Leveraging your tax situation. If you have a Roth IRA and need cash for expenses, you may want to look at some combination of withdrawals from your Roth and your employer-sponsored plan. Since qualified withdrawals from a Roth are tax-free, taking some distributions from the Roth and some from your tax-deferred and taxable accounts may help keep you from crossing a tax bracket threshold.*
Leaving money to heirs. Distributions from inherited employer-sponsored retirement plan accounts are taxed at the recipient's ordinary income tax rate, which can be as high as 35%. However, beneficiaries may be able to take money out of an inherited Roth IRA income-tax-free.** Money inherited from a taxable account benefits from a step-up in basis, which typically reduces the amount of capital gains taxes due upon the sale. It may make sense to draw down your employer-sponsored plan first if your goal is to leave the maximum amount of money to your heirs.
Rebalancing your investments. If some of your retirement money is tied up in highly volatile investments in taxable accounts, you may want to start drawing those down to reduce your investment risk.
What About RMDs?
Your options for withdrawals become more limited once you reach the magic age for required minimum distributions (RMDs). You must start taking annual distributions based on IRS life expectancy tables from employer-sponsored retirement plans by April 1 of the year after the year you turn age 70 1/2.*** If you don't, you may face a 50% penalty on the amount that should have been withdrawn but wasn't. Traditional IRAs also have RMDs; Roth IRAs do not have RMDs during the original account holder's lifetime.
Making Your Money Last
It's wise to meet with a financial advisor to help develop a strategy for taking distributions that helps you meet your tax and financial goals while helping ensure your money lasts as long as you do. Some studies indicate that many retirees can withdraw about 4% annually from portfolios that are invested at least 50% in stocks.† However, your situation is unique. A financial advisor can run financial simulations that illustrate the potential impact of various withdrawals rates and hypothetical rates of return over time.
* Withdrawals from a Roth IRA are tax-free provided the account holder is at least age 59 1/2 and has held the account for at least five years. Nonqualified withdrawals are subject to ordinary income tax and a 10% IRS penalty. Qualified withdrawals (those made after age 59 1/2, or age 55 if separating from service) from an employer-sponsored plan are taxed at ordinary income tax rates. Nonqualified withdrawals are subject to a 10% tax penalty (does not apply to 457 plans).
** IRS minimum withdrawal rules for inherited IRAs apply.
*** Some plans may allow you to delay distributions if you are still working at age 70 1/2.
† Source: American Association of Individual Investors, www.aaii.com.
Note that this financial institution does not give tax advice. Consult a tax advisor regarding your personal situation.