Saving for retirement is top of mind for many Americans. Am I putting money away in the right places? Will I have enough saved to live the lifestyle I want in my later years? Will I have money to leave for my family after I am gone?
These are all highly valid and very real concerns. However, many people don’t consider that once they reach retirement, how they withdraw and spend their money can have just as big of an impact on their portfolio as how and where they saved.
A good withdrawal strategy is critical to extending the life of your portfolio. A successful strategy can greatly extend the life of your retirement and expand the assets you wish to leave for your heirs. In this article, we will cover some basic considerations that go into a withdrawal strategy, and address some of the most common mistakes we see when it comes to withdrawing and spending money in retirement.
RMDs and Tax Implications
An important factor in any retirement withdrawal strategy will be RMDs, or Required Minimum Distributions. When you reach age 70.5 and have saved for retirement with an IRA, 401(k), 403(b), or other profit sharing plan, you are required to take an RMD. Depending on the situation, this can bump you into a higher tax bracket than you’d like, so it’s important to ensure that your retirement distribution strategy accounts for these minimum requirements. If you fail to meet the distribution requirements, you are subject to significant penalties of up to 50%.
It’s important to consider the potential implications RMDs might have on your overall income and how that will impact the distribution strategy early in retirement.
The order you withdraw money and from which accounts is a crucial element of a successful retirement distribution strategy. Should you draw from your taxable account before your IRA is depleted? And when should you start tapping into your Roth?
Generally, advisors recommend following this prescriptive order: withdraw from taxable accounts, then tax-deferred, then tax-free. This is generally a good rule, as it allows your tax-deferred and tax-free assets to grow tax sheltered for a longer period of time, but it’s important to caveat that advice with the fact that there is no “one-size-fits-all” solution here. Each person has a unique financial situation that must be looked at holistically when determining a withdrawal order strategy. Consideration must be given to the combination of accounts you own, how much you have saved in each type of account, potential liquidity events, passive investments, social security benefits, and more.
A proper plan for withdrawal order that is tailored to your specific situation can increase your chance of not running out of money in retirement by 8%*.
Working with a Financial Advisor on Withdrawal Strategy
A financial advisor who is a fiduciary for your money can help you come up with a strategy around withdrawal order that works best for you. Personal Capital offers free, no-obligation introductory consultations in which we use information that you provide to show you an overall recap summarizing your goals, time horizon and risk tolerance, balance sheet, and annual cash flow. We’ll also help you better understand your current investment allocation and present our recommended portfolio allocation based on your specific goals and financial situation. This will also include a projected retirement value — our wealth advisors are here to help you chart a course to a successful retirement. We also offer a tool called Smart Withdrawal™ to our wealth management clients to help them map out their income in retirement.
Here is what you can expect from a Personal Capital Introductory Consultation:
The Pitfalls of Short-Term Thinking
These are some of the most common mistakes we see people make when it comes to withdrawing money in retirement:
- Short-term thinking. Not having a long-term plan, focusing on immediate spending needs, not setting budget goals for the entire length of retirement — these are all common mistakes when it comes to planning a withdrawal strategy. Focusing on immediate needs will make forecasting income and taxes for the latter part of your retirement extremely difficult. Short-term thinking can have significant negative effects on your overall portfolio in the long-term.
- Anxiety-induced decision making. Retirement is a huge life change for many of us, and it’s difficult to shift your mindset away from living off of a salary-based income to learning to live with the money you have. This can be a large source of anxiety for people and cause them to make snap decisions that might not be beneficial to the overall longevity of their retirement savings.
- Overemphasizing income-focused investments. People are often afraid to dip into principal and therefore end up relying heavily on dividend-bearing assets for income in retirement. A common mistake is going too conservative or concentrating in certain areas/sectors of the market which have higher yields. This actually creates more risk in the portfolio, and oftentimes belies proper diversification allocation. The result is a focus on short-term or current income needs, and distraction from a more long-term view.
Retirement can be scary. It’s very common for our clients to be concerned about the longevity of their portfolios.
Taking a holistic view of your entire portfolio will allow you to map out a long-term plan that will positively impact the length and quality of your retirement. By forecasting and planning ahead for withdrawal order, RMDs, and tax implications 20 years in the future, you will be able to make more informed decisions about what to do now.
To this end, Personal Capital recently introduced “Smart Withdrawal”, a new brand feature available to our wealth management clients. Smart Withdrawal was specifically designed to give you clarity into where your income will come from in retirement, which accounts you should use to provide your annual retirement income, and in what order. No more guessing about whether you should take money from your tax-deferred, taxable, or tax-free account — based on your age, tax status, and overall account mix, we’ll tell you exactly which accounts to draw from each year in retirement.
To learn more about Smart Withdrawal, contact a financial advisor.
Disclaimer: The calculations in Smart Withdrawal are based solely on information provided by the user, data based on the accounts that users have aggregated on the Personal Capital dashboard, historical market returns, and the assumptions shown or selected. Because there is no way to know all information about your finances or your personal situation, analysis may be incomplete or inaccurate. All insight provided represents a courtesy extended to you for illustrative purposes only and you should not rely on this information as the primary basis of your investment, financial, or tax planning decisions. No representations, warranties or guarantees are made as to the accuracy of any estimates or calculations. Personal Capital is not liable for any damages or costs of any type arising out of or in any way connected with your use of this calculator. Past performance is not a guarantee of future return, nor is it necessarily indicative of future performance, and future returns may be less favorable or negative. Keep in mind that investing involves risk.
The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.
Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.