As adults, we know the importance of saving for retirement. It’s easy. Just set up an automatic withdrawal from each month’s paycheck and direct it into a retirement account. What becomes trickier is the amount we should be saving and how to best invest it.
But what happens as we enter retirement? We’ve been saving money our entire lives. In theory, we know what’s needed—simply rely on savings, Social Security, and if we have one, a pension.
Put another way, we are in a transition period that moves us away from retirement planning to retirement-income planning.
Over the years, I’ve had many clients and colleagues reach out to me as they recognize that the seemingly simple concept of relying on savings really isn’t so simple.
At this juncture, I could stuff this newsletter with overwhelming facts and information.
Instead, I want to provide a high-level overview of two key components of retirement income planning.
But let me emphasize—I would be delighted to answer any questions you may have. I am simply an email or phone call away.
Two key aspects
A survey a couple of years ago by the American Institute of CPAs revealed that two prime retirement income planning concerns are (1) running out of money and (2) how to more efficiently and effectively tap into assets.
That shouldn’t be a surprise. “How much money do I have to live on each month?” is a common question. And, “Which accounts and in what amounts should I pull funds from?” comes up often.
Let’s start with the first question. Sources of income during retirement may include Social Security, assets, earnings from part-time work, earnings from an annuity, and a pension.
Social Security, a pension, and the annuity are reasonably stable. For most people, however, it’s not enough to live on, and a lifetime of savings plays a key role in filling the gap.
Some of you are in a position to live off interest and dividends, only withdrawing principal for special needs. Many, however, must rely on carefully meting out and using much of their lifetime savings.
One approach is to employ what’s called a “sustainable withdrawal rate.” One common method is called the 4% rule, which some of you may have heard of.
Simply stated: Withdraw 4% each year from your savings, an amount you may decide to keep constant or increase to keep pace with inflation.
This was once a helpful rule of thumb, but low interest rates have made it less than ideal for today’s retirees.
Let’s look at another scenario. We can always increase the annual withdrawal rate to 5% or more; however, if we raise it too high, there is the risk of running low or running out of savings.
Instead, you should consider a withdrawal rate based on your time horizon, asset allocation, and confidence level.
Questions we can consider include:
1.How many years do you want to plan for?
2.What asset mix between stocks and bonds are you comfortable with?
3.What level of confidence do you want to have that your money will last?
A lower withdrawal rate can increase the odds the portfolio will last through your retirement years—that’s intuitive. But it also means less discretionary income.
This dilemma also illustrates the need to keep an eye on capital appreciation, especially in today’s low-rate environment. It’s why I’m likely to recommend that your portfolio includes a mix of stocks that pay out a nice dividend.
Of course, flexibility and ongoing monitoring are critical. This isn’t a “set it and forget it” portfolio. Adjustments can be made based on your personal situation. So it’s important we monitor and modify as necessary.
Let’s move to the next question—withdrawal order. Which accounts should you tap first if your goal is to maximize spending during your lifetime?
- Let’s start with the required minimum distribution from tax-deferred accounts such as IRAs. At 70½ years old, the IRS requires that you take a minimum distribution each year. Miss it and you’ll pay a big penalty.
- Taxable interest, dividends, and capital gains distributions may be the next best source of income.
If additional funds are needed, your anticipated future tax bracket comes into play. Let me explain.
If we expect a higher marginal tax bracket in the future, withdrawing from the traditional IRA today may be the most advantageous choice. But be careful the distribution doesn’t push you into a higher tax bracket in the year you take it.
If you anticipate a lower tax bracket down the road, a Roth IRA may be the best option for today’s income needs. If cash is still needed or desired, then look to a traditional IRA.
However, there is one big advantage to leaving the Roth alone. You continue to take advantage of the tax-free umbrella the Roth provides. Or, you can hold on to the Roth for unexpected expenses.
Moreover, the Roth can be used as an estate planning vehicle because heirs may be able to sidestep federal taxes when withdrawing from it.
These are a few ideas designed to provide you with the proper framework as you enter or gear up for retirement. It is a broad overview that’s designed to shed light on a situation that’s unfamiliar to many retirees.
Each situation is unique, which means there are many other aspects of retirement income planning that could be useful for your specific situation.
If you have any questions or would like to discuss any matters, please feel free to give me or any of my team members a call.
As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.
The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.
This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.
Stock investing involves risk including loss of principal.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.