There are a lot of moving pieces to taking money out of your accounts. We broke things down to help you navigate the process.
As we begin to transition into retirement there are things that seem complicated that turn out to be simple and things that seem simple that turn out to be complex. One of those areas for many has to do with how they replace their income and take withdrawals from their retirement accounts.
During our working years things are pretty straightforward. We work to earn our income and then our employer places the money into our bank accounts and somehow, magically, all the taxes and other details are accounted for. But what happens when it’s up to us to manage that process? Suddenly our minds can become filled with questions.
What do we do about taxes? How does this impact our social security income? When should we take money out? What do we need to know and do to be successful in managing distributions from our retirement accounts?
While there are many questions that could be asked, here are a couple of key questions that can help you in navigating this process.
First thing’s first, identify what is the nature of the withdrawal. Is this a one time thing or are you setting up income? We have to look at these types of distributions from different angles. If you haven’t thought about what a fulfilling retirement looks like, you can start here with our dreams & goals video.
A one-time withdrawal can be more simple to manage but still requires some thought in order to execute it in the most tax efficient manner while considering investment strategies.
However, when we begin setting up an income stream, there is more work to be done. In the past, people have lived by things like the 4% rule of thumb. Meaning, if you take out 4% from your investments each year you should be fine throughout retirement. That sounds great but may not cover everything you need. What if 4% doesn’t cover the expenses? What if 4% is more than what you need and you are sabotaging your compounding interest? What if 4% pushes you into another tax bracket?
So before we start pulling 4%, we suggest spending some time creating a budget that shows what we will need for our recurring expenses. Here is a place where you can learn more about what it means to create a spending plan in retirement.
Once we determine what the money is for and we have our budget, then it’s time to look at our next question…
Which account should we use to meet our needs?
The reason that we ask this next question is really for tax planning purposes. Some of us may only have one account as an option to fund retirement and if that’s the case, things are pretty cut and dry. But if you have non-qualified accounts, IRA’s, 401K’s, and Roth IRA’s, then it’s important to understand which account makes sense to use in your specific scenario.
Non-qualified accounts carry the advantage of using the capital gains tax rates which, based on your other income and tax bracket, can range from 0-20%. Being able to use an account like this can be a large advantage for both a one-time expense or supplementing income at a lower tax rate.
IRAs & 401Ks have been growing tax-free throughout our working careers but once we start to draw on them in retirement we have to pay the taxes based on our marginal income tax rate.
Roth IRAs can be a powerful tool in retirement because they are tax free upon withdrawal as long as the necessary holding requirements have been met. Many people try to avoid using these accounts as long as possible to build a tax-free inheritance or a tax-free account to pull from once their required minimum distributions start.
As a firm, we have spent years helping thousands of families figure out how to best withdraw money from their accounts.
Okay, we know what the money's for and we have thought about which account to use. Here is our next big question…
To sell or not to sell...that is the question. But how do you decide the answer?
We have all heard sell high and buy low, so doesn’t that mean you just sell wherever you have gains? Not when you are being strategic in your planning. Sometimes it may be best to actually sell at a loss. I know what you’re thinking...WHAT?! That goes against the cardinal rule. Well the rule isn’t accounting for tax planning.
The easiest way to fund your withdrawal of course is from the cash positions that may be in your investment account or in your bank account. But if you have chosen to use a non-qualified account it could be wise to sell investments at a loss to offset the additional income you're taking on your taxes.
However, if you are using an IRA or Roth IRA then it’s a different story. The key however is to consider how selling a specific position will impact your overall portfolio.
Our firm helps families understand the importance of what’s called properly “weighting” your portfolio. That means that you diversify your portfolio in such a way that you are not overly exposed in a certain area. Sometimes when you sell positions you unintentionally overweight the portfolios with the remaining investments. This means it’s time to rebalance.
As you can see, there are a lot of moving pieces to taking money out of your accounts but the good news is that we are not alone. If you have any questions about getting yourself organized, please reach out to our firm and we can help you answer your questions.