Retirement Withdrawal Strategies: How to make your savings last

July 28, 2021
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News

People save for retirement for years and years

When the time to retire comes, efficient tax strategies are necessary to ensure a smart withdrawal from all sources of income available to you. This stage of retirement is not to be taken lightly as failure to plan could result in a disaster during your retirement years when you need your savings the most.

This article was designed to help you understand the traditional and nontraditional options of withdrawing your assets. The purpose is to make sure you will not run out of money shortly after retirement or outlive the money during your retirement years.

You saved so that you can retire and enjoy a comfortable and relaxing lifestyle in retirement. Here are some traditional ways and orders to withdraw your money.

First, prioritize utilizing non-investment income:

  1. Social Security
  2. Pension plans
  3. RMDs (Required Minimum Distributions from retirement plans)

Second, prioritize using distributions from investment income:

  1. Interest
  2. Dividends
  3. Capital gains

Third, generally speaking, the order of withdrawal starts with:

  1. Taxable accounts (brokerage or TODs)
  2. Tax-deferred accounts (IRAs, qualified annuities, 401(k))
  3. Use the tax-exempt accounts (Roth IRAs)

As mentioned at the beginning, tax-efficient planning will be particularly important in both pre-retirement and during retirement.

For example, a married couple filing jointly and making more than $250,000 of Net Investment Income (net income from qualified dividends, interests, capital gains, etc..), will pay a surplus Medicare tax of 3.8% for federal taxes and soon an additional flat tax rate of 7% would apply to Washington residents’ net federal long-term capital gain, effective on January 1, 2022. Federal ordinary income and cap gain taxes still apply. Qualified dividends, interests, and capital gains from your investment income are taxed somewhere between 0%, 15%, and 20% (which is the highest rate for this taxing category). Ordinary rates range between 10%, 12%, 22%, 24% to 37%.

Another relevant factor of retirement income planning is considering the risks associated with it, including:

Longevity risk: the risk is that you may outlive your retirement assets.

  • Effective planning with the right life expectancy assumptions can help mitigate this risk.

Inflation risk: the risk of purchasing power is due to an overall increase in the prices for goods and services.

  • It will be helpful to use a conservative inflation rate rather than the current Consumer Price Index (CPI) rate. For example, at McIlrath & Eck, we use a 4.28% inflation rate rather than the rate of the last 30 years, 2.49%.

Long-term care risk: the risk that you will need long-term care insurance and will be ineligible to receive insurance because of your age or pre-existing illness or disability.

  • Buying a Long Term Care policy between 50-55 especially when you figure out that it will be needed down the road will help avoid higher premiums or denial by the insurer due to health issues.

Investment risk: the risk that a desired rate of return may not be achieved. Those risks include:

♦ Market risk or risk that affects the market in general, such as recessions or bear markets. This can be reduced by:

  • Diversification
  • Lower stocks exposure level when getting closer to retirement years because a recession at the first year of retirement can wipe off your savings
  • Lower withdrawals in the bad market (bear market) conditions.

♦ Interest rate risk, a risk related to bonds interest and price fluctuation due to interest rate changes.

  • Using short-term and intermediate bonds in your portfolio instead of long-term bonds would help reduce this risk.

Liquidity risk: the risk of cash flow needs or the speed to transform an asset as quickly as possible. For example, real estate and business interests cannot be sold quickly at a fair market value.

  • Reducing your portfolio’s risk by lowering the stocks exposure and increasing short-term fixed-income funds, CDs, and money markets can help lower this risk.

Let us look at some nontraditional ways of withdrawing your money

All the risks we mentioned previously make investment returns variable and unpredictable. We call it “the sequence-of-return” risk. It can be minimized by choosing a given withdrawal rate or “percentage -of- portfolio” which is a percentage of the current portfolio’s total value. This percentage will need to be readjusted often depending on the market conditions. This means that your income needs might have to be flexible as the percentage will keep changing and given that your portfolio’s value goes up or down with the market.

Using a mixture of methods can be beneficial. For example, if you inherited an IRA account from your parents, the new tax laws require that you spend the entire account value within 10 years from the date of death of the owner. This can be the first source to withdraw from.

Another example is when you have enough money to sustain your desired lifestyle for a few years until your reach age 70. At Full Retirement Age, 67 years old for those born in 1960 or later, you receive a 100% of your benefit. However, waiting until age 70 would increase your social security benefit by 132% or 32% more at which point your benefit stops increasing even if you keep delaying taking it. You can take it as earlier as age 62 at a reduced amount, but if you can afford to wait until age 70, it will make more assets available to fund your goals.

A third example is when you inherit a brokerage account (TOD/POD etc..). This account gets a full step-up in basis in community states like Washington State. This means tax implications are minimal. This account could be a first or second source of income to withdraw from.

When your budget is tight, you can use a blend of different strategies that work specifically for your situation. For instance, if you are a homeowner, you could refinance your home to get access to your home equity and/or use a reverse mortgage as a source. However, a reverse mortgage can only be used when we are at least 62 years old. This could supplement social security income and portfolio incomes during retirement.

Every individual has a unique story, lifestyle, goals, and objectives for their retirement. This makes your withdrawal strategy unique, customizable, and adaptable to your specific situation. We are here to help you reach and fulfill your financial goals upon retirement and help you make your savings last.

Conclusion

Knowing your options to alleviate tax burden can save you and your estate thousands.  Sometimes going against conventional wisdom can help you to get the most out of your retirement.

As always, our answer to risk concerns such as taxes and retirement income is to have a sound financial plan that accurately and conservatively accounts for the unexpected risks. Using a thoughtfully planned strategy can help make the most of your retirement income.