Withdrawing money the right way matters. We often talk about how to save for retirement. That is, after all, essential business for everyone during their working life. Whether you follow the 60/40 strategy, put your money into real estate or simply buy up all the S&P 500 index shares you can, how you save for retirement matters. There are plenty of things to consider before deciding on the right withdrawal strategy You may also want to work with a financial advisor who can help you set up the right retirement withdrawal strategy.
Defer, Defer, Defer
This is less a strategy than an overall mindset, but it’s still important to discuss. One of the biggest moving pieces when it comes to retirement is your network of age-related deadlines. Most tax-advantaged retirement accounts require minimum distributions at or around age 72. Social Security is available beginning at age 62, but must be taken starting at 70. Your general investments, as well as your Roth accounts, have no age limits whatsoever.
Your exact deadlines will depend on personal circumstances and income needs, but a good rule of thumb is this: Delay. In virtually all cases, your retirement options will grow in value if you can put off making withdrawals. Social Security pays more if you begin collecting at age 70 than at 62. The more money you can keep in your retirement accounts, the more you can maximize compounding returns. For any given account, waiting longer usually means more money in the long run.
Now, putting everything off isn’t a viable strategy for most retirees. The whole point is that this is money you’ll live on, after all. However, when income and circumstances allow, keeping your money in place as long as possible is a good strategy.
Withdraw for Sequence Risk
Sequence risk, otherwise known as “sequence of returns risk,” is the risk posed by market fluctuations during your retirement.
In a nutshell, this is the risk that your portfolio will face market downturns at the same time that you need to make withdrawals from it. It can happen in short bursts, for example, if you need to make withdrawals early in the year during a short downturn. It’s more commonly discussed on annual terms, though. In an annual context, this is the risk that your early retirement will coincide with a recession.
In all cases, though the basic risk is the same: You have to withdraw money while the market is down. This forces you to take a potential loss on your assets and leaves your portfolio with fewer assets to recover its value when the market bounces back.
There are a number of ways to plan for sequence risk. However, a strong approach is to maintain a diversified portfolio, with money kept in multiple asset classes. For example, say you have investments in both stocks and bonds. Those markets usually move counter-cyclically against each other, allowing you to sell your stocks if your bonds are down and vice versa. A diversified portfolio also will give you capital to tap into during a down market, so that you can sell strong assets and replace weak assets while their prices are low.
Whether you approach this from a diversification strategy or take another approach, be sure to plan for sequence risk management. It can take a huge bite out of an unprepared portfolio.
Tax Advantage Maximization
Broadly speaking, retirement portfolios come in three categories:
- Taxed
- Pretax
- Post-tax
A taxed portfolio is one that has no special tax advantages. You invest with money on which you paid taxes and you will pay taxes on the account’s profits when you withdraw them.
A pretax portfolio, such as a 401(k) or an IRA, is one in which you made investments with untaxed money. Your contributions to this account qualified as a full tax deduction, but you pay taxes on the portfolio’s profits when you withdraw them during retirement.
Finally, a post-tax portfolio, such as a Roth IRA or Roth 401(k), is one in which you made investments with fully taxed money. Your contributions to this portfolio did not qualify as a tax deduction, but you don’t pay taxes on the account’s profits when you withdraw them during retirement.
One strategy in retirement, then, is to structure your withdrawals around letting your most advantaged accounts grow longest. Historically, finance experts have recommended that you withdraw money in order of taxation. In other words, withdraw from your fully taxed accounts first so that your tax-advantaged accounts can grow more. Then withdraw from your pre-tax accounts so that your highest advantage, post-tax accounts can grow. Finally, withdraw from the Roth accounts on which you will pay no taxes.
Some experts suggest other, more sophisticated approaches, such as Fidelity’s whole-portfolio tax planning math. But the bottom line remains the same: Your portfolio can have three tax statuses depending on the nature of each account. Maximizing the value of those portfolios, while minimizing the tax impact of your withdrawals, will take planning, but it’s worth it.
Collect Income First
Again, broadly speaking, any investment asset has two footprints in your portfolio: returns and yields. Your returns are the money you make off selling assets for a profit. Your yields are the income you make by holding those assets over time. Yields include income such as interest payments from bonds and dividends from stocks.
For many retirees, this kind of income can be your first line of planning. When lumped in with payments such as Social Security and long-term assets (for example if you own a rental property), this is a great way to establish stable, long-term income for your retirement. More to the current point, it’s an excellent way to generate retirement income without having to sell assets.
By maximizing yields rather than returns, you can generate money from your retirement portfolio without drawing down on its assets. This will minimize how much you reduce the value of your retirement account over time, increasing its longevity potentially by quite a lot.
The Bottom Line
Saving for retirement requires work and planning, so much so that we often forget the second stage of retirement, making withdrawals. While this is a field with lots of potential options, you can follow a variety of different strategies when deciding how and when you should withdraw retirement funds. The right one for you depends on how much money you may need.
Tips for Retirement
- The truth is, this can get complicated. Maximizing tax advantages and figuring out returns, can involve a lot of math and knowledge. A financial advisor can make it all easier by helping create a plan and managing your retirement strategy for you. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Check out no-cost retirement calculator for a quick estimate of These are just four possible ways to plan your retirement withdrawals. There are many ways to approach this, so perhaps the best place to start is to make a proper plan.
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