It’s an extremely common question and let me tell you why. In the world of investing, most of us have experienced that pre-retirement is geared towards accumulation and not distribution. For example, workplace retirement accounts such as 401(k)s, 403(b)s and cash balance pensions are all designed to gather money. They often include your payroll contributions and the employer’s match or discretionary contribution, all of which are designed with accumulation in mind. Any information regarding distributions are commonly laced with legitimate warnings of possible taxation and penalties for distributions prior to age 59 ½. Furthermore, the mechanisms of contributing to these vehicles are generally outgoing payroll deductions, but when you retire most people prefer incoming funds and there’s virtually no discussion regarding that. Our expertise helps clients develop specialized financial plans designed to show them how to efficiently generate retirement income and where it should come from.
First, we look at social security and pension statements, if applicable, and determine the optimal time to begin distributions based on your specific situation. Next, we move onto your investment accounts. Generally, each source of retirement income may fit into one of three categories: taxable accounts, tax-deferred accounts, and tax-exempt accounts. When you retire, you need to decide what money to use first. One approach to consider is withdrawing money from taxable accounts first, then tax-deferred, then tax-exempt. By using taxable money first, you avoid paying taxes as long as possible with tax-deferred investments, and your tax-exempt accounts remain that way for a longer period.
If your nest egg is comprised exclusively of pre-tax Traditional IRAs/401(k)s/403(b)s, meaning all distributions are taxable, then you need to be very careful with your withdrawal technique to make sure you are not overpaying taxes. Consider the analogy of carrying a jug of water in the desert and drinking only what you need. Each sip will provide you with life sustaining hydration, but will be taxable. Excess sipping may quench your thirst, but you may run out of water sooner, and remember each sip is taxable, therefore increasing your tax liability.
Several factors – such as your goals, investment mix, time horizon, risk tolerance, and tax situation –may all play a role in determining the best approach for you. Keep in mind, that this information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. If you are not sure how to efficiently take retirement income and you are approaching retirement or currently retired, please give us a call so we can determine what strategies make the most sense for you. We can create a customized financial plan specific to your needs.
Securities offered through LPL Financial, Member FINRA/SIPC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.