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Dollars and $ense: Retirement withdrawal strategies

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Congratulations! You are finally retired. When you consider all of the major transitions in your life (off to college, first job, get married, buy a house and start a family), no other transition is as welcome and feared as your retirement. Does it really have to be that way? If you benefit from one theme of this article, it would be that with some thought and careful planning you can enjoy a retirement that is comfortable and happy and rewards you for many years of hard work.

In this article we will focus on two key issues: (1) how to calculate a withdrawal amount and (2) how to select which account (taxable, tax-deferred and Roth) to withdraw from.

Your initial withdrawal amount is meant to be a starting point that will be adjusted based on the circumstances of your retirement going forward. There are several different methods of calculating this amount, including fixed dollar amount, fixed percentage amount, inflation-adjusted and withdrawing only investment earnings (dividends and interest).

The amount withdrawn, plus any other income sources like a pension or Social Security, becomes the amount you can spend in a calendar year. The commonly known 4 percent rule is simple to use. Withdraw 4 percent of your retirement assets in the first year and then in the second (and each subsequent year) withdraw the previous year amount adjusted for inflation.

A more creative approach might be to combine strategies to target specific needs. For example, use an inflation-adjusted strategy for essentials and withdraw investment earnings for travel and entertainment. Adjust your discretionary spending based on market performance – spend a little less if the market is down and allow yourself to enjoy that great trip if the market rallies.

Many retirees have accumulated savings in multiple account types including taxable savings and investment accounts, tax-deferred retirement accounts (examples are 401k and IRAs) and Roth accounts (withdrawals are tax-free).

How and when you choose to withdraw from various accounts can impact your taxes in retirement in different ways. Optimizing withdrawals in retirement is tricky and requires a good understanding of tax implications, financial goals and how each type of account is structured.

The order in which you withdraw from your accounts is critical – most advisors suggest taxable first, then tax-deferred and then Roth, which order allows investors to keep their retirement assets in more tax-efficient accounts for a longer period of time by delaying withdrawals from their tax-deferred and Roth accounts as long as possible. This more traditional approach of withdrawals from one account type at a time is straight-forward and easy to implement.

A second approach is one of proportional withdrawals in which retirees withdraw from all of their account types each year, in proportion to their overall retirement savings. A retiree with $500,000 in savings divided among taxable ($100,000), tax-deferred ($300,000) and Roth ($100,000) would thus take 20 percent of his/her annual withdrawal amount from a taxable account, 60 percent from tax-deferred and 20 percent from Roth.

This approach is considered more tax efficient than the one account approach in that it spreads out taxable income more evenly over retirement.

A combination of the two approaches (one account and proportional) might also be a good alternative. In this combination of methods, taxable accounts are used up first and then the proportional approach is applied.

Rick Welch is a Registered Investment Advisor (RIA) and chief investment officer of Academy Wealth Advisers. He can be reached at 215-603-2976 or rickwelch@academywealthadvisers.com.


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