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Written by Alex Seleznev, MBA, CFP®, CFA | Sept 25, 2024
Even the best financial plan can result in suboptimal results if you fail to execute the right withdrawal strategy. In my experience, there is frequently little thought behind how you would actually draw from your different accounts and other sources. This can significantly impact your retirement without you even knowing it.
Below are some ideas for you to consider if you are planning to take funds out of your accounts or are already in the distribution stage of your retirement.
1.) Conventional distribution strategies are not always the best
The most typical approach to draw from one’s portfolio is in the following order:
- Taxable account
- Pre-tax accounts such as Traditional IRA or 401k
- Post-tax accounts such as Roth IRA
In some situations, this approach is adequate and results in the maximization of your retirement income and benefits. But it’s certainly not the case in every situation!
When I work with young retirees, I frequently suggest they take at least some funds out of their Traditional IRA accounts before they reach the required minimum distribution (RMD) age.
The reason behind this is that you frequently find yourself in “artificially low” income years when you haven’t started your Social Security benefits yet and you are not required to take your RMD.
I find that, in my cases, you have anywhere between 5 to 10 years early in your retirement to take some funds out of IRA accounts and pay taxes in one of the lower tax brackets, such as 22% or even 12%.
There are dozens of different early withdrawal scenarios that need to be analyzed to come up with a “sweet spot” approach for your specific situation.
Keep in mind that your distribution strategy may have a significant impact on your Social Security taxes, Medicare premiums and even long-term capital gains tax rates.
Why is this important to you? A poorly structured withdrawal strategy can cost you $10,000s or even $100,000s in lost gains and/or additional taxes.
2.) Not accounting for additional expenses in retirement
For planning purposes, many retirees want to ensure they can safely have a certain amount each month in retirement, such as $10,000/month to age 95.
This is a good starting point, but for most people, it doesn’t really work this way in practice.
Early in retirement, during your “go-go” years, you may potentially want to spend more on travel and other discretionary expenses.
Once you get closer to your “slow-go” and eventually “no-go” years, and begin to redirect your expenses toward medical care, your total budget will likely look very different.
You also need to understand how your taxes will be impacted throughout your retirement. For example, large medical expenses may be deductible and result in significant tax savings once you reach this stage of your retirement.
Having a more granular plan when you reach the retirement stage of your life can greatly benefit you in both the short and long term.
You may want to consider working with a retirement planning specialist, especially if you’ve been managing your finances on your own or working with a generalist financial advisor.
3.) Not adjusting your investment portfolio according to your specific income plan
This specific point is one of my key concerns. As an example, I believe many people are making a potential mistake when they automatically assume they should be investing conservatively in retirement.
I certainly wouldn’t argue that a 60-year-old should have the same investment strategy as a 30-year-old. This is unlikely.
What if you have a pension and Social Security income that covers more than half of your projected expenses in retirement? Wouldn’t this fact at least suggest that you should consider investing your funds for more growth?
Some people unconsciously neglect to account for the fact that they will be in retirement for 30 years or even longer. Having an overly conservative portfolio can significantly increase your risk of running out of money in retirement.
On the other hand, the “sequence of returns” risk is one of the biggest issues for young retirees, and if not managed properly, it can not only derail but even destroy your financial plan.
What if the markets experience unusually poor performance results in the first several years of your retirement? What if we experience a prolonged recession?
This is important because even if your portfolio earns the projected rate of return in the long run, such as 6% or even 8%, the first several years will have a significant impact on the value of your portfolio.