The transition into retirement brings a number of options about lifestyle, relaxation, and enjoyment. It also requires decisions about how to supplement your income from your retirement savings, if needed. Here are a number of considerations relevant to shifting from accumulating to distributing your wealth.
The method of sourcing income from your investments is not universal. There is no one-size-fits-all solution. Everyone’s investments and finances are different relative to age, retirement income sources, taxes, types of accounts, investment allocations, etc.
Where to Begin
The first step in determining investment decisions in retirement is to know how much income your investments will need to support. This is often the difference between how much you need less Social Security income, pensions, and other supplemental income sources. Taxes need to be factored in as well.
The next step is to know how much income your assets can safely provide throughout retirement. Your assets need to keep up. If your assets are not sufficient to sustain your projected needs, spending adjustments are likely necessary.
Appropriate Investment Allocation
People frequently assume their investments should become more conservative when they enter retirement. It is important to have adequate exposure to more conservative investments to help reduce risk. However, the appropriate percentage allocation depends upon many factors.
- Projected Cash Needs Amounts: It’s wise to hold enough in cash, CDs, and bonds to support at least a few years of cash needs. Doing so helps to reduce investment risk and avoid having to sell stocks during market downturns.
- Longevity: Remember that retirement often spans multiple decades, requiring investment growth for your assets to keep up. A meaningful allocation to stocks is frequently required to achieve the long-term growth you need.
- Risk Tolerance: Your ability to stomach market downturns is an essential consideration, especially evaluating how you might react once you begin relying upon your assets in retirement.
Which Accounts to Choose
People often have a number of accounts such as checking and savings accounts, IRAs, and brokerage investment accounts. These types of accounts are very different relative to withdrawal considerations, particularly due to tax impacts.
- Checking & Savings: Taking money from your checking and savings accounts is tax-free. This might be a good account to choose from but be sure to maintain adequate balances as an emergency fund.
- Traditional Retirement Accounts: Every dollar withdrawn from traditional, tax-deferred retirement accounts is taxable. These accounts include IRAs, 401(k)s, 403(b), and TSP accounts. You must take required minimum distributions (RMDs) if you are 73 or older. Elective distributions can be made earlier and without penalties if you are 59 ½ or older. These might make sense in certain circumstances.
- Brokerage Accounts: Taking withdrawals from non-retirement brokerage accounts generates less taxable income as compared to retirement account withdrawals. You only pay taxes on the amount of gain or profit in your investment when it is sold. Additionally, capital gains are subject to lower tax rates. Taking withdrawals from brokerage accounts versus traditional retirement accounts often helps to lower your taxes. However, it’s important to consider how quickly you are depleting these funds relative to long-term tax planning.
- Roth Accounts: Distributions from Roth accounts are tax-free. Taking withdrawals now will lower your current taxes. However, it might be better to defer distributions into higher taxable income years, or to transfer this tax-advantaged account to your family upon death.
Tax Planning
Evaluating your current and projected taxable income has a large bearing on how to source retirement income. Your taxable income often varies (sometimes significantly) throughout retirement. Common variables include when you begin taking Social Security income and when your required minimum distributions (RMDs) begin. While it seems counterintuitive, there are times when generating elective taxable income is part of a wealth maximization strategy. For example, if you’re temporarily in a low tax bracket, it might be wise to take an early IRA distribution, do a Roth IRA conversion, or electively realize capital gains.
Investment Selections
Ultimately, once you determine the best account to source withdrawals from, you still need to choose what asset to sell. The best selection will vary depending upon a number of factors, such as:
- How segments of the markets (i.e., stocks vs. bonds) are performing.
- How specific investments are performing.
- Positioning for upcoming cash needs.
- Appropriate rebalancing in your portfolio.
- Tax implications.
Successful investment management in retirement entails many interrelated decisions. SageVest Wealth Management’s investment management process carefully integrates financial planning and tax considerations in all investment decisions. This approach helps our clients to successfully prepare for, enter, and enjoy retirement.
