The Best Retirement Withdrawal Strategies
Let’s talk retirement it’s time to enjoy all those bucket list items that you didn’t get to do have some additional income streams like annuity or some rental income but now that your paycheck will soon be turned off how during retirement well this is a complex question and every situation is different but if
You stick with me i’ll explain the optimal it’s colin exelby here and i provide financial planning for business owners and their families i’m the owner of a virtual financial advisory i provide advice to families all over the country part of that advice is retirement income planning into the most efficient retirement
Income stream possible numerous studies have shown that with a little thought preparation and analysis you can extend the life of your portfolio increase your distribution rate or pass on more wealth to your heirs i’m going to talk about withdrawals from three types of accounts taxable accounts now taxable are
Non-retirement accounts where you’ve already been taxed and your only taxes would be capital gains when liquidating assets and you will owe income taxes when you are typically traditional or rollover iras sep or simple iras 401(k)s or 403(b)s all right tax-free gains or income taxes when you distribute them these
Are typically a roth 401k or a roth ira account where contributions were initially taxed when you would draw them as long as the okay the first step to figuring out how to distribute assets is to figure out how much you need annually to live on after taking into account any other income sources so what do you do
After taxes of course and then subtract like social security pensions rental income amount that’s needed for retirement withdrawals made from a combination of those three types of accounts the goal of retirement income planning is to maximize after tax distributions you want to be mindful of your tax brackets
Throughout retirement and both at the federal and the state level distributions from retirement accounts or pensions if you are considering a move in retirement a state without retirement income taxes could be a major help to your portfolio nine states don’t currently levy any state taxes and another alabama
Taxes 401(k)s and iras but doesn’t tax pensions for a list of states that don’t tax retirement income just check out the notes below all right to analyze your federal and state income tax rates the first step is to project your income tax rates taking into account tax credits and deductions ideally you want to be
Very mindful of the points where the tax brackets jump up there are certain income levels where the marginal tax rate increases meaning your retirement income is much total income you have all right let’s take a look at five strategies for withdrawing assets and who might typically use them for each of these
Strategies it’s important to know the age limitations and withdrawals and whether penalties for early withdrawals is the worst strategy the government created these plans and gave incentives for you to save for retirement don’t blow up these benefits in early withdrawal penalties if you need distributions prior to the
Appropriate age there are additional strategies that may limit the impact of those penalties let’s dive in baseline income strategy it typically is the least tax efficient but often it’s the easiest one to employ it’s called pro rata and means that you your tax deferred and your tax-free accounts after your
Other income sources have been used the pro rata strategy would be to take two thousand tax deferred account and your tax-free account if your investment strategy is to hold the exact same asset allocation in each type of account then as you would draw assets your asset allocation stays consistent over time the assumption
Is that by withdrawing equally from each type of account you diversify your tax burden over time this strategy is ideal for someone who would not change marginal tax brackets based on distributions on the surface this isn’t a bad strategy if you don’t know what to do don’t wish to do deeper analysis assets
Strategy number two i’m going to call this the taxable pro rata this means distributions are funded with the taxable account first until it and the tax-free accounts this strategy typically keeps tax rates lower in the early years because gains from the investments not any principal distributions from the retirement
Accounts this also allows the tax deferred and the tax-free accounts to grow without taxes for a longer period of time this strategy could be ideally employed smaller retirement accounts the downside with this strategy is that you may be exchanging lower tax rates now for future taxes at much higher rates
Are and what the heck future tax rates are all right strategy number three is to use tax deferred accounts first followed by the taxable aims to keep the tax-free assets growing as long as possible and more evenly spread the tax obligation over time typically in the early years of retirement or if you retire early
Your income levels are much lower than while you were working using tax deferred assets first capitalizes on the fact that while your income is lower usually before mandatory retirement distributions take effect and potentially before receiving social be taxable and still stay in a lower marginal someone who
Retires early with a large amount in tax deferred retirement assets like in the ira or 401(k) and having smaller amounts in taxable and tax-free accounts especially if those assets are invested in higher growth areas it allows those assets to grow for a longer period of time before liquidation and then liquidation could be
At lower tax rates strategy number four is to distribute taxable assets first then tax free assets and finally tax deferred assets this strategy is designed to defer the largest amount of tax for as long as possible and this strategy would be ideal for someone who either has a shorter life expectancy maybe due
To some medical condition or some family issues or someone with a larger taxable assets first of course you only pay income taxes from tax deferred distributions be distributing them at all before passing away first then tax deferred and finally tax-free retirement income strategy and intuitively it
Makes sense especially if your asset allocation is aligned meaning your investments across the different accounts are aligned first allow your tax-free roth assets to grow as long as possible you’ll want to distribute all your taxable assets first where only capital gains taxes are paid you next would withdraw all your
Tax deferred assets this is when you would most likely be in your highest marginal income bracket in retirement and finally when all of those other assets are gone then you distribute your tax-free roth assets this strategy would be ideal for someone with assets to their heirs because tax-free roth to pass on
Because of their tax-free nature the problem with this strategy is that in your early retirement years when your income is often the lowest you’re not taking advantage of those low marginal tax rates you often end up in much higher tax brackets than needed in the years so what’s the ideal strategy in my opinion the
Ideal strategy is to be fluid not rigid look tax rates change your distribution needs change we all make assumptions but we don’t know what’s going to happen in the future and market conditions change i’m a big believer that maintaining flexibility makes a lot of sense in my experience retirees often spend the most in
The early years of retirement you do all those things that you wanted to do and you didn’t have the time and you pay a lot of expenses in the later years when health care costs are significant both in the home and if you need additional care the years in the middle are often when you have lower spending needs
Because retirement spending isn’t often a straight line your withdrawal strategy should reflect those changing needs i firmly believe that based on much analysis that attempting to maintain a consistent than lower and then higher later on makes a lot of sense the most tax-deferred assets that you can distribute in the early
Years of retirement at lower tax rates the better even if you don’t need the assets right away they could potentially be reinvested in tax-free roth accounts through a conversion or in a taxable account where only the capital gains taxes would be due or maybe some combination of both this is a strategy that
Many people miss out on i see it all the time they miss out due to the desire to delay taxes as long as possible and this creates potential tax bonds in retirement accounts and if tax rates increase in your retirement you could be in for a rude awakening these are the most common distribution strategies but they’re not
The only ones every family situation and their needs are different advice thankfully nowadays powerful financial planning software exists to examine each of these strategies as it relates to your own situation and determine the best course of action currently in my practice i use some incredible software
With my clients if you’re getting close to retirement and wish to analyze your withdrawal strategies feel free to reach out to me at my website celestialwm.com or speak with your trusted advisor if you enjoyed this video just hit that little like button and make sure you smash that subscribe button so you’re notified
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Transcribed from video
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