How to Tap Your Retirement Investment Accounts
Be strategic in deciding which funds to access
The goal is to maximize your ability to generate income throughout retirement while keeping your tax burden low. That may not be easy, however, given that many savers have money stashed in a variety of accounts, all with different tax implications, including tax-deferred 401(k)s and Individual Retirement Accounts (IRAs), after-tax Roth IRAs and taxable investment accounts.
(MORE: To Tap Your IRA or Not)
Adding to the complexity, retirees must decide when to claim Social Security. That, in turn affects how much they need to pull from savings.
In the end, the financially smartest choice may not be immediately obvious — or easy to accept.
With that in mind, here is a guide on how to proceed:
First Things First
If you’re already age 70½ or older, the first income source is a no-brainer: Take your required minimum distributions from IRAs and company retirement plans, or risk onerous penalties. (Some company plans let you wait until you retire if you are still on the job.)
Generally, the next step — which is the first step for those not subject to minimum distributions — is to begin withdrawing income produced in taxable accounts. You are likely to pay capital-gains or qualified-dividend tax rates on this income, which is lower than the ordinary tax rate you would pay on money withdrawn from traditional IRAs and 401(k)s. Plus it can be smart to let IRA and 401(k) assets continue to grow tax-deferred. (These are generalizations; all retirees should assess their own tax situation.)
When dipping into taxable accounts, taxes and asset allocation are two important considerations.
One strategy is to withdraw cash flows such as interest, dividends or capital gains that you had been reinvesting in additional shares. These payouts are taxable whether or not you reinvest, so consider having them deposited to a cash account at your brokerage.
Another idea: Pull income first from any asset class where your allocation has grown bigger than you’d like. Investors who are overweight in stocks might tap stock dividends “to keep their asset allocation closer to their target and reduce the need for future rebalancing,” says Colleen Jaconetti, senior investment analyst in Vanguard Group’s Investment Strategy Group.
Next is where it gets uncomfortable for some: Dipping into the principal of taxable accounts.
Selling assets can be a psychological challenge for retirees who prefer the old-school method of living off investment income. But in today’s low-interest-rate environment, that can be tough. Some retirees have reacted by shifting into higher-yielding — and riskier — assets.
“We hear all the time, ‘I don’t want to touch my principal,’” Jaconetti says. But ultimately, investors seeking to create sufficient income without touching their savings may “put their portfolio at much higher risk” than if they simply sold some holdings, she says.
Delay Social Security
After depleting taxable accounts, your next income source is likely tax-deferred accounts such as IRAs and 401(k)s.
It used to be that people not yet at minimum-distribution age would be advised to delay tapping these accounts to keep them growing as long as possible. But some experts now say that retirees who have a reasonable chance of living beyond average life expectancy should accelerate withdrawals from these accounts if doing so will enable them to delay claiming Social Security.
Delaying Social Security benefits as long as possible (until age 70) can pay a hefty return in the form of higher benefits and, potentially, a lower tax bill on average over your retirement.
Every year you delay claiming benefits after reaching your full Social Security retirement age (age 66 to 67 for those born after 1942), your benefits increase by about 8 percent of your Full Retirement Age benefit. You can claim as early as age 62, but your monthly benefit will be cut by about 20 percent to 30 percent.