by Stephen Reed | Accounting News, News, Retirement, Retirement Savings
Retirees routinely withdraw cash from retirement accounts to cover basic living expenses, but selling low could negatively affect your retirement portfolio. If the economy experiences a downturn during your retirement years, you can use the strategies discussed below to minimize the impact to your long-term financial plan.
Before Making Any Withdrawals
While younger investors are generally advised to leave their cash invested and wait for the market to rebound, retirees typically rely on market withdrawals to create cash flow. In an effort to avoid or postpone withdrawals during tricky market conditions, try to find assets unlinked to the market that you can tap into until the market normalizes. Market downturns and steep inflation can be considered financial emergencies if you’re struggling to make ends meet, so you can certainly dip into emergency funds without feeling guilty. Just be sure to prepare a plan to replenish the funds as soon as possible. If you must withdraw from your investment accounts, it’s important to be strategic in your withdrawals.
Begin with Interest and Dividends
Before selling low, try to leave your original investment intact by only withdrawing the interest and dividends from your taxable accounts. This move could allow you to conceivably grow your income when the market rebounds in the future.
Sell Lower Volatility Investments
Short-term bonds and bond funds generally aren’t as affected by market unpredictability, and their values are ordinarily stable. Selling them in a down market can supply necessary cash and not cause too much damage to your retirement savings. They also favor smaller price fluctuations than stocks during stretches of market volatility.
Rebalance Your Portfolio
If your investment portfolio is out of alignment with your asset allocation goals due to market volatility, it’s an opportune time to look for opportunities to raise needed cash by rebalancing. In order to return your allocation to its original goal, sell assets where values have increased disproportionately in value relative to your desired allocation, and buy assets that may have dropped in value.
Make Tax-Smart Choices
If you’re forced to sell assets from taxable accounts for needed cash flow, be sure to make tax-smart choices. You can minimize your taxes owed by selling investments that you’ve held longer than one year. Those gains are taxed at the long-term capital gains tax rate of 20% and not at the federal ordinary income tax rate. Keep in mind that some gains may also be subject to state and local taxes.
by Daniel Kittell | Accounting News, News, Retirement
A retirement withdrawal strategy can help you establish the appropriate amount of money to take out of your investment accounts each year. The amount you decide to make available to yourself will affect your quality of life in retirement, and you want to make sure your withdrawal strategy will protect against your savings accounts running dry. Below we discuss retirement withdrawal strategies that should ideally work together for an optimal distribution plan.
The 4% Rule
If you follow the 4% rule, you will withdraw 4% of your investment account balance in your first year of retirement. Theoretically, by increasing that amount each year in order to keep up with inflation and the rising costs of goods and services, you should have enough money available to maintain a 30-year retirement. The benefit of this approach is that it’s simple and keeps up with inflation. However, the best percentage for each retiree will vary person to person. This method also doesn’t support flexibility to adjust based on the performance of your investments.
Fixed Dollar Withdrawals
With fixed-dollar withdrawals you take the same amount of money out of your retirement account every month, quarter, or year for a set period. For example, you may decide to withdraw $2,000 monthly for the first three years of retirement and then reassess after that time to determine if this is still the best amount for your circumstances. The benefit of this distribution strategy is the predictable income, but it doesn’t account for inflation or a fund’s performance. Withdrawing a fixed dollar amount each month or year could cut into your account’s principal.
Systematic Withdrawals
Using this approach, you withdraw only the income your investments produce from interest or dividends, so your account’s principle remains intact. The benefit of this strategy is that you can be assured your account won’t run dry since the principle isn’t touched. However, your principal needs to be quite sizable to provide income for you to live on. Keep in mind that your income will vary from year to year, depending on market performance, which makes it challenging to create a financial plan.
Create a Floor
The simplified explanation of income flooring is to determine how much income you need to live comfortably for the rest of your life if you didn’t make another penny, and when that lifetime income should begin. First, you need to create your income floor, typically by building up accounts that provide guaranteed income on a regular schedule—Social Security, pensions, and annuities. By creating a strong financial floor, you can rest assured that you will be able to pay at least the necessary expenses in retirement, no matter the volatility of the markets.
Buckets
Implementing a bucket strategy means creating three separate sources of retirement income:
- A savings account that holds approximately three to five years’ worth of living expenses in cash
- Fixed-income securities, including government and corporate bonds or certificates of deposit
- Equity investments and growth funds
To use this approach, you draw from your savings account to cover your expenses and refill that “bucket” with funds from the other two sources of income. This allows you to refrain from selling assets at a loss. You can refill your savings account by selling stocks (as long as the market is up) or by selling your fixed income securities (as long as they’ve performed well). If both of these are down, continue drawing from your savings.
This approach allows you to potentially grow your investment account balance over time, but it can be time-consuming, and you need to use an additional method to figure out the amount you can afford to spend each year.
Account Sequencing
The goals with an account sequence strategy are to:
- Maximize the amount of money you can spend in retirement
- Receive a higher lifetime after-tax income
- Enhance the longevity of your portfolio
- Reduce taxes paid over the course of your retirement
- Eliminate or reduce Social Security benefits from being taxed
- Reduce Medicare premiums
Your tax bracket can heavily influence when to withdraw money from tax-advantaged funds, and the best approach may be to withdraw cash from a combination of savings and investment accounts. This is where the expertise of advisory firms can help you determine the best course of action.