Saving to Spending: Build a Tax-Smart Withdrawal Strategy
As you near retirement, it’s time to start thinking about the next chapter of your financial journey. After years of saving and investing, shifting from accumulation to spending can feel uncomfortable. A well-planned, tax-efficient retirement withdrawal strategy can help you make the most of your assets and set the stage for a fulfilling, confident retirement.
Understanding Your Retirement Income Sources
To craft an effective retirement withdrawal strategy, you must understand the different savings and investment vehicles you’ve used over the years. Here are some common income sources you may receive in retirement.
Required Withdrawals
Once you reach the age of 73, you’ll need to start taking required minimum distributions (RMDs) from certain retirement accounts, like traditional IRAs and 401(k)s. These withdrawals are mandatory and taxed as ordinary income. The amount you’re required to withdraw each year is calculated based on factors like account balance and life expectancy.
RMDs can significantly impact your tax situation, and failing to take them can result in hefty penalties.
Automatic Income
Some income streams provide regular payments without requiring active management on your part. These include:
- Social Security benefits: Government-provided payments based on your lifetime earnings and contributions, designed to provide financial support during retirement.
- Pensions: Employer-funded retirement plans that provide regular, guaranteed income, based on your years of service and salary.
- Annuities: Insurance products that offer a steady income stream, either for a fixed period or for life, often used to supplement retirement income.
You should also note that rising healthcare expenses can affect automatic income streams. For instance, Medicare premiums are often deducted from Social Security benefits, potentially reducing your expected income. Additionally, unexpected medical costs during retirement could strain your budget, potentially affecting the margin you have to live on. Proper risk management and planning for potential healthcare costs can help you preserve automatic income streams and maintain your financial confidence.
Optional Income
Optional income sources are retirement accounts where you generally have more control over when and how much you withdraw. Here are some examples.
Traditional 401(k) and IRA accounts are employer-sponsored and individual retirement accounts that allow for tax-deferred growth. While these accounts are subject to required RMDs, you still have the flexibility to take additional withdrawals as needed to meet your income goals.
Roth 401(k) and Roth IRA accounts are funded with after-tax dollars, offering potential tax-free growth and withdrawals in retirement. Unlike Roth IRAs, which are not subject to RMDs during the account holder's lifetime, Roth 401(k)s are subject to RMDs starting at age 73. However, RMDs on a Roth 401(k) can be avoided if you perform a Roth conversion, rolling the balance into a Roth IRA. It’s important to work with your financial professional to understand the irreversible tax implications of a conversion.
Taxable investment accounts are non-retirement accounts that can hold a variety of investments, such as stocks, bonds, and mutual funds, and offer greater flexibility in withdrawals. These accounts are not subject to RMDs, but withdrawals are taxed based on the capital gains and income generated.
By understanding how and when to tap into optional income sources, you can create a more tax-efficient retirement withdrawal strategy that maximizes your retirement income while aiming to minimize unnecessary tax burdens.
Know Your Tax Situation
Taxes on Withdrawals
Different types of accounts are taxed in different ways. Withdrawals from traditional 401(k)s and IRAs are typically taxed as ordinary income since the money was contributed pre-tax. Roth 401(k)s and Roth IRAs, on the other hand, allow for tax-free withdrawals, provided you meet the conditions for qualified distributions. Knowing which accounts provide tax-free withdrawals versus those that trigger taxable events can help you plan your withdrawals more efficiently.
How Retirement Affects Your Tax Bracket
Retirement often brings changes to your tax bracket, as your income sources shift from salary or wages to withdrawals and other retirement income streams. If your income decreases, you may move into a lower tax bracket, allowing you to take advantage of more favorable tax rates. However, required minimum distributions (RMDs) or large withdrawals from tax-deferred accounts could push you into a higher bracket, potentially leading to a bigger tax bill than anticipated. Professional, tax-intelligent financial advice can help you keep more of your income in retirement.
State and Local Taxes
Don’t forget to consider the impact of state and local taxes. Some states are more tax-friendly for retirees than others. For example, some states don’t have an income tax, while others exempt certain types of retirement income or tax it at a lower rate. Sales tax rates can vary between different states, which affects all residents, including retirees. Property taxes can also vary greatly from state to state and can be a significant expense for retirees who own homes.
Work With an Advisor
Managing your finances and optimizing your withdrawal strategy can be a complex endeavor, but the good news is that you don’t have to do it alone. A financial professional can help you navigate the intricacies of retirement planning. By working together, we can create a clearer picture of what to expect during your retirement years.
Form a Tax-Efficient Retirement Withdrawal Strategy
Your financial professional can work with you to develop a tax-efficient retirement withdrawal strategy tailored to your unique situation. They'll help you determine the optimal order of withdrawals from your various accounts, considering factors such as required minimum distributions, tax implications, and your overall financial goals. Together, you'll establish a plan for the timing, order, and amounts of withdrawals in order to maximize your income and ensure sustainability, while minimizing the impact of taxes.
Whether your goal is to maintain your lifestyle throughout retirement, leave a legacy for your loved ones, or both, your advisor can help you optimize your strategy accordingly.
Let’s Work Together
By partnering with a financial professional, you can form a plan to make the most of your hard-earned savings. Together, let’s create a personalized, tax-efficient withdrawal strategy that aligns with your unique goals and helps you enjoy the retirement you've always envisioned. Contact the office today to schedule a consultation.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera nor any of its representatives may give legal or tax advice.
This material was developed and prepared by a third party for use by your Registered Representative. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. The content is developed from sources believed to be providing accurate information.
