by Nancy Osborne, COO of ERATE®
July 12, 2007 - Saving for retirement is a huge accomplishment and finally reaching your goal is precisely what you've worked your whole life for. Now that you have finally achieved critical mass and are ready to leave the working world behind you, make sure that you take the time to carefully consider how you will tap into your accumulated funds so they can sustain you throughout all of your years in retirement. Determining how much you'll need to cover your living expenses, as well as your required minimum distribution (RMD)*, is the first step then next you may begin the process of mapping out your withdrawals. Your goal should be to use the interest, dividends and capital gains that your investments generate to supply the cash you'll need to fund your monthly living expenses, meet RMD* requirements and pay the taxes due. Under typical conditions retirement assets will last longest if taxable accounts are drawn on first and for those retirees in higher tax brackets this is even more important. Drawing on tax-deferred accounts such as IRA's, 401(k)s and 403(b)s should be put off for as long as possible as this will permit these tax-deferred assets to benefit from the longest period of growth and tax deferral possible. The sequence of withdrawal should generally proceed in the following order: taxable accounts, then tax-deferred accounts and last any Roth IRAs.
The primary objective of any retiree is not to out live their money. Therefore you must use caution and prudent planning to avoid overspending in your initial years of retirement. A safe pace to withdraw from your retirement accounts would be a rate of approximately 4% to 5% and this should supplement any social security benefits you receive. Any increases beyond 4% to 5% should be based solely on the rate of inflation which occurs within a given retirement year. Capping your withdrawal rate at this level will help you achieve the mutual, yet sometimes conflicting, goals of providing you with sufficient cash to maintain a comfortable lifestyle while allowing for the growth in your portfolio to support your cash needs throughout all of your years in retirement. As you move into each new decade of your life you may gradually increase your rate of withdrawal, raising the level of cash you consume into your 70's, 80's and 90's.
With taxable assets being drawn on first, select those assets which may generate a tax loss or the least amount of capital gains. Matching your tax losses to your capital gains may be an effective strategy for minimizing your tax impact. For those accounts which no taxes have yet been paid, you should plan on any distributions being fully taxable as ordinary income. Any tax-deferred accounts which have been funded through partially taxed earnings should be distributed prior to any fully taxable retirement assets so that the income tax liability may be postponed into later years, with any Roth IRAs available to be distributed last. If in your portfolio there are large capital gains pending on stocks or mutual funds which are held outside of your retirement accounts, these would be good candidates to hold onto and distribute to your heirs upon your death as part of estate planning. For at the time of death any heirs to these assets would receive the stepped up basis bringing the asset to its current market value for taxation purposes at the time of sale. Any taxes then due on these assets would be dramatically reduced for your heirs.
*RMD=Required Minimum Distribution
The internal revenue service (IRS) requires that you withdraw this minimum amount from your retirement account on an annual basis beginning the year you turn age 70.5. For more information visit:
Always consult with your tax or financial advisor regarding your own individual circumstances.
Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.
"I am addicted to Bloomberg TV" says Nancy.