Strategically Withdraw Money for Retirement

Jane Young, CFP, EA

Jane Young, CFP, EA

After years of contributing money to 401k plans and Roth IRAs you are finally ready for retirement and face the dilemma of how to best withdraw your retirement savings.  Many retirees have several sources of income such as pensions, social security and real estate investments to help cover their retirement needs. Review your annual expenses and determine how much you need to pull from your nest egg for expenses that aren’t covered by other income sources.

One way to manage your retirement income needs is to create three buckets of money.  The first bucket is for money that will be needed in the next twelve months.  This money should be fully liquid in a checking, savings or money market account.  The second bucket is money that will be needed over the next five years.  At a minimum, hold money needed in the next five years in fixed income investments such as CDs and short term bond funds.  By investing this money in fixed income investments it is shielded from the fluctuations in the stock market; avoiding the agonizing possibility of having to sell stock mutual funds when the market is down.

Consider buying a rolling CD ladder where a CD covering one year of expenses will mature every year for the next four to five years.  After you spend your cash during the current year a new CD will mature to provide liquidity for the coming year.

The third bucket of money is your long term investment portfolio.  This should be a diversified portfolio made up of a combination stock mutual funds and fixed income investments.  Every year you will need to re-position investments from this bucket to your CD ladder or short term bond funds to cover five years of expenses.  Rebalance your long term portfolio on an annual basis to keep it well diversified.

In conjunction with positioning your asset allocation for short term needs, you need to decide from which account you should withdraw money.  Conventional wisdom tells us to draw down taxable accounts first to allow our retirement accounts to grow and compound tax deferred, for as long as possible.  Gains on money withdrawn from a taxable account are taxed at capital gains rates where withdrawals from a traditional retirement account are taxed at regular income tax rates and withdrawals from Roth IRAs are generally tax free.

Withdrawing all your money from taxable accounts first isn’t always the best solution.  You need to analyze your income tax situation and strategically manage your withdrawals to avoid unnecessarily going into a higher tax bracket.  Additionally, the taxation of Social Security is graduated based on income.  After starting Social Security, you may be able to minimize taxation of your benefit by taking withdrawals from a combination of taxable, traditional retirement and Roth accounts.  Do some tax and financial planning to strategically minimize taxes and maximize your retirement portfolio.

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