Planning for Retirement: Withdrawal Strategies Explained

You spent your working years saving for retirement. Once you retire, you need to switch gears and start spending money. That may sound simple enough, but there’s a lot to consider. Without prudent retirement withdrawal strategies, you could spend too much or too little.

There’s More to Planning for Retirement Than Saving

Building a nest egg is an important aspect of retirement planning, but it’s not the only thing that matters. You also have to consider how you’ll spend the money you’ve saved.

On the one hand, if you blow through your savings too quickly, you risk ending up impoverished in your final years. On the other hand, if you’re too frugal, you risk depriving yourself of the enjoyment that your retirement years should bring. It’s a balancing act, and it’s made even more complicated by strict tax codes and complicated Social Security benefit schedules.

Deciding When and How Much to Withdraw

Let’s say you have $1 million in retirement savings. If you follow the 4% rule, you’ll withdraw 4%, or $40,000, in your first year and adjust this for inflation. This guideline is supposed to make your retirement savings last for 30 years, but it could lead to shortfalls due to unexpected economic conditions like high inflation or poor market performance. It can also be a problem for people who retire early or expect to enjoy a very long retirement. The similar 3% rule, which would give you $30,000 in the first year, is a more conservative approach.

But there’s a lot more to consider. You need to think about taxes, which can take a big chunk out of your retirement withdrawals. You also need to consider other sources of income, including Social Security. We’ll look at both of these issues in more detail in the following sections.

Tax-Efficient Retirement Withdrawal Strategies

Deciding on a retirement withdrawal strategy isn’t just about accessing funds when you need them and making sure your money covers your retirement. It’s also about avoiding tax penalties so you keep as much of your savings as possible.

According to the IRS, most retirement plan distributions are subject to income tax, and some are also subject to an additional 10% tax penalty for early distributions taken before the participant or owner reaches age 59 1/2.

The IRS also warns that you can’t keep retirement funds in your account indefinitely. If you don’t start withdrawing from your retirement plan by the time you reach age 73, you’ll be hit with expensive penalties. Starting then, you have to withdraw the Required Minimum Distribution (RMD) or more each year to avoid penalties that can be as high as 25%. The RMD applies to the following types of retirement plans:

• Traditional IRAs
• SEP IRAs
• SIMPLE IRAs
• 401(k) plans
• 403(b) plans
• 457(b) plans
• Profit sharing plans
• Other defined contribution plans
• Roth IRA beneficiaries

In addition to tax penalties, you may owe regular income tax on your withdrawals. The IRS says distributions from retirement plans must be included in income, with some exceptions. One exception applies if the distributions represent the employee’s own contribution, such as an after-tax employee contribution. The other exception applies if it’s a qualified distribution from a designated Roth account.

Deciding When to Take Social Security

When you’re creating your retirement withdrawal strategy, you also need to consider your Social Security strategy. Although the typical retirement age is 65, and that’s when you age into Medicare, it’s not necessarily when you want to start claiming Social Security retirement benefits.

You can start claiming Social Security as early as age 62, but if you do that, your benefits will be reduced for your entire retirement. Over the course of a long retirement, you will ultimately receiving a much smaller total benefit. Your full retirement age will be between 66 and 67, depending on when you were born, and that’s when you’ll receive the full retirement benefits owed to you. If you can delay even longer, you’ll receive credits that increase your monthly Social Security benefits, but these credits stop once you turn 70.

These rules mean you can boost your future retirement income by delaying Social Security benefits until sometime between ages 67 and 70. To make ends meet until then, you may need to make slightly higher withdrawals or rely on another sources of income, such as a part-time job.

Aligning Your Withdrawal Strategy with Your Spouse’s

Saving for retirement can be easier when you have two incomes, but married couples also need to align their withdrawal strategies, and that can add complications. There’s a lot to consider, including:

• Income taxes – Are you going to file jointly? Which tax bracket will your withdrawal strategies put you in? 
• RMD – How does your marital status impact your RMD? The IRS has tables you can use to calculate your RMD.
• Social Security – When will each spouse claim benefits, and will you claim your own benefits or spousal benefits?
• Longevity – Is one spouse expected to outlive the other, and how will this impact your withdrawal strategy?

How to Withdraw Money from Your Retirement Accounts

Once you have a retirement withdrawal strategy, it’s time to think about the practical details of how you’ll withdraw money.

If you have multiple retirement accounts, you need to decide which ones to withdraw from first. The order can make a big impact on your taxes and penalties, so consider the taxes that are applicable for each account as well as any RMD that you need to meet.

Combining retirement accounts can simplify this process. Consolidating or rolling over retirement accounts may also reduce administrative fees. However, before you take this action, make sure you understand what fees it may involve and how it will impact your investment. Also follow the IRA rollover rules, including the one-rollover-per-year rule.

Ultimately, you should use a retirement withdrawal calculator and/or spreadsheet to map out your withdrawal plan by month/year, combining all the retirement income sources available to you. Of course, this plan can be adjusted as needed.

Consider an Annuity as a Source of Retirement Income

You may find that you have enough retirement income from withdrawals and Social Security benefits to live comfortably during your retirement years. However, you may also worry about running out of money.

Many retirees are facing this fear right now. They worry about outliving their retirement savings, or about potential cuts to Social Security. They want another source of retirement income to help them manage their finances. Some go back to work, possibly on a part-time or consultant basis, while others purchase an annuity.

An annuity is contract between an insurance company and the annuity owner. You can purchase an annuity by paying a premium, and in exchange, you receive payouts. There are many different kinds of annuities, with different rules regarding your premium payments, the growth of the annuity, and your payouts. However, it’s possible to use an annuity to secure a guaranteed source of retirement income – and that has major appeal for retirees.

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