Plan to Withdraw Wisely

As your retirement time horizon grows shorter it’s time to plan how you will convert years of savings into a lifetime income you can’t outlive. Getting the most from your retirement savings involves creating a spending plan, and it also requires that you determine the most tax efficient way to access your capital. Different sources of retirement income will usually have different tax implications. Drawing down your income so that it can last longer needs to be done with careful attention to the amount of tax you will pay at different stages of retirement.

Conventional wisdom says that you should begin drawing income first from your taxable investments to allow your tax deferred investments in your 401k or IRA to continue compounding free of taxes. The assumption is that you might be in a lower tax bracket once you retire. Therefore, you will pay taxes on your taxable investments at a lower tax rate. In addition, investments held in stock accounts and mutual funds, if held longer than a year, will be taxed at a lower capital gains rate which could be 0%, 15% or 20% depending on your actual tax bracket.

Next up will be your tax deferred investments, which have had the advantage of an extended period of compounding without paying taxes. This income will be taxed as ordinary income based on your tax bracket (.i.e. 10%, 15% or 25%). The only concern about allowing your tax-deferred investments to accumulate for too long is that you will be required by the IRS to begin withdrawing income at age 70 ½ at a rate specified by the IRS. If you don’t withdraw enough income, you could be hit with a staggering 50% penalty tax.

The best strategy is always based on your particular situation, but, as it turns out for most people, taking income from a mix of taxable and tax deferred investment may work out the best. Retirement income planning should be done with the guidance of a qualified and objective financial advisor.