Much is written on how to prepare for retirement. Save early, save often. And many retirees have done just that, accumulating an appropriate nest egg invested across a combination of 401(k) plans, traditional and Roth Individual Retirement Accounts (IRAs), personal investments and real estate.
However, at the point of retirement, a new decision set emerges. Which assets do you take withdrawals from, and in what amount and order? Under the right circumstances, the answers to these questions can have a million-dollar impact on your lifetime net worth.
By using this recommended withdrawal strategy, a retiree can help achieve three key goals:
- Make their money last longer
- Minimize their taxes
- Increase the amount of money available for their heirs
Here’s How the Withdrawal Strategy Works
At the onset of retirement, many people try their best to pay for living expenses from a variety of sources, such as a pension, Social Security income, rental income and part-time work. Few have enough passive income to fully cover their expenses, and therefore need to begin tapping into their investment accounts to cover the difference.
Since many people have most of their money in traditional IRAs and 401(k) retirement accounts, it’s often the first place where they begin. Plus, it would seem to make sense: These funds were saved with retirement in mind, right?
Unfortunately, this can be a mistake. By relying on these accounts first, retirees draw too heavily on assets that generate income that’s fully taxable upon distribution. Plus, these accounts have rules and potential penalties for early withdrawals before age 59½.
This logic, while well-intentioned, can reduce retirement savings by several hundred thousand dollars over 20+ years of retirement. No one wants to pay more taxes and have less money for themselves and their heirs.
Instead, we recommend focusing on a two-part strategy:
- First, withdraw funds in a way that minimizes your taxes.
- Second, selectively convert portions of qualified retirement plans – IRAs and 401(k) plans – into a Roth IRA.
In the example below, the impact of employing these tactics is dramatic. Using a tax optimization approach with the following specific parameters can increase our example couple’s assets by over 50% – or approximately $1,040,000 – over the rest of their lives.
Potentially even more important, by converting some money from traditional retirement plans into a Roth IRA in the years when income is low, the couple shift about approximately $1,175,000 from accounts that are taxable to those that are tax-free as part of a loved one’s inheritance.
Here’s how a typical retired couple can put this strategy to work. We …….