Tips for determining when and how to withdraw from retirement savings
These tips — and some guidance from a financial professional — can help you make more informed decisions when it's time to start drawing from your retirement savings.
You've spent your career saving for retirement. Once you retire, the challenge will be figuring out how to draw from your retirement savings. After all, how you withdraw your retirement savings can greatly affect how long it will last.
Consider these steps
Decide how much you'll need to pull from your savings each year. These steps can help.
- Determine how much you need to spend each year.
- Determine how much of your need is offset by Social Security, pensions, income annuities and work income.
- Categorize your savings (because any remaining need will come from retirement savings) into two buckets as follows:
- Accounts built with after-tax dollars, such as bank accounts and investments that are not tax-deferred
- Tax-deferred accounts, such as individual retirement accounts (IRAs), 401(k)s and 403(b)s
Withdrawing from your savings
Generally, your first stop for withdrawals should be required minimum distributions (RMDs) from tax-deferred accounts. That's because any amount of RMDs not taken for the year as required will be subject to an excise tax of 50 percent of the amount not distributed.
Next, consider withdrawing from accounts that are taxable to you — regardless of whether you spend or reinvest the distributions. Examples include capital gains, dividends and interest.
For most retirees, withdrawing more than the RMD from tax-deferred accounts should generally be the last choice. This is due to the way these accounts are taxed — every dollar withdrawn from tax-deferred accounts is taxed as ordinary income.
However, if you're in a year in which your overall income is lower than normal or if you feel your future tax rate will go up, you may want to think differently. Consider drawing from tax-deferred money up until the point that it would push you into the next marginal tax bracket.
You may also opt to draw from tax-deferred money if you want to pass some money on to heirs that will potentially be in a high future tax bracket. It may benefit them to receive taxable accounts because of the potential step-up in basis these types of accounts may receive upon your death.
Focus on your strategy
You should also consult with your tax advisor before making any decisions, because no single withdrawal strategy is right for everyone. Because how you withdraw your savings can have such a big impact on how long your savings may last, this is a crucial time to seek guidance.
- Individual Retirement Accounts (IRAs) require individuals, and qualified retirement plans require highly compensated employees (HCEs) (greater than 5 percent owners or those earning compensation more than $115,000 in 2013) to receive a minimum distribution by the April 1 following attainment of age 70 1/2, and each December 31 thereafter. For an employee of a qualified retirement plan that is not a HCE but still actively employed, RMDs can be delayed until April 1 of the year following the year they terminate employment and each December 31 thereafter. RMDs may also apply to some beneficiaries.
Withdrawals from annuities, an IRA or other qualified retirement plans may be subject to a 10% IRS early withdrawal penalty if taken before age 59 1/2.
The subject matter in this communication is provided with the understanding that The Principal is not rendering legal, accounting or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
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