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Creating an Income Stream in Retirement: Withdrawal Considerations, Taxes, and More

There’s more to a retirement plan than ensuring you’ve saved enough to stop working. Thinking about how to strategically withdraw from that savings is just as important as focusing on your growing nest egg number. A sound withdrawal strategy can make your money last longer, reduce your taxes, and allow you to spend more. 

Here are some key ideas to keep in mind as you consider your withdrawal plan. 

The 4% Rule

The 4% is a common rule of thumb for retirement withdrawals. The rule originated with a study performed by financial planner Bill Bengen in the early 1990s. He found that, historically, if someone withdrew 4% of their savings in the first year of retirement and adjusted that amount for inflation each year, their money always lasted for 30 years.

This rule can serve as an excellent base to start with, but there are many reasons you may want to tailor it, such as a shorter life expectancy or concerns about the future. Also, understand it is a very conservative starting point. In most historical cases, retirees ended up with more money than they started with after 30 years. This may be okay for you, but it does mean that you could have enjoyed your money more – either taking more frequent or exciting trips, helping family who needed assistance, supporting charities and causes you’re passionate about, or whatever your values-aligned life looks like.

Tax-Efficient Withdrawals

Most retirees will have money in several different “tax buckets” such as tax-deferred retirement accounts, Roth IRAs, and taxable brokerage accounts. Rather than spending from them in a particular order, it often makes sense to take a portion of your annual withdrawal from each account to spread your tax bill out over time and stay under certain taxation thresholds. 

Doing this effectively requires that you think ahead for several years at a time. Completing Roth conversions in early retirement could also help reduce your total tax burden.  

Balancing Growth and Income

You may want to tilt your investments toward income-producing assets in retirement. However, be mindful that you still need your portfolio to grow so that you’ll have money available in later years. Finding the proper balance between stable income and sustainable growth is key.

One hurdle you may need to overcome is the idea that it’s ok to spend from principle. You don’t have to rely on dividends or interest payments if you have a sound withdrawal plan and structure your portfolio to support it.

Longevity Risk

Although living too long is a risk we’re all happy to have, the reality is it’s still a serious risk we need to plan for. Rather than spending too little and lowering your lifestyle in retirement, you can protect yourself from longevity risk by creating a lasting income stream through your investment portfolio, Social Security, and other income sources in retirement (like consulting or freelance work). 

Healthcare Costs

It’s no secret that your healthcare expenses will increase as you age. Failing to account for them can be disastrous. Medicare and other health insurance plans can cover some of your costs, but they won’t cover everything, such as long-term care. About 70% of people turning 65 will need some type of long-term care. Long-term care insurance, or dedicated savings to cover this need, can protect the rest of your retirement. Most people will require  dedicated savings for healthcare costs in retirement as long-term care insurance becomes less viable as the years go on.

Health Savings Accounts are perhaps the best tool for funding healthcare in retirement because they offer a triple tax advantage. Much like an IRA, your contributions are deductible, and earnings are shielded from taxation. However, you can also withdraw from the account tax-free when the money is used to pay for qualified health expenses. You do have to meet certain requirements to open one, but if you can they are an excellent way to boost your retirement.

Market Volatility

Since you’ll need to maintain some exposure to the market for long-term growth, volatility is inevitable. While it can be scary, remember that it’s a natural part of investing. You can also account for it in your withdrawal plan.

You don’t need to react to every dip, but reducing your withdrawals when your portfolio dips below certain levels can reduce a lot of strain on your savings. Even reducing your withdrawal by just 10% when your balance drops below a certain level has been shown to significantly mitigate shortfall risk. You may want to set aside a certain amount of money in cash, money market funds, or t-bills that you can withdraw from during periods of exceptional volatility. 

Legacy Planning

For many, leaving something for your heirs is an important goal. However, even if it isn’t, a natural outcome of a sound withdrawal plan is that you’ll still have savings left when you pass. 

The more conservative your withdrawal plan is, the bigger your financial legacy will be. Consider how that could impact your heirs, and take proactive steps to ensure you pass any assets most efficiently. This includes naming beneficiaries on accounts, writing a will, and possibly establishing a trust to direct distribution.

Planning Your Withdrawal Strategy

There are many ways to plan your withdrawals in retirement. These ideas will help you start thinking about the best way to craft a distribution plan you are comfortable with, and that properly supports your retirement lifestyle. 

Do you want to discuss what withdrawal strategy makes the most sense for your unique goals? Reach out to us today by clicking here. 

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