Retirement withdrawal strategies: how to withdraw retirement funds

In this article, we will dive into retirement withdrawal strategies to help you maximize your hard-earned savings when the time comes.

Whether you’re still exploring your withdrawal options or already have a retirement plan, this guide offers valuable insights and practical advice to assist you on your financial journey.

Best way to withdraw from retirement accounts: 5 smartest retirement withdrawal strategies

1. Withdraw funds from your IRAs or 401k plans as late as possible

Withdrawing funds from your IRAs or 401(k) plans as late as possible in retirement can provide several benefits:

• Tax advantages: Traditional IRAs and 401(k) plans offer tax-deferred growth, meaning you don’t pay taxes on the investment gains until you withdraw the funds. By delaying withdrawals, you allow your investments to continue growing tax-free, potentially maximizing the value of your retirement savings.
• Required Minimum Distributions (RMDs): Once you reach the age of 72 (or 70 ½ if you were born before July 1, 1949), the IRS requires you to take RMDs from your traditional IRAs and 401(k) plans. It’s crucial to make sure you withdraw the required amount annually to avoid penalties. These distributions are subject to income tax. However, if you continue working or have other sources of income, delaying withdrawals can help you manage your tax liability by minimizing additional taxable income.
• Social Security benefits optimization: Delaying retirement account withdrawals can be particularly advantageous if you plan to claim Social Security benefits. By postponing withdrawals, you can potentially increase your Social Security benefits, as your benefit amount is based on your highest 35 years of indexed earnings. Higher Social Security benefits can provide a more secure income stream in later years when you may need it the most.
• Longevity and inflation protection: The longer you leave your retirement savings invested, the more time they have to potentially grow and keep pace with inflation. By deferring withdrawals, you give your investments the opportunity to generate higher returns, which can help ensure your funds last throughout a longer retirement period.
• Flexibility and emergency funds: Keeping your retirement savings intact provides a financial cushion for unexpected expenses or emergencies. By tapping into your IRAs or 401(k) plans only when necessary, you can avoid depleting your savings prematurely and maintain a more secure retirement.

Once you reach the age of 73, it’s important to follow the rules for Required Minimum Distributions (RMDs). An RMD is the minimum amount you must withdraw each year from certain retirement accounts like traditional IRAs or 401(k) plans.

2. Withdraw funds from accounts in the right order

We recommend you start withdrawing from taxable accounts before tapping into your Roth IRAs. Why prioritize taxable accounts first? Well, withdrawing from taxable accounts allows you to take advantage of their tax benefits. 

These accounts are typically subject to capital gains tax or ordinary income tax, depending on the investment type and ownership duration. Initially utilizing the funds from taxable accounts, you can minimize your tax liabilities in the early stages of retirement.

On the other hand, Roth IRAs offer unique advantages. Qualified withdrawals from Roth IRAs are tax-free, and the earnings within these accounts can grow tax-free over time. 

When you leave your Roth IRAs untouched during the initial withdrawal phase, you allow them to continue accumulating tax-free growth, which can be extremely beneficial in the long run.

Preserving the tax advantages of Roth IRAs for later stages of retirement can be a wise move. As you age and potentially enter higher tax brackets or face required minimum distributions (RMDs), having tax-free income from your Roth IRA can provide a valuable source of funds without increasing your tax burden.

3. Consolidate multiple accounts

If you have multiple retirement accounts from different jobs, one of the best retirement withdrawal strategies is consolidating them into a single Individual Retirement Account (IRA), which can bring several benefits.

First off, consolidating your retirement accounts simplifies your paperwork. Instead of juggling multiple accounts, statements, and distributions, you can have everything nicely organized in one IRA. It’s like tidying up your financial life and giving you a clear view of your investments and their performance.

And here’s the best part; having a consolidated IRA makes it easy to calculate your future withdrawals. When all your retirement savings are in one place, you can easily determine the amount you’ll need to withdraw each year to meet your Required Minimum Distribution (RMD) requirements.

Another great advantage of consolidating is that it gives you better control over your asset allocation when managing retirement withdrawals. Having all your retirement funds in a single IRA can create a well-diversified portfolio matching your investment goals and risk tolerance. You can manage your investments more effectively and make adjustments whenever necessary.

Remember, you can’t fulfill RMD requirements for certain retirement plans like 403(b) or 401(k) by simply withdrawing from an IRA. But don’t worry! In such cases, rolling those accounts into an IRA is worth considering. That way, you merge all your retirement funds into one account, making it easier to meet the RMD requirements without any hassle.

4. Stick to the 4% rule

The 4% rule is a popular approach used in retirement tax planning. Here’s how it works: In the first year of retirement, you take out 4% of your initial investment account balance. And as the years go by, you adjust that amount for inflation. This way, the idea is to have a steady income that keeps up with the rising cost of living.

One of the great things about the 4% rule is its simplicity. It is a retirement withdrawal strategy that gives retirees a clear guideline for their annual withdrawals, considering inflation so that their income maintains its purchasing power over time. That can bring a sense of security and help people plan their expenses without too much worry.

But, let’s not forget that the 4% rule does have its limitations. It doesn’t consider changes in how your investments perform or the market behaves. 

You see, the rule assumes a certain average rate of return on your investments, but we all know that the stock market can have its ups and downs. And, during periods of poor performance or market downturns, the sustainability of that 4% retirement withdrawal rate may be affected.

Also, knowing that the 4% rule may not be the best fit for everyone is important. We all have different circumstances and preferences, right? Some retirees might need a higher or lower withdrawal rate depending on their specific financial goals, how much risk they’re willing to take, and how long they expect to live. 

We recommend you look at your situation and chat with a financial advisor or retirement specialist. They can help you come up with a withdrawal strategy that’s just right for you.

5. Use the buckets strategy

With the buckets strategy, you divide your retirement income sources into three buckets, each serving a specific purpose. The first bucket is a cash savings account, which you use to cover immediate expenses. This cash bucket ensures you have easy access to money for your day-to-day needs and unexpected expenses that may arise.

The second bucket consists of fixed-income securities, such as bonds. These provide a more stable income stream and are suitable for medium-term needs. Bonds typically offer regular interest payments, and their value is less likely to fluctuate compared to stocks. This bucket helps ensure you have funds available for expenses that you anticipate in the near future.

The third bucket is composed of equity investments, which are intended for long-term growth. These investments have the potential for higher returns but also come with higher volatility. By allocating a portion of your retirement savings to equities, you allow your money to grow over time, potentially outpacing inflation and supporting your long-term financial goals.

You draw from the appropriate bucket based on your expenses to implement the bucket strategy. If you have immediate cash needs, you tap into the cash savings bucket. If your expenses fall within the medium-term horizon, you rely on the fixed-income securities bucket. And if your expenses are more long-term in nature, you can consider selling some equity investments to cover them.

An important aspect of the buckets strategy is the idea of replenishing the buckets as needed. When you withdraw from a bucket, you aim to refill it later on using resources from the other buckets. 

For example, if you deplete your cash savings bucket, you may sell some bonds or stocks to replenish it. This approach allows you to maintain a balanced allocation and ensures you have funds available for different timeframes.

One of the benefits of the buckets strategy as one of the best retirement withdrawal strategies is that it provides more control over which investments you sell to cover your expenses. Instead of being forced to sell investments during a market downturn, you can strategically choose when to sell based on your bucket allocation and market conditions. 

Additionally, by having a portion of your portfolio allocated to equities, you have the potential for long-term growth that can help sustain your retirement income needs.

The worst way to withdraw from retirement accounts

Regarding withdrawing from your retirement accounts, 5 strategies are generally considered less favorable. Let’s take a look at some of the approaches that could be considered the worst ways to withdraw from your retirement accounts.

1. Withdrawing too much, too soon

One of the worst ways to withdraw from your retirement accounts is by taking out large sums of money early on in your retirement. 

While it may be tempting to splurge or cover major expenses, excessive withdrawals can deplete your savings too quickly, leaving you at risk of running out of funds later in retirement.

2. Ignoring required minimum distributions (RMDs)

RMDs are mandatory withdrawals that you must take from certain retirement accounts once you reach a certain age, typically around 72 years old. 

Failing to take these distributions can lead to substantial penalties, including a hefty excise tax of up to 50% on the amount you were supposed to withdraw. It’s crucial to stay informed about RMD requirements and fulfill them accordingly to avoid unnecessary penalties.

3. Relying solely on Social Security

While Social Security benefits play a vital role in retirement income, relying solely on them may not be sufficient to meet all your financial needs. It’s important to consider diversifying your income sources by utilizing other retirement accounts or investment options that can provide additional financial support, such as:

• Individual Retirement Accounts (IRAs): Traditional IRAs and Roth IRAs offer tax advantages and allow you to supplement Social Security benefits.
• Employer-sponsored retirement plans: 401(k)s or 403(b)s provide pre-tax contributions, potential employer matching, and additional retirement income.
• Annuities: Insurance products that provide a regular income stream for life or a specific period, ensuring stable retirement income.
• Rental properties: Real estate investments can generate rental income, diversifying retirement income sources.
• Dividend-paying stocks: Investing in stocks that pay regular dividends can provide both capital appreciation and recurring income.
• Mutual funds and ETFs: Investment options that offer diversification and potential income generation through dividends or interest payments.

4. Neglecting tax planning

Not paying attention to tax planning during retirement can greatly impact your income. 

It’s important to remember that taxes can eat into your retirement savings if you don’t consider the tax implications of your withdrawals. 

But how can you avoid this? We recommend you take the time to understand the tax rules related to your retirement accounts. Seek guidance from a financial advisor or tax professional who can help you develop a tax-efficient withdrawal strategy. 

5. Poor investment management

If you’re not actively managing your investment portfolio during retirement, it can lead to suboptimal outcomes. 

You must rebalance your portfolio or align your investments with your risk tolerance and financial goals to avoid missed opportunities or excessive exposure to market volatility. 

Regularly reviewing and adjusting your investment strategy can help ensure your retirement funds are appropriately allocated and positioned for long-term growth.

Which retirement account should I withdraw from first

• Taxable Brokerage Accounts: These accounts are subject to capital gains and dividend taxes, making them the least tax-efficient. By utilizing these funds initially, you allow your tax-advantaged accounts to continue growing and compounding without the drag of taxation.

• Social Security: Social Security benefits can provide a steady income stream during retirement. However, the optimal time to start taking Social Security benefits can vary depending on your individual circumstances, such as your health, life expectancy, and other sources of income. Consider consulting with a financial advisor to determine the best strategy for maximizing your Social Security benefits.

• Traditional IRA and 401(k): Once you have exhausted your taxable brokerage accounts, move on to withdrawing from your IRA or 401(k) accounts. Both types of accounts are subject to required minimum distributions (RMDs) once you reach 70½ years old. From a tax perspective, it doesn’t matter which account you start with, as the taxation treatment is similar.

• Roth IRA: You should leave your Roth IRA untouched for as long as possible. Roth IRAs offer tax-free growth and withdrawals in retirement, which is highly beneficial. Unlike Traditional IRAs and 401(k)s, Roth IRAs do not have required minimum distributions (RMDs). This means your investments can continue to grow and compound tax-free for as long as you desire unless future laws change.

• Other factors: Additionally, your specific financial goals, current income needs, projected expenses, and possible future tax rates should all be taken into account when deciding which retirement account to withdraw from first. It’s generally advisable to create a comprehensive retirement income plan that considers all these factors and seeks to optimize your withdrawals while minimizing taxes and penalties.

Takeaway

Everyone’s situation is unique; these withdrawal strategies are just general guidelines. If you want to fine-tune your approach, don’t hesitate to reach out to a financial advisor or tax professional. They can help tailor a plan that fits your specific circumstances and goals.

With that said, congratulations again on reaching the retirement phase! Knowing withdrawal strategies makes you better equipped to make wise financial decisions. Enjoy the fruits of your labor and savor the well-deserved rewards of your retirement years. Cheers to a fulfilling and financially secure future!