The good news is that, statistically, you’re going to live for a long time. The bad news is that, statistically, you’re going to live for a long time. The average 65-year-old American can expect to live for over 19.2 additional years. (Source: National Vital Statistics Reports, Volume 61, Number 6, October 2012.) The bottom line is that it’s not unreasonable to plan for a retirement period that lasts for 30 years or more, reinforcing the importance of proper distribution planning.
Retirement Income: The “Three-Legged Stool”
Traditionally, retirement income had been described as a “three-legged-stool” comprised of Social Security, an employer pension, and individual savings & investments. With fewer and fewer individuals covered by traditional pensions and the future of Social Security uncertain, never before has as much of the onus been on we individuals to secure our own financial future. It has become increasingly important to have a well-thought-out and deliberate approach to your retirement income. This can be one way of increasing the probability of success in achieving your retirement goals. Since most individuals are not going to be able to rely on Social Security and traditional pensions to provide for all their needs, that leaves the last leg of the stool, or personal savings, to carry most of the burden when it comes to your retirement income plan.
The Psychology of Portfolio Withdrawals
Until now, when it came to personal savings, your focus was probably on accumulation – building as large a nest egg as possible. As you transition into retirement, however, that focus must change. Rather than accumulation, you’re going to need to look at your personal savings in terms of distribution and income potential. After all, your savings is going to be providing your “paycheck” from this point forward. Do not underestimate the psychological and emotional shift that is required in making such an adjustment.
The bottom line: You want to maximize the ability of your personal savings and investments to provide annual income during your retirement years, closing the gap between your projected annual income need and the funds you’ll be receiving from Social Security and any pension payout.
Tapping tax-advantaged accounts – first or last?
The order in which you tap various accounts can be very important. Tax considerations can affect which accounts you should use first, and which accounts you should defer using until later. You may have assets in accounts that are tax deferred (e.g., traditional IRAs) and tax-free (e.g., Roth IRAs), as well as taxable accounts. Given a choice, which type of account should you withdraw from first?
Excluding any estate planning considerations to the contrary, consider withdrawing money from taxable accounts first, then tax-deferred accounts, and lastly, any tax-free accounts. The idea is that, by using your tax-favored accounts last, and avoiding taxes as long as possible, you’ll keep more of your retirement dollars working for you on a tax-deferred basis.
All things considered, there is no “One Right Answer”. Your financial situation is unique, which means you need to adopt the strategy that is best for you. The important thing is that the strategy you adopt is one that you’re comfortable with and understand. That will make it easier to stay disciplined during the periods of uncertainty which will inevitably come.