Turn Savings Into Retirement Income
Create a Plan Before Tapping Your Investment Accounts
If you save regularly for retirement, putting a portion of your paycheck or annual earnings into a tax-deferred investment account like a 401k or individual retirement account, at the end of your career you should have a substantial portfolio from which to draw income. But the money may live in many different investments, held within various accounts. It's not uncommon to have several tax-favored retirement accounts, along with one more taxable investment accounts as well.
You may already be familiar with the important concept of asset allocation. Paying attention to your asset location is just as important. How and when you take distributions from each account will impact your taxes and income planning. Here's what to think about when tapping your own retirement savings accounts for income.
Plan to Take a Set Percentage Each Year
Retirees who set a disciplined rate of withdrawal can make their savings last longer. Retirement experts generally recommend a distribution rate of about 4 percent per year, adjusted for inflation. You can use a calculator to see what that 4 percent would look like from your accounts. It may be necessary to adjust the withdrawal rate at some point. Opinions vary on annual withdrawal flexibility in the 3 percent to 7 percent range.
Prioritize Certain Accounts
The order in which you start taking money from various accounts will depend mostly on taxes.
Taxable accounts get tapped first. These include brokerage accounts, inherited investment portfolios, and any account for which you pay taxable earnings. Leave the tax-deferred money compounding for as long as possible.
Those tax-deferred IRAs and 401(k)s are the accounts to pull from next. Investors can start taking distributions from these accounts beginning at age 59 1/2.
If you prefer to wait, you have until age 70 1/2 before you are required to begin taking distributions. Miss a required distribution and you could owe a penalty of 50 percent of the amount that should have been distributed. Plus the taxes you'll pay for the withdrawal that you still forced to take. Ouch. It's not worth the risk.
The final account to touch is a tax-free account such as a Roth IRA, Roth 401k, or Health Savings Account (HSA). These accounts are not subject to required distribution rules, regardless of age. (The exception is if you are dead, then a full distribution is required.) Until then, investments in a Roth can accumulate tax-free gains.
Some employer plans and investment companies offer funds that will automate retirement payouts for you. One example is Vanguard's managed payout fund, which is designed to balance principal growth and payout rate to make your savings last. Undistributed assets within these funds can be passed to a surviving spouse or other beneficiaries. Investigate the options offered by your 401(k) administrator or through your bank or brokerage to see if there's a plan that makes payouts easy for you.
Protect Against Income Uncertainty
For retirees or pre-retirees who are concerned about running out of money, some financial advisors recommend the purchase of an immediate annuity or income annuity to cover essential expenses. An annuity is a type of insurance. Basically, the investor trades a lump sum amount for guaranteed income for life. If you live 30 or 40 years in retirement, it's a great deal for you. If you live only a few years, it's a better deal for the insurance company. Some annuities include survivor benefits that cover a spouse after the annuity-holder has died, but you may pay a bit more for this option. Could you do better investing in the market through a low cost fund or ETF? Maybe. But when other guaranteed income streams are not there, an annuity can help provide some peace of mind that the basics are covered.
Of course, this is just the tip of the iceberg in terms of what to think about when planning retirement income. Remember to consider other sources of guaranteed income, such as Social Security, annuity payments or pension income when calculating your account distribution needs.
The content on this site is provided for information and discussion purposes only. It is not intended to be professional financial advice and should not be the sole basis for your investment or tax planning decisions. Under no circumstances does this information represent a recommendation to buy or sell securities.