Retirement Withdrawal Strategies: Maximize Savings and Minimize Stress

Planning a comfortable retirement typically means having more control over your finances. You need to take a look at your investments, savings and cash on hand, but you should consider your living expenses and lifestyle choices.

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What Are Your Financial Needs in Retirement?

Knowing your financial needs helps you prepare for retirement.

Taking a clear look at your living expenses means asking the following questions:

• Do you know your fixed expenses? Calculate your mortgage, rent, utilities, gas, grocery bills and other fixed expenses you spend monthly. Make a list of what these monthly expenses will be during retirement.

• What are your discretionary expenses? Consider what you want to spend on vacations, home upgrades, hobbies or other dream bucket list items. Knowing these wish list items will allow you to match your retirement savings with your interests.

• Are you evaluating your expenses at different stages of retirement? At different stages of your retirement, you may have varying expenses. For instance, you may want to spend more on travel early in your retirement while in the latter years you may prefer to upgrade your home. By doing this, you’ll have an idea of where your finances stand if you need to adjust.

Another important consideration is your healthcare costs in retirement. Medical expenses and long-term care play a role in your budget. Evaluate the following when factoring for healthcare costs in your financial strategy in retirement:

• Do you have Medicare coverage? Medicare coverage will cover some healthcare costs, but rarely does it cover all medical related expenses. You may have to use your retirement withdrawals to pay for the difference in coverage.

• Do you have supplemental insurance? Supplemental insurance can bridge the gap between what Medicare coverage doesn’t provide.

• Are you prepared for long-term medical care? Long-term health insurance can set you up for expenses related to assisted living and nursing homes. Alternatively, having a special account for these expenses could prevent you from withdrawing from your retirement funds.

What are the Types of Retirement Accounts and Their Tax Implications?

There are several types of retirement accounts that carry various tax implications. First take a look at traditional IRAs vs. Roth IRAs.

Traditional vs. Roth IRAs: Key Differences

Other Plans and Employer-Sponsored Accounts

Here are a sample of other plans and employer-sponsored accounts that have tax implications:

• 401(k) and 403(b): The contributions in a 401(k) and 403 (b) programs are usually made with pre-tax dollars. The investment typically grows tax-deferred until withdrawal. When withdrawals are made, they are taxed as ordinary income. Many plans offer Roth IRA option with contributions made after tax and withdrawals are tax-free.

• 457(b): These are plans that are typically for government and some nonprofit employees. The contributions are pre-tax with some Roth options available. The growth is tax-deferred. When withdrawals are made, they are taxed as ordinary income.

• SEP IRA: For those employees who are self-employed or small business owners, you can make pre-tax contributions. The growth is tax deferred, and when funds are withdrawn, it’s taxed as ordinary income. Also, there is a 10% penalty if withdrawals occur before 59½, though, there are some exceptions that do apply.

• HSA: Pre-tax contributions are made to the HSA account and the growth is tax free if made for medical expenses.

Understanding the 4% Rule: A Popular Guideline for Withdrawals

In the 1990s, William Bergen designed an approach to withdrawals using a balanced portfolio by considering both stocks and bonds. Under the 4% rule, retirees should withdraw 4% of their savings each year during a 30-year time frame. Presumably subsequent withdrawals at the 4% rate account for inflation.

There are pros and cons to the 4% rule:

Pros

• Simple to apply: The 4% rule is simple to apply. It’s straightforward to understand without complicated formulas and equations.

• Accounts for inflation: It keeps up with inflation, allowing you more room for your purchases.

• Balanced approach: This approach is conservative enough to handle downturns and capture growth in bull markets.

Cons

• Not personalized: The 4% rule may not consider a more personalized look into your portfolio. You may have unexpected expenses, healthcare needs and other spending needs.

• Assumes a 30-year timeframe: For those retirees who have longer lifespans, the 30-year time span is not enough.

• May leave money unspent: There is a possibility retirees may leave money unspent. If you’re a retiree with ample resources, the 4% rule may not be the best approach.

• Market assumptions may not hold: The 4% rule is based on historical data and may not hold true for future market conditions.

What Are Dynamic Withdrawal Strategies?

A dynamic withdrawal strategy takes into consideration withdrawals based on market conditions and your spending needs. Unlike other withdrawal approaches, the dynamic strategy focuses on the individual’s personal financial landscape to decide when to withdraw funds. Here are few approaches that are labeled as dynamic strategies:

Guyton-Klinger Guardrails

You set upper and lower limits based on portfolio performance. If the portfolio increases the withdrawal amounts increase if it falls in the upper guardrail limit. If the portfolio decreases, the withdrawal limit is reduced so it stays above the lower guardrail.

Constant Percentage Withdrawal

In this method you withdraw a fixed percentage of the portfolio each year. If the portfolio is doing well, the amount you receive will be higher. Conversely, if the portfolio is in a downturn, you will not receive as much money.

Floor and Ceiling Method

You can set a minimum withdrawal amount for essential expenses and a maximum withdrawal amount for discretionary spending. Withdrawals will fluctuate.

What Is a Bucket Strategy?

The bucket strategy is an approach to withdrawing retirement funds based on risk tolerance and age. Your retirement savings are divided into buckets. Each bucket is designed to meet your needs over a specific period.

1. Bucket one holds cash and cash equivalent funds. It may contain money market funds, savings accounts and short-term bonds. These funds are designed to handle day-to-day expenses and unexpected emergencies in the first three years.

2. Bucket two is meant to target medium-term needs. It holds bonds and conservative investments. It’s meant for moderate and stable growth. The funds in this bucket are meant to replenish bucket one when it is depleted.

3. Bucket three is for stocks with the understanding that these funds will grow over 10 years or more. Assets will grow because they aren’t to be tapped for withdrawal until after a decade.

The Impact of Inflation on Your Withdrawal Strategy

• Increase withdrawal needs. Your purchasing power lags during high inflation. What you could buy with $10 can vary significantly when inflation is higher. If you are on a fixed income, you may need to withdraw more during inflationary time periods.

• Adjust withdrawals based on inflation. Using the 4% rule can help hedge against inflation consistently. Although some may want to use dynamic withdrawals to personalize their approach based on spending and individual portfolios.

• Rethink how you spend. During years of high inflation, you may want to reduce discretionary spending. You should delay larger purchase during high inflation periods.

Social Security: When and How to Maximize Your Benefits

To maximize your benefits, knowing how to approach your social security benefits is important.

Consider the following when deciding when to take advantage of your social security benefits:

• Wait until full retirement age. You will receive the maximum amount of benefits if you take them at the FRA. If you take them before the FRA, you will receive 30% less.

• Delay benefits for more of a payout. If you delay your benefits until age 70 or beyond, you are eligible to receive 8% more on your payout.

• Coordinate benefits with your spouse. The lower earning spouse should take benefits first, while the higher earning spouse should take a delay. This approach maximizes the survivor’s benefit, as the surviving spouse earns the higher benefit.

• Evaluate your health and lifespan. If you expect a shorter lifespan, taking benefits early can potentially help you. If you are healthy, you can wait to take social security later to maximize the payout.

Tax-Efficient Withdrawal Strategies

You do not want to lose the purchase power of your money over time. Implementing tax-efficient withdrawal strategies will help you maximize your retirement savings. Here are three strategies you can use:

1. Withdraw from taxable accounts first. It is a good idea to allow funds in a 401(k) or IRA to continue to grow. If you need to withdraw funds, do so from your brokerage or your investment accounts.

2. Manage required minimum distributions withdrawals. RMDs are taxable and so make certain that you time your withdrawals. Gradual withdrawals will help to keep you out of higher tax brackets.

3. Consider a qualified charity distribution.  You can donate directly from your IRA to a qualified charity. This is considered a qualified charity distribution and isn’t taxable.

What Common Mistakes Should You Avoid in Retirement Withdrawals?

Withdrawing too early or late could have consequences on your finances in retirement. Try to avoid the following when approaching your retirement withdrawals:

Avoid Overspending Too Early

Many retirees become overzealous when entering retirement and may take too many withdrawals out of their accounts. They are eager to spend money on vacations, a dream house or home upgrades. Spending too early can chip away at the nest egg and leave you straddled for funds when you need them the most.

Failing to Account for Healthcare Costs

Underestimating healthcare costs is detrimental for retirees. Relying heavily on retirement funds for long term care may mean you have quite a bit less for other expenses. Consider a separate long-term care insurance policy or a HSA for medical expenses.

Mismanaging RMDs

You are required to take required minimum distributions from your IRA and 401(k) accounts. Not taking the distribution at the right time means paying a penalty. Know exactly when you should take your required minimum distribution.

Putting Too Much Emphasis on the 4% Rule

The 4% rule is meant to be a guideline for retirees and not a complete approach for withdrawals. You must consider for market fluctuations and unexpected expenses. Sometimes relying too heavily on the 4% rule means withdrawing too heavily in a downturn and too little in a prosperous market.

Not Paying Attention To Tax Implications

Sometimes withdrawing too much can put you in a higher tax bracket. This will cause a higher tax burden and reduce net income.

Withdrawing Too Little

The fear of running out of money may push some retirees not to withdraw enough money during retirement. This approach could prevent retirees from enjoying the full benefits of retirement.

Crafting Your Personalized Withdrawal Strategy

Designing a retirement withdrawal strategy that fits your lifestyle and financial needs. By combining foundational guidelines like the 4% rule with dynamic, flexible approaches, you can adapt to changing markets, inflation and personal spending.

This article originally appeared on GOBankingRates.com: Retirement Withdrawal Strategies: Maximize Savings and Minimize Stress