Many retirees are understandably concerned about living beyond their means. But once you’ve managed to build a nest egg, smart withdrawal strategies can help make your savings last longer.
Here’s how planning ahead with retirement calculations and using tax-informed withdrawals can save your portfolio.
Simple calculations behind safe withdrawals
Everyone’s retirement savings plan should be unique to their specific financial situation, but the 4% rule can be used to get an idea of how much you need to retire. Retirees using this model withdraw 4% from their portfolio during their first year of retirement to cover expenses, then adjust that amount for inflation in subsequent years.
You can determine how much you spend each year to calculate how much you need in your nest egg. For example, if you spend $50,000 a year, you’ll need about a $1.25 million portfolio for retirement ($4% of $1.25 million is $50,000). Although remember the way you spend money may change when you retire.
A rising stock market can boost your portfolio and give you more spending flexibility. But you also want to make sure you have enough money saved up so you don’t need to sell during a market downturn.
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Withdrawal strategies for all accounts
It is important to consider the tax implications when choosing which accounts to withdraw from, as there are significant differences:
- Merchant accounts are taxed: Accounts funded with after-tax dollars; capital gains and dividends are taxed with any taxes paid each year
- A traditional retirement account: Accounts funded with pre-tax dollars; the money grows tax-deferred and qualified withdrawals are taxed as ordinary income
- Roth retirement accounts: Accounts funded with after-tax dollars; there are no taxes on qualified withdrawals or capital gains
Gradually withdrawing money from your traditional retirement accounts can help spread the tax you have to pay over time. You can also check your tax brackets and limit regular retirement account withdrawals if you’re about to fall into a higher tax bracket.
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Inflation and the reality of the RMD
Inflation reduces the purchasing power of idle money, which is why it’s important to grow your portfolio every year. However, you may need to shell out more money as the cost of products and services increases with inflation. Increased Social Security checks and dividend-paying companies increasing their dividend payments can offset inflation to some extent.
You should also monitor required minimum distributions (RMDs), which begin when you turn 73. If you have too much money in a traditional retirement account, you may have to withdraw more than you would like and end up in a higher tax bracket. That’s why it can be a good idea to spread the withdrawals over several years to reduce your tax impact.
Roth retirement accounts and taxable brokerage accounts do not have RMDs.
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How to enter your future income plan
Online modeling tools and financial planners can help you create a long-term plan to make your money last. In general, using a 4% withdrawal schedule and focusing on steady growth instead of taking big risks can help preserve your nest egg – as well as your lifestyle and legacy.
