working.
Planning for your retirement often involves determining how you are going to
save enough money to afford the lifestyle you want to maintain. But some
forethought about when you’ll withdraw money from your retirement accounts—and
which accounts you’ll tap first—can help you maximize your hard-earned savings.
Many Americans have more than one source of money in retirement—income from
Social Security retirement benefits, distributions from work-related accounts
such as a pension or 401(k) , and money saved in an individual retirement
account. You may also have put a little extra aside in a high-interest savings
or taxable investment account.
After working for decades to save money in all these different pots, it can
be a challenge to determine the order in which you should take withdrawals.
One hint: Follow the taxes.
Withdrawals from each source of money are taxed differently. Distributions
from your tax-deferred accounts—such as your traditional IRA or 401(k)—are taxed
as regular income, up to a maximum of 35% in 2008. (Money withdrawn from a Roth
IRA in retirement isn’t subject to income taxes as long as you have held the
account for at least five years.)
Meanwhile, income from your taxable investments—dividends and long-term
capital gains—is taxed at 15%, which for most taxpayers is less than the tax
you’ll pay on regular income.
In general, the longer you wait to call on your retirement money, the more
money you’ll have in the end.
But there are limits: traditional IRAs and workplace plans mandate that you
begin taking required minimum distributions by age 70½. Your taxable investment
portfolio, with its 15% long-term capital gains, has no such distribution
requirements. These funds can keep growing until you call on them—or pass them
along to your heirs. The same is true for a Roth IRA.
In retirement, you could dip into your taxable accounts first in order to
allow your tax-deferred savings to grow as much as possible. This is a good idea
if you believe that your income tax bracket will be lower later in retirement,
or if you feel taxes may rise after the presidential election this fall.
Alternatively, you may think your tax rate will stay steady—or even
increase—throughout your retirement. In that case, you could let the money
subject to the lowest tax rate (your Roth IRA and your taxable investments) keep
growing while you take distributions from your tax-deferred accounts.
You also have choices with regard to your Social Security retirement
benefits. The benefits you receive from Social Security count as regular income,
but only 85%, at most, of your benefits is taxable. For every year you delay
taking benefits after your full retirement age (66 years old for those born
between 1943 and 1954), your monthly Social Security checks increase by 8%. The
8% increases stop at age 70.
But when you should take Social Security depends mostly on your health and
expected longevity. The Social Security Administration can help you make this
calculation by determining your break-even age. If you expect to live beyond the
break-even age, it would likely be to your financial advantage to delay taking
Social Security distributions.
Ultimately, the appropriate order of withdrawals depends on your specific
financial situation. Your best bet is to sit down with a certified financial
planner who can analyze your situation and determine what makes the most sense
for you.
Freeport, Maine.
