If you're in or near retirement and you've saved enough money to live on, congratulations -- the hard part is over. Now the question is: Where should you draw money from first?
Here's a quick guide on when you should start tapping different accounts.
Regular, taxable brokerage accounts
If you have any of your retirement savings invested in an ordinary, taxable brokerage account, you should use this money first in retirement. By doing this, you allow the money you have saved in your tax-advantaged accounts to continue to grow on a tax-deferred or tax-free basis as you spend the money that is subject to capital gains and dividend taxes.
Thanks to their tax benefits, IRAs, 401(k)s, and similar account types allow your money to compound at a faster rate, especially if you have a lot of dividend stocks. Consider that a 4% annual dividend yield is effectively reduced to 3.4% if you're subject to a 15% dividend tax rate (taxpayers in most tax brackets are).
Your 401(k) and traditional IRA
Now, these two account types are a toss-up, and your choice of which to tap first depends on your personal preference. I would argue for spending the money in your 401(k) before tapping into a traditional IRA, because you have more control over your investments in the IRA. The money in your 401(k) is invested in an assortment of funds, which have (hopefully) grown nicely over the years. Although you can adjust your allocations -- for instance, moving more money into fixed-income funds -- your options are rather limited.
On the other hand, in a traditional IRA, you are free to invest in any stock, bond, or mutual fund you want. In other words, there is much more flexibility to design a portfolio that fits your retirement objectives (growth expectations, risk tolerance, income requirements, etc.).
Both of these accounts have required minimum distributions that kick in after you turn 70-1/2 years of age. The exact amount you'll be required to withdraw can be calculated using tables from the IRS, but just bear in mind that at this point in your life you'll have to start taking a certain amount of money out of both of these accounts.
I always advocate leaving your Roth IRA alone for as long as possible, as there are some great benefits associated with Roth accounts.
The biggest reason to draw down Roth IRAs last is that they have no minimum required distributions. You can wait until you're 90 or older to start withdrawing money from a Roth IRA if you so choose, so your money can compound tax-free indefinitely. As far as the IRS is concerned, you already paid the taxes on the money in the account when you contributed, so it won't really dictate what you can and can't do once you're retired.
A word about Social Security
It probably won't surprise you to learn that the majority of Americans begin collecting Social Security at age 62 -- the earliest age at which they can start. However, if you don't need the money right away, it may be a good idea to wait a few years, because your eventual benefit will increase for each year you delay Social Security until age 70.
Let's say you're retiring this year and are 62, and you have been told that if you start collecting your benefits now, you'll receive $750 per month.If you waited until your "full retirement age" (66 for those born between 1943-1954), this amount would jump to $1,000. And by waiting even longer until age 70, you'd receive monthly checks of $1,360.
Keep in mind that the Social Security system is designed to give you roughly the same total amount of money regardless of when you start collecting. If you start collecting earlier, you'll get more checks, but they'll be smaller. If you delay benefits, you'll get fewer checks, but they'll be larger. The formula is based on average life expectancy, so if you are a particularly healthy individual who expects to live an extra-long time, you may be better off waiting if you can afford to. However, if you don't expect to reach average life expectancy, or if you need that income to get by, you can start collecting immediately without worrying too much about missing those delayed-retirement credits.
The bottom line
Like most financial topics, this is not a one-size-fits-all guide. Your individual circumstances may warrant a different withdrawal strategy. For example, if you have more than enough money saved and want to do some speculative investing in your taxable accounts, go for it.
The point here is that these are general guidelines for where your retirement income should come from. With a little planning, you can maximize your retirement savings and leave more to the ones you love.
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