What bucket of money do I tap into first when I retire?
I am 63 years old. I have a 401(k), another savings account, Social Security ( which I haven't yet collected), and a pension which I haven't tapped into. Is there a general rule or recommendation of which account to draw from first? Which account should I distribute from first?
That sounds like a simple question, but the answer is complicated. It depends a lot on how much your total income varies from year to year. As a general rule, you will pay the lowest overall taxes if your income is exactly the same each year; they used to have a form called Schedule G where you could smooth out your income, but that was abolished in 1986. Therefore, you should attempt to do that yourself; when your income is lower than usual as you get into November and December, increase it by filling out your marginal tax bracket. For example, if you can withstand another 20 thousand in income in 2017 before you jump from the 15% to the 25% federal tax bracket, take 17 or 18 thousand out of your 401(k) or any other non-Roth retirement account during 2017. On the other hand, if your income is higher in a particular year and you are already in the 25% tax bracket, don't withdraw any money from a retirement account (you won't have to until you're 70-1/2).
By smoothing out your income and using up the lower tax brackets, you will save money on taxes in the long run, even if you pay more in any given year.
I absolutely agree with previous answer. The general rule is to withdraw in the following order:
1. Taxable accounts (brokerage account, mutual fund accounts, etc.)
2. Tax-deferred accounts (IRAs, 401(k)s, 403(b)s, etc.)
3. Tax-free accounts (Roth IRAs)
I think the general consensus of folks at your age is to not tap into retirement accounts for as long as possible and start taking Social Security whenever income is needed (even it that means starting at 62). We would typically disagree with that train of thought (unless the individual is in poor health). If I was able to collect all of the details surrounding your situation, chances are that I would find the crossover point between drawing at 62 and FRA is somewhere around the age of 79 year old. This means that if you think you'll live past 79, you'd be better off waiting until FRA to start drawing Social Security.
If you thought you would live past age 84-85, then the option that would provide the most income for you during your lifetime would be delaying benefits until age 70. Of course, nobody knows how long they'll live, but statistics would say it's likely a safe bet that waiting until FRA is the best place to start. If you're in great health and do not have any additional income needs at that time, you can delay further.
Pensions can be similar to Social Security, but they can also be different. Some pensions will accrue benefits up to a certain age. Some may be frozen and may not be increasing in value. We'd also have to take a look at your survivorship options with the pension. Social Security has a built in survivorship component, but if the pension survivorship options are better, it may be a better idea to take Social Security sooner and let your pension defer.
What you're lacking right now is an income plan. The only way to truly find the best solution is to put all of the variables on the table, discuss your income objectives, and formulate a plan. A CERTIFIED FINANCIAL PLANNER™ professional can help you with this.
Joe Allaria, CFP®
The quick answer is it depends on how long you plan to work, current and future income needs, value of assets, and state and other tax considerations. In general, it is usually best to take from taxable accounts first, then tax-deferred, then tax-free. However, the ideal distribution strategy is also dependent on where tax rates are and how various markets are performing.
To go deeper, currently all of your future income will be taxable. That is, the amount coming from the pension, the 401(k), and some portion of Social Security will be taxed at regular income tax rates. It would likely be prudent to have some funds in a tax-free environment (like a Roth IRA) so you have options as you get into your later years. This insulates you from drastic tax changes - if taxes are high in 10 years, you can take from the Roth. If taxes have fallen, you can withdraw from tax-deferred planes, like the 401(k). You could fund a Roth (or a "back-door Roth") by up to $6,500 per year because you're over 50.
General rule of thumb: there should be 3-4 segments.
- Segment 1: Keep 2-3 years of the income needs in a safe place. This provides short-term income.
- Segment 2: Keep years 3-10 (e.g. your age 67-76) of projected income needs in a moderate allocation. This is mid-range income, which will carry some volatility, but should be no more than 50-60% equities.
- Segment 3: Keep years 11-25 (e.g. your age 77-102) of projected income needs in a more aggressive allocation.
- Segment 4: The 4th segment is one that most retirees don't have. It would be a safety net. This would be funds you could come to if some sort of extreme economic event occurs. It doesn't have to be much, maybe 5-10% of your overall portfolio - but it's purpose it's provide a potential hedge against a significant market declines. Examples could be annuities, gold/silver or other commodities, or other alternative assets.
Hope this helps!
B. Chase Chandler, CFP®
The general rule of thumb is to access any accounts which are already taxed savings, such as a bank savings account or mutual funds held in your name first; then your tax deferred accounts such as 401(k) or Traditional IRAs, and delay taking Social Security until you are 70 unless you know of a major health issue. The reason for delaying Social Security is that its value to you increases by approximately 8% for each year you delay and that is a much better Government guaranteed rate of return than you can find elsewhere.
As regards your pension, every pension is different so it depends on whether there is any benefit to you in delaying it and whether you need pension payments now to meet your spending needs.
Of course, the above is just the general rule of thumb and the answer might be slightly different depending on your health, tax rates, spending needs, and overall wealth level. For example, if your 401(k) is large and if your Required Minimum Distributions (RMDs), which start when you are 70 1/2, will push you up in a higher tax bracket (of course we have no idea what will be the tax brackets seven years from now), then there is a strategy to take some from your 401(k) now and pay tax as long as you are and remain in a lower tax bracket than when RMDs start in seven years.
There is not enough information and too many things to consider. Like, when are you fully retiring? When do you plan on taking Social Security? When will you begin drawing from your pension? And how much will all these amounts and timings be? And how much money do you need annually? So, the answer is not simple. However, taxes and your tax bracket are an important (and sometimes overlooked) element to consider. Once you know how much you need annually and your projected tax brackets, you can begin to develop a retirement withdrawal strategy that looks to minimize taxes and provide the income needed.
For example, (1) in the years BEFORE you start collecting your pension and Social Security, you may be in a lower tax bracket and it makes sense to consider withdrawing from your 401(k) tax-deferred account and filling up your tax bracket at the lower rate now. This would reduce your 401(k) balance for later when you take RMD’s and you may find yourself in a higher tax bracket due to pension and Social Security income. (2) Perhaps it makes sense to use your after-tax savings in years that your taxes are higher (due to pension and Social Security withdrawals) rather than withdrawing from a 401(k) if funds are needed and you are younger than 70 ½.
Work with a trusted tax professional or a holistic Financial Planner (A CERTIFIED FINANCIAL PLANNER™) with tax experience. They should be able to help your annual income needs (expenses), project income from all these sources (and any other applicable sources), your deductions, credits, and estimate your tax bracket over the next several years so that you can develop the starting point for a retirement withdrawal plan. Keep in mind, this plan really needs to be reviewed annually and updated if needed – this isn’t a one-time exercise.