The lack of retirement readiness among American workers receives a lot of attention in the press and rightly so. Depending upon which study you read this is an issue of varying severity. Accumulating a retirement nest egg is tough in today’s world where defined contribution plans are the primary retirement savings vehicle for many of us.

Once you reach retirement and even if you have saved enough it’s not smooth sailing just yet. As important as saving enough for retirement is, managing the process of drawing down your retirement saving is equally important. For many they may be retired nearly as long as there working careers. How do you make you money last for 30 or more years? This is an area where a financial advisor knowledgeable in this area can really add value to their clients. (For more, see: When Retirement is Around the Corner.)

Retirement Income Sources

A major part of the process is to look at all of the various resources the client has available to them to fund their retirement expenses. These might include many of the following:

There could certainly be other resources but these are among the most common out there. A financial advisor should be able to take sources from this list along with other information and determine what type of income and cash flow the client will likely be able to generate during retirement. Certainly they will need to make some assumptions in conjunction with the client as to how the money will be invested during retirement. (For more, see: Retirement Savings: How Much Is Enough?)

Retirement Income Needs

Hopefully the client has done a retirement budget of some sort and has an idea of what their income needs will be during retirement. Things like living expenses, travel, medical costs and the like should be included. So should lifestyle changes, such as as relocating and/or downsizing their residence.

Social Security and Pensions

Social Security and possibly pension decisions should be made or at least the ramifications of making one choice or another should be considered here. In the case of Social Security when will the client take their benefit? Can they wait until their full retirement age or even age 70? If they are married does one of the claiming strategies available to married couples fit their situation? As for a pension, if the client has one, options such as taking a lump-sum versus a lifetime stream of payments need to be analyzed if both options are available.

How Much to Withdraw?

Once the client and the financial advisor have gone through the steps outlined above it is time to start planning a withdrawal strategy. This assumes that the client’s various financial resources are sufficient to support their lifestyle or, if not, that adjustments in their planned spending have been made. Many retirement planning programs and online calculators will look at withdrawals as somewhat fixed either in nominal or inflation-adjusted terms. In reality this may not be the case and withdrawals may vary.

As an example, earlier in retirement the client may be working and drawing a salary even if it is just part-time. This would reduce the amount needed from their retirement accounts and would allow them to delay filing for Social Security. Once they reach age 70½ the government would dictate, at least in part, a withdrawal strategy namely their required minimum distributions (RMDs) for IRA and 401(k) accounts and other similar retirement plans. (For more, see: Top Tips to Reduce Required Minimum Distributions.)

Which Accounts and in What Order?

Depending upon the client’s situation, they may have several retirement accounts from which to draw funds. Some may be tax-deferred such as a traditional IRA or a 401(k) account and withdrawals are taxed at the client’s highest marginal tax rate. A Roth account, assuming the rules are followed, provides tax-free withdrawals as does an HSA account when used to cover qualified medical expenses.

Appreciated taxable investments are taxed at preferential capital gains rates as long as they are held for at least a year and a day. Conventional wisdom might say to delay paying taxes as long as possible and also to always take funds from the source with the least tax impact. Both make sense to a point, certainly the time value of money principal says that delaying taxes into the future is a good idea. (For more, see: How Much Should Retirees Withdraw from Accounts?)

However, it might make sense to pay some additional taxes now to reduce taxes down the road and into retirement. For example, if the client is in a relatively low tax bracket in retirement but prior to age 70½ it might make sense to convert some of their traditional IRA money to a Roth IRA. This will cause an added immediate tax liability in those years but might serve to reduce the amount of the RMDs from that account later on. If the client doesn’t need the RMD money to support their lifestyle this allows more money to remain invested and the lower resulting distributions will result in a lower tax hit each year.

A Bucket Approach

A bucket approach to retirement entails setting up three buckets or portions of your retirement nest egg. Bucket number one would contain enough cash or very low risk, short-term fixed income investments to fund several years of your anticipated needs in retirement. This allows for peace of mind and eliminates the need to for the client to dip into stock investments to fund their retirement during a declining market. (For more, see: A Comparison: The Bucket Strategy vs. Systematic Withdrawals.)

The next bucket would contain moderately risky investments that would offer a bit more growth or some income. These might include high quality fixed income investments, dividend paying stocks or moderate-risk balanced mutual funds for example. The last bucket would contain growth vehicles such as stock mutual funds and exchange-traded funds (ETFs) and this portion of the portfolio would be designed for the growth that most retirees will need to be able to make their money last throughout their retirement years.

A strategy to replenish the first bucket will be needed and will vary from client to client. Factors such as taxable and tax-deferred accounts will also need to be taken into account.

The Bottom Line

Drawing down your retirement savings is not a task to be taken lightly. There can be significant tax advantages to taking withdrawals from one account over another. The order of withdrawal can also be varied based on the client’s circumstances at various stages of retirement. A financial advisor who is knowledgeable in this area can be a great asset to their clients. (For more, see: Managing Retirement Account Withdrawals.)