Are you wondering where to withdraw money first in your retirement income strategy? It’s a critical decision that can significantly impact your financial future. In this comprehensive guide, we’ll break down a proven framework to help you make informed choices, illustrated by a real-life case study.
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Understanding Retirement Account Buckets
Before delving into the strategic withdrawal framework, it’s crucial to grasp the three primary retirement account buckets:
- Taxable Bucket: This includes brokerage accounts, individual, joint, or trust investment accounts. You’ll pay taxes annually on dividends and potential investment gains.
- Tax-Deferred Bucket: Accounts like IRAs or 401(k)s fall into this category. While investments grow or pay dividends, no taxes are incurred. However, withdrawals in retirement are often taxed at ordinary income rates.
- Tax-Free Bucket: Accounts like Roth IRAs or Roth 401(k)s offer tax-free withdrawals for both federal and state purposes. They also provide flexibility by not mandating distributions in your seventies.
The Framework: 5 Steps to a Smart Retirement Income Strategy
Step 1: Categorize Your Accounts
Organize your accounts into the three buckets mentioned earlier. Assign a percentage value to each bucket based on your entire portfolio.
Step 2: Determine Your Monthly Income Needs
Calculate the amount you require each month for a comfortable retirement lifestyle, factoring in any existing income sources like Social Security or rental income.
Step 3: Create a Withdrawal Bar
Visualize your income needs as a bar and fill it with existing income sources first, such as Social Security or rental income. Then, strategically add withdrawals from specific buckets.
Step 4: Apply Taxes to Each Income Source
Estimate the tax impact on each income source. If, for instance, you plan to withdraw from your tax-deferred bucket, calculate the additional amount needed to cover taxes.
Step 5: Revision and Optimization
Review your initial plan, considering tax efficiency. Ensure you’re utilizing tax-efficient strategies, such as Roth conversions, to minimize taxes and maximize after-tax income.
Real-Life Case Study: Mike and Judy
Meet Mike and Judy (Names changed), a couple seeking to optimize their retirement income strategy. With a $2.5 million portfolio distributed across taxable, tax-deferred, and tax-free buckets, they faced the challenge of deciding where to withdraw funds first.
Following the conventional wisdom of tapping into taxable accounts first, their initial tax projection showed a low tax bill in the early years. However, as they relied heavily on tax-deferred accounts in later years, their tax burden skyrocketed, particularly with mandatory distributions in their seventies.
Optimized Plan: A $420,000 Tax Savings
In the revised plan, we strategically utilized Roth conversions to fill their 12% ordinary income bracket, taking advantage of lower tax rates. This optimized approach resulted in a projected tax savings of approximately $420,000.
Conclusion: Empowering Your Retirement Journey
Making informed decisions about retirement withdrawals can substantially impact your financial well-being. By understanding the strategic framework and learning from real-life examples like Mike and Judy, you can navigate your retirement with confidence, ensuring maximum after-tax income over your lifetime.
Remember, seeking professional advice tailored to your unique situation is crucial for implementing these strategies effectively. Plan wisely, and enjoy a financially secure retirement!
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This does not constitute an investment recommendation. Investing involves risk. Past performance is no guarantee of future results. Consult your financial advisor for what is appropriate for you. Disclosures: https://onedegreeadvisors.com/solutions/#disclosures
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