If you're disciplined, it's likely that by the time you ready for retirement, you'll have accumulated funds in several different savings accounts to support you throughout the remainder of your life. Some of these monies may include 401(k) accounts from different employers, possibly some other tax-advantaged accounts such as IRAs or HSAs, and lastly, perhaps some investing accounts.
When determining how best to withdraw and utilize retirement funds, it’s important to be strategic about the order in which you decide to do so, to ensure that your money goes as far as possible in your retirement. In fact, if you go about withdrawing from your various retirement accounts haphazardly, it could end up costing hundreds of thousands of dollars in retirement income.
The following are some of the more common withdrawal mistakes people make when planning their retirement. Try to avoid them so your golden years are stress-free.
Withdrawing from a 401(k) or IRA Before Your Investment Income
Making the mistake of withdrawing from your 401(k) or IRA first could mean losing potentially years worth of income in retirement savings. Withdrawing from your investments first allows more time for your retirement accounts to grow with compound interest. Mutual funds, brokerage accounts, ETFs, stocks, or bonds are all taxable, so you’ll have to pay capital gains taxes on any withdrawals. Some investments, such as some mutual funds, also require you to pay taxes on distributions each year.
70 is the Magic Number
If you want to fully maximize your Social Security benefits, you need to do two things: (1) work until your “full retirement” age, which is age 62, and (2) wait until age 70 to begin collecting on those benefits. The reason for this is because the maximum Social Security retirement benefit kicks in at age 70. You could collect earlier, but you will not be getting your full entitlement.
Every year after full retirement, your payout increases by a certain percentage based on specific criteria. To maximize these benefits, try to hold off until you are 70 if at all possible; your payments will be the highest possible, as they increase by 8% every year you wait.
Wait for Required Minimum Distributions to Kick In
Even though you’re allowed to begin withdrawing money without penalty from your 401(k) at 59 1/2, it isn’t something that you should do if you can avoid it. Again, in this scenario, age 70 is the key; if you’re able, wait until then, as that’s the age at which you’re legally required to begin taking Required Minimum Distribution (RMD’s). The amount you must withdraw will depend on your age and the value of the account at the time. That’s an additional 10 ½ years in which your money can continue to grow with compounding interest!
Exhaust all Other Options Before Dipping into Your Roth
You should avoid withdrawing money from your Roth IRA for as long as you’re able to. A Roth IRA holds after-tax funds (taxes are paid up front), so the IRS doesn’t need to tax it again, and you also aren’t required to take Required Minimum Distributions. A Roth IRA will continue to grow tax-free for as long as you don’t touch it and instead tap into your other accounts.
The Optimum Way to Plan Your Withdrawals
Determining the optimal sequence to withdraw money from your retirement accounts is different for everyone, so it’s highly recommended that you speak with a professional financial advisor to determine what will work best for your specific circumstance. That being said, when withdrawing money from your retirement accounts, your primary goal should always be to keep your taxable income as low as possible while allowing your tax-advantaged accounts to continue growing. One way to accomplish this is by using a proportional withdrawal strategy, which involves withdrawing a proportional amount from each one of your accounts based on the proportion of your retirement savings in each account type. This strategy can help stretch your retirement savings by spreading out the tax advantages that your retirement accounts offer so there are not some years where you owe little or nothing and others where you owe a lot. By utilizing this approach, your tax payments every year should be a roughly similar amount, which makes taxes easier to budget for.
Get Help Dealing With Financial Struggles
Even if your retirement accounts are all in order, many people approaching retirement age still find themselves dealing with significant debt. If you find yourself in this position and are unable to find relief from debt through your own efforts, Financial Rescue LLC may be able to help with debt and tax relief solutions. Contact us today to learn more.