SAVING MONEY TO YOUR retirement fund is only part of ensuring a financially secure future. The other half involves making smart decisions about when and how to withdraw cash.
Finance experts say there are a handful of retirement distribution strategies that can be used to stretch money further for a long retirement, and these can be combined and changed over time. “It’s really specific to the client and their own situation,” says Monica Sinha Eckberg, a Northwestern Mutual wealth management advisor in Edina, Minnesota. Current market conditions, tax rates, and a person’s expected longevity are all factors that need to be considered.
Rather than pick a single strategy to use throughout retirement, talk to a financial planner to see how to make the following distribution methods work together for you.
- Create a floor.
- Bucket your money.
- Minimize mandatory distributions.
- Make systematic withdrawals.
- Use account sequencing.
Retirement Distribution Strategies
CREATE A FLOOR FOR RETIREMENT DISTRIBUTION STRATEGIES
Some retirement accounts provide guaranteed income. These include Social Security, pensions, and annuities. Sinha Eckberg calls them “mailbox money” because retirees can count on them to deliver cash on a regular schedule.
A flooring strategy involves building up enough of this guaranteed income to meet basic needs. One way to do that is to purchase an annuity with an income rider that is inflation-adjusted, says Steve Sexton, a financial professional and CEO of Sexton Advisory Group in Temecula, California. Another option is delaying the start of Social Security benefits. For each year you delay the start of benefits past your full retirement age until you reach age 70, you’ll get an 8% boost in your monthly Social Security payments.
A strong financial floor provides peace of mind that no matter how the markets perform, a person will be able to pay necessary expenses.
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For funds that don’t provide guaranteed income, such as 401(k)s and IRAs, a bucket strategy ensures some money is protected for short-term use while other money is allowed to grow for long-term use. While the details can vary depending on a person’s needs and life expectancy, a typical strategy might use three buckets.
The first bucket places money needed within the next three years in cash or bond funds. There, the money won’t see significant gains, but the stability of these funds should insulate it against losses. Money that will be needed in three to 10 years may be put into a mix of stocks and bond funds where it may see more moderate growth. Funds not needed for 10 years or more may be invested more aggressively in growth funds.
Using a bucket strategy helps ensure retirees won’t have to pull money from stocks in a down market. With a recession on the horizon, it may make sense to put even more money in cash and bond funds. “You really should plan to have five years of living expenses in this bucket,” says Dawn-Marie Joseph, president of Estate Planning & Preservation in Williamston, Michigan.
MINIMIZE MANDATORY DISTRIBUTIONS FOR RETIREMENT DISTRIBUTION STRATEGIES
Having control over when and how you use your retirement money is a key component of stretching funds across a long retirement. However, traditional 401(k) accounts and IRAs have required minimum distributions that must be taken starting at age 72. Known as RMDs, these distributions have the potential to significantly increase a retiree’s taxable income.
It is possible to reduce or eliminate RMDs by converting money from traditional retirement funds to Roth accounts. Money in Roth accounts grows tax-free and can be withdrawn tax-free. However, tax is due on any amount converted from a traditional fund to a Roth account. New retirees who delay the start of Social Security may find they have several years of low income early in retirement which may be a good time to complete a conversion.
If you aren’t able to convert all the money by age 72, be smart about how you use cash from an RMD. “If it’s money you don’t need, think about putting it into your income-producing bucket,” Joseph says.
Some seniors treat their retirement accounts like piggy banks, withdrawing money whenever it is needed. However, a smarter approach is to make systematic withdrawals of the same amount every month, quarter or year. Of these, monthly distributions typically make the most sense, according to Michael Lackwood, investment advisor and founding principal of Spring Delta Asset Management in New York City. “Not taking out a huge amount at the start of the year will let the balance grow,” he says.
Financial advisor William Bengen is credited with originating the 4% rule, which many people use to guide their systematic withdrawals. The rule determined that withdrawing 4% from a retirement fund in the first year, followed by inflation-adjusted withdrawals every year after, should ensure money is available to sustain a 30-year retirement.
It’s been 25 years since Bengen created his rule and current advisors say people shouldn’t be too wedded to the idea of withdrawing 4%. While the concept is sound, in theory, the right percentage for a retiree should be customized for a person’s age and life expectancy. “The 4% rule should be really more like a 2% rule,” Sexton says.
USE ACCOUNT SEQUENCING FOR RETIREMENT DISTRIBUTION STRATEGIES
When it comes time to make those systematic withdrawals, people should be strategic about where they pull money. Known as account sequencing, the optimal order for withdrawing funds is the one that will minimize taxes and allow money in long-term buckets to continue to grow.
“We encourage people to have money in all different sorts of funnels and vehicles,” Sinha Eckberg says. That means retirees will have numerous options when it comes to when and how to pull money from accounts.
The best approach for many retirees may be to withdraw cash from a combination of savings and investment accounts, Lackwood from Spring Delta says. Many advisory firms use software to help them determine the best method and order to dip into funds.
Retirement distribution strategies can be daunting for many retirees to navigate. However, with professional guidance, these five methods can help ensure retirement accounts don’t run dry.