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Life Events, Strategies to Save

Here’s How to Withdraw Your Savings When You Finally Retire

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

There isn’t a shortage of material on how to build up your retirement nest egg. But once you get it, and you’re ready to retire, how do you actually spend it? Withdrawing from your retirement account (also referred to as “taking a distribution”) isn’t as simple as withdrawing from an ATM. In fact, there is an entire strategy as to which account you should take from first, when you should file for Social Security, and how much to withdraw each year.

The main objective of retirement is to have your money outlive you; and making your money last throughout retirement is harder now than it used to be. This can be attributed to three big factors: people are living longer, the number of pension plans are declining, and the costs of living and health care are rising. If your retirement savings isn’t large enough, you could be forced to go back to work, assuming you’re physically capable to do so, or rely on family.

Also, taking from the wrong account could result in losing some of your money to taxes; withdrawing too much can shorten your money’s overall lifespan. Here are some key points you’ll want to know.

Key Rules to Follow

Age matters

Generally speaking, you cannot start withdrawing from pre-tax retirement accounts like a 401(k), 403(b), or traditional IRA until age 59½ without a penalty. This does not apply to Roth accounts, however. You are allowed to withdraw any principal funds from your Roth accounts without penalty because you paid taxes up front on those funds — you just can’t withdraw any of the gains you’ve earned over the years. To keep everything simple, we’ll assume that you’re already over 59½ and all of your retirement savings are in tax advantaged accounts like a 401(k).

Don’t cash out everything at once

Let’s go back to our original assumption that you’re over 59½ and ready to retire. One of the biggest mistakes would be to liquidate all of your account into a lump sum. This causes two problems.

First of all, taxes. Taking large lump-sum distributions could leave you with a very large tax bill because whatever you withdraw will be treated as additional income. The second problem is that once you liquidate your investments, that means they are no longer growing. It may be a mistake to become too conservative with your investments in retirement, because many of us will live well into our 80s. With potentially 20 years ahead of you, you’ll want your money to keep growing, keep beating inflation, and give you the best shot at not outliving your funds.

The solution: periodic distributions

It’s recommended that retirees take periodic distributions, usually on a monthly basis. This allows you to take a portion of your money out to spend while letting the remainder stay in the market to grow. Figuring out how much you’ll need can be tricky. Many retirees stick to the 4% rule, which seeks to provide steady income while preserving the principal. If you had $1 million saved, you could withdraw $40,000 each year. A person with a $1.25 million retirement savings withdrawing 4% could receive $50,000 per year.

It is considered a best practice to withdraw your investments proportionately, also known as pro rata. To understand what that means, say you have a retirement account with four investments: Stock A, Stock B, Stock C, and Stock D, and each of them makes up 25% of your portfolio, or $250,000 each, for a total of $1 million.

If you follow the 4% rule, you need to withdraw $40,000. It could be a mistake to take the full $40,000 from one single stock as this would throw off the allocation. Pro rata means that you would take $10,000 from each stock, which keeps your portfolio balanced.

Depending on how many investments you hold, calculating a pro rata distribution can become difficult. Your best bet is to consult a financial planner in your area or call your investment firm’s customer service line.

Don’t forget to factor in taxes

Remember, if you’re withdrawing from a pre-tax account, the amount you take out and the amount you actually receive will be different. These funds will be taxed as regular income in your top tax bracket. For example: If you need $2,000 per month to meet your needs, you may need to take out an amount closer to $2,500 to leave room to pay taxes.

Tap into non-retirement savings first

It’s common to have more than one retirement account. To avoid taking a tax hit, many financial experts recommend tapping into non-retirement savings first. “Very generally, and depending on your tax bracket, you should typically take money out of your non-retirement accounts first to keep your taxable income lower,” says Neal Frankle, CFP and blogger at Wealth Pilgrim.

This way, you can give your retirement funds an even longer time to grow before you’re ready (or forced by the required minimum distribution) to start making withdrawals.

Of course, this is an oversimplified strategy and won’t fit every case. Again, it’s wise to seek professional help, at least in the last few years before you retire, to map out a game plan. “This takes a little time and may cost a bit, but it is by far the best investment a pre-retiree can make in my experience,” says Frankle.

Delay Social Security withdrawals as long as possible

We’ve saved the best (worst?) for last. If trying to decide whether to dip into your savings account or 401(k) first was complicated, it doesn’t get much trickier than figuring out the right time to start tapping your Social Security.

In an ideal world, you would ignore your Social Security until at least age 70. That’s when you can capture your maximum benefit. The longer you wait to take Social Security, the more you will receive. Sure, you can start withdrawing funds at age 62, but you’ll only get 75% of your potential earnings.

To get 100% of your potential benefit (for those born between 1943 and 1954), you’ll have to wait till age 66.

But the deal gets even sweeter if you can hold off till 70, when you’ll get your full benefit plus another 32%.

Of course, that’s an ideal world.

In reality, most people start tapping their Social Security funds at age 62.

To visualize the benefit of delaying Social Security for as long as possible, check out this chart from Merrill Edge:

Planning Your Social Security Strategy

There are a lot of complexities attached to Social Security and when to start taking benefits; some of which include your tax bracket, life expectancy, marital status, and how much you’ve saved. The easiest way to help sort this out is to decide the amount of money you could live on each year. For some, this amount is 75%-80% of their pre-retirement income. Someone living on $60,000 might be comfortable with having about $48,000 per year in retirement. It is up to you and your financial planner to decide what combination of options can get you to that number.

But here are some things to consider:

If you’re married

The bulk of the complexities around Social Security are with married couples. When you tally up the options, married couples have dozens of strategies to choose from compared to a handful for singles.

The two main concepts you’ll want to be familiar with are the spousal benefit and the survivorship benefit.

The spousal benefit can allow a spouse to collect up to 50% of their spouse’s benefit based on the spouse’s full retirement age. This could allow for the higher earning spouse to wait to file later to receive the maximum benefit. You can look up your full retirement age here.

For example, Jack and Jill are married, and both are 66 years old. Jill earns significantly more than Jack, and her full retirement age for Social Security is 66. Jack could file Social Security on his own age and earnings history or for the spousal benefit. Since 50% of Jill’s benefit is higher than what he would have gotten on his own, he can file for the spousal benefit now, and Jill can file at age 70. This could help them maximize their total benefit as a couple.

The survivorship benefit is much more straightforward; it allows the surviving spouse to collect a portion of a deceased spouse’s benefits. You can learn more here.

If you’re single

Figuring out Social Security if you’re single can be a lot simpler. You could begin taking Social Security at 62 for a reduced benefit or wait until age 70 to get the highest possible payout. Those who are single due to death or divorce may have a few more options.

In the case of divorce, if you were married for at least 10 years and you have not remarried, you may be eligible to claim a spousal benefit. This is also the case for an ex-spouse who is deceased.

How much do you have saved?

This is perhaps the biggest component: the longer you wait to file for Social Security, the more you could earn. If your nest egg can cover the majority of your retirement lifestyle and your health is good, you may be better off waiting until later to start Social Security.

What’s a Required Minimum Distribution?

There’s also the pesky required minimum distribution (RMD) to consider. When it comes to any retirement funds that were set aside, tax deferred during your working years, the RMD rule makes sure that workers eventually withdraw those funds. Why? Because the IRS isn’t going to leave billions of tax dollars on the table forever.

In a nutshell, the RMD is the amount of money you have to begin withdrawing from your tax-deferred retirement accounts by age 70½. There’s a whole complex way to figure out what your RMD is exactly, but the truth is that you probably won’t have to worry about it.

In fact, most retirees who are living off of their retirement funds meet the RMD by default. Someone with $100,000 in a traditional IRA on December 31 of last year would have to withdraw about $3,780 if they turn 71 this year. If you’re close to 70½ and want to estimate your RMD, you can use this link.

Not taking your RMD, or less than what is required, from a traditional IRA or 401(k) will cost you. The IRS will levy a 50% penalty on the difference between the amount you withdrew and the amount you should have withdrawn.

What if you’ve got more than one retirement account?

If you have multiple traditional IRAs, your RMD will be calculated using the combined value of each account. This allows you to choose which IRA to withdraw from, or to divide the RMD between the accounts.

What if you’re still working in your 70s?

If you are still working beyond 70½, you do not have to take an RMD from your 401(k) until the year you retire. You would still have to take it from your traditional IRA whether you’re working or not. If you are not working and you still have old 401(k)s at different employers, you would be forced to calculate and withdraw the RMD amount from each account separately.

What about Roth retirement accounts?

The RMD rule does not apply to Roth accounts. “Your money grows tax-free in the account and will pass to heirs without any tax obligations,” says Joseph Hogue, a Chartered Financial Analyst. Roth accounts can be a great tool when you’re withdrawing because you have much more control of what you pay in income taxes while in retirement.

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Featured, Life Events

The 3 Secrets to Retiring Early

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

The 3 Secrets to Retiring Early

You’ve likely read articles about people retiring early. Is it possible for you, and if so what will it really take? First let’s establish the age at which most people retire.

Age 66 is considered full retirement age by the Social Security Administration, but that clearly hasn’t stopped people from exiting the workforce a lot earlier. According to a 2016 Gallup survey, retirees said they stopped working at an average age of 61.

The definition of early retirement can be pretty subjective. You cannot draw from Social Security until age 62, but under certain circumstances you can begin withdrawing from your 401(k) at age 55 (age 50 if you’re a public safety employee like a firefighter). So for the purposes of this conversation we’ll peg early retirement as any age before 50.

The key to retiring early? Low expenses, no debt, and high income.

Retiring early is no easy feat, and in most situations it will require several events to occur, some of which you may not have control over. In the vast majority of cases you will need to keep your current cost of living extremely low, earn a high salary, and have little to no debt. These barriers automatically make it harder for the 42.4 million Americans with student loan debt, according to latest data from the U.S. Department of Education; the class of 2016 alone had an average of about $37,000 in loans.

Though debt always plays a factor, cost of living may be the biggest hurdle to overcome on your path to early retirement. Peter Adeney, who runs a very popular financial blog called Mr. Money Mustache, retired at 30 and has become one of the most popular names behind the FIRE (Financial Independence Retire Early) movement. (Pete does not reveal his last name to media to protect his family’s privacy).

But he is hardly kicking back at an island villa sipping cocktails all day. According to an interview in MarketWatch, his family of three subsists on $25,000 per year in Longmont, Colo. Not everyone is able (or willing) to cut back their expenses to fit under such a low threshold. Where you choose to live can determine how much of your income you can save. MagnifyMoney recently analyzed over 200 U.S. cities to find the best and worst places to retire early.

Choosing the right career with a high salary on the front end can be a huge boost, Travis and Amanda of the blog Freedom with Bruno saved $1 million by 30 and retired to Asheville, N.C., according to Forbes. Thanks to a career in tech they were earning a combined income of $200,000. Jeremy of Go Curry Cracker, who made nearly $140,000 per year at Microsoft, saved 70% of his income, and lived on less than $2,000 per month, also retired at 30. It is also important to know that Pete and his wife (mentioned earlier) were also in the tech industry.

Not everyone can relocate to an inexpensive region of the country due to their job or the need to be close to their family, nor do most Americans have the privilege of a six-figure salary, but there are some great lessons that can be applied to your situation, no matter your income or age.

What you would need to retire early

Regardless of salary, debt, or cost of living, having a clear and defined goal is what gives people the confidence to retire early. Without it, they wouldn’t know the amount needed to leave their jobs. You will need to know how much you should be saving toward retirement each year and how much you will need while in retirement. Bankrate has a free retirement calculator here to help you visualize your retirement savings.

The typical rule of thumb is to live off of 4% of your total retirement savings. If you can live comfortably off of $40,000 per year in retirement, you would need about $1 million by the time you retire. If you could live comfortably off of about $25,000, you would only need about $600,000; this is what Pete from Mr. Money Mustache saved when he retired. Another easy way to get to that number is by multiplying your ideal retirement income by 25. So someone needing $55,000 in retirement would need $1,375,000. Once you figure out what you would be comfortable living on, you’ll need to select quality, low-cost investments. For many early retirees this comes in the form of index funds.

If you’re looking into cutting your cost and putting more toward retirement, you may have to get creative or put some serious efforts into increasing your income. This may include keeping a car on the road that’s 19 years old, cooking for every single meal, or moving in with your adult siblings to pay off your debts. Early retirement will require serious commitment and discipline. If you’re in the right position to do it, then this may be the path for you.

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Investing

Should My Spouse and I Have the Same Investments?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

 

Should My Spouse and I Have the Same Investments?

One of the golden rules of investing is not to have all of your eggs in one basket. This is pretty easy to do when you’re planning by yourself. It can get complicated when you are married. Should you both have the same investments or is it better to do something different?

Unlike combining checking accounts or getting a joint credit card, combining your investment goals and objectives with your spouse is a bit more complex. Legally, it is not possible to combine retirement accounts like a 401(k) or IRA. However, it is possible to align your retirement saving strategy. Typically these are the biggest investment accounts, and how you choose your investments will determine your level of financial freedom during retirement. Before you sit down with your spouse (possibly with help from a professional financial adviser) to determine how you can both approach your savings in order to maximize your joint benefit, it’s important to consider these things first.

Before you align your investments, start by aligning your investment goals

Before deciding on what investments you may need, you and your spouse should figure out your investment goals. If you’re around the same age, do you both plan on retiring at the same time? If there is a significant gap in age, there is a chance that one of you could be working much longer than the other, and your investments should reflect that.

A common example could be shown with target-date funds (TDFs). Currently, TDFs are offered by 70% of 401(k) plans, and they give investors the ability to invest according to the year they plan on retiring. Someone planning to retire in 2040 would choose the 2040 target-date fund. If you and your spouse are the same age, it would be OK to invest in the same TDF. But if one of you is choosing to retire in 2040 and the other in 2030, it may be in your best interest to choose funds that correspond to your individual goals instead.

Even if you don’t choose TDFs, your investment choices should be based primarily on your tolerance for risk and the amount of time you estimate working before you retire (also known as time horizon). If you and your spouse have different risk levels, then you should definitely have different investments.

If the younger spouse earns significantly less income, this presents a special challenge best left to a financial planner. A discrepancy in income would directly affect the amount you’re able to save and how it is allocated. In some cases you may have to adjust your allocation to compensate. Again, because there are several individual factors which could affect your investment decisions in this specific situation, you will want the guidance of a financial planner.

Understand diversification and asset allocation

The concepts of diversification and asset allocation are the cornerstones of sound investing. By diversifying your assets, you are spreading out your risk over several different types of assets, rather than simply owning one or two. This is why mutual funds have become extremely popular. Because mutual funds consist of a broad range of investments across the stock and bond market, they provide instant diversification. But it may not be necessary or helpful for you and your spouse to own different mutual funds in hopes of diversifying yourselves even more.

Sometimes it is best to keep things simple. You and your spouse could own the same investments but in different proportions.

For example, the two of you may decide to own Mutual Fund A, which is made up of stocks, and Mutual Fund B, which is made up of bonds. Because you’re older and more conservative, you may choose to invest in a portfolio that is split down the middle: 50% in Mutual Fund A and 50% in Mutual Fund B. Your spouse, especially if they are much younger, may choose a more risky asset mix, investing in a mix of 75% Fund A and 25% Fund B. Both of you would still own the same investments but own different amounts due to your preference for risk.

Additionally, if you invest consistently in funds from the same investment firm, such as Franklin Templeton Investments, MFS, or American Funds, you could qualify for discounts after investing a certain amount called breakpoints. Most companies will charge you a percentage to invest in the fund. For example, if you invest $10,000 consistently every year, you could be charged 2.25% or $225. When you hit a breakpoint, however, the fee goes down. After 10 years, you’ve invested $100,000 and anything you put in after this point will be 1.75%. Instead of paying $225 on every $10,000 you invest each year, you would now pay $175 until you hit the next breakpoint. Every company has their own breakpoint levels and fees they charge, which can vary wildly depending on the type of fund and philosophy of the company.

Most experts agree that it is better to choose a few mutual funds with one fund manager and take advantage of the breakpoints rather than choose one fund from several different managers. Using more than one manager can also make it more difficult to track your investment performance.

The Bottom Line

If you and your spouse are the same age and plan to retire around the same time, you should be OK holding the same investments, assuming they are solid investment choices. But if your age difference is more than three years, this should be reflected in your separate portfolios.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.