You spent your lifetime working hard, diligently saving and investing money to secure your financial future. But what comes next? When it’s time for retirement, how do you take income from your savings in a way that can help preserve your wealth as long as you need? What is considered a safe withdrawal rate?

Whether you’re approaching retirement age or already retired, the right withdrawal strategy can help you manage taxes and maintain the standard of living you’ve planned for. But what is the “right” retirement withdrawal strategy? It depends.

Every individual is unique, so the optimal answer depends on your circumstances, your goals and changes in the economic climate.

At Edelman Financial Engines, our planners, along with your tax professional, can design a strategy for your unique situation. We’ll help you develop a retirement plan that considers your changing needs, as well as the impact on your taxes, Social Security benefits and even the amount you pay for Medicare.

WHAT IS A RETIREMENT WITHDRAWAL STRATEGY AND WHY IS IT SO IMPORTANT?

Let’s start by understanding what a retirement withdrawal strategy actually is. For some retirement accounts, such as an IRA or 401k, you’ll be required to withdraw a certain amount of money once you reach a required minimum distribution (RMD) age. Not all accounts will carry these requirements, such as a Roth IRA or a Roth 401k. In any situation, retirees will need to develop a plan that provides enough income to live comfortably without outliving their funds.

This is where your retirement withdrawal strategy comes into play. For instance, you might have heard of the 4% rule, which limits your annual withdrawals from all accounts to just 4% of the total balance in your first year of retirement. While this might sound like a safe rule of thumb to help balance spending and savings, there is no one-size-fits-all solution when it comes to retirement withdrawal strategies. The 4% rule also doesn’t take factors like market volatility, inflation and rising interest rates into account, meaning it can be difficult for retirees to actually live by.

So, how can retirees develop a withdrawal strategy that works for them?

WATCH: WITHDRAWAL STRATEGIES TO HELP CARRY YOU THROUGH RETIREMENT

The co-hosts of Everyday Wealth are not employees or clients of EFE. They receive fixed cash compensation for acting as host, and have an incentive to endorse EFE and its planners.

IDENTIFY THE CHALLENGES OF RETIREMENT WITHDRAWALS

Planning for a steady stream of retirement income can seem like an overwhelming task. First, you must consider your spending habits, expenses and expected income from a number of sources: any investment account, pension, part-time work, rental income, Social Security, etc. However, many people are not certain how much they actually spend throughout the year, or even on a monthly basis.

Since financial planning is about having financial security and an enjoyable lifestyle, a financial planner can help you determine how much your income stream should be and identify the relevant income sources to help get you there.

Here is another question: Do you expect changes in your income or expenses in your retirement years? You might need to reassess how much income you need and how long your retirement savings will last based on your desired lifestyle.

MARKET CONSIDERATIONS FOR YOUR RETIREMENT WITHDRAWAL STRATEGY

As anyone who's entered or neared retirement age in recent years knows all too well, market downturns, increased volatility and higher inflation can have a significant impact on your withdrawal strategy. That’s why building a year or two of cash reserves outside of your retirement accounts is a good plan – it can help offset some of the impact of drawing down your investments when market values are down.

Maintaining sufficient cash reserves can also help provide the ability to cover unforeseen financial circumstances without needing to take withdrawals too early from your retirement accounts. Extracting funds before retirement age could also incur fees, interest or penalties.

Keep in mind that early on in your retirement, you most likely will be taking a small percentage of the total value of your retirement portfolio. That means the rest of your balance is still invested and positioned to benefit from any portfolio growth.

It can be uncomfortable to see account values drop, but we have been through this before and our advisors will give you guidance on how to use those cash reserves to get you through. Remember, the markets go up and down, and we can construct a retirement portfolio that is designed for these ups and downs.

IRA WITHDRAWAL RULES

Let’s say you have an IRA and a 401k account from your prior employer. Many people think that when they reach the RMD age, they can calculate the required minimum withdrawals from both and simply take the grand total out of one retirement account – for example, the IRA.

But that’s incorrect. You cannot choose a retirement withdrawal strategy that only debits one account, even if it meets the RMD amount. And an error like that could cause you to incur up to a 25% penalty from the IRS.¹

That’s why it’s so important to have a retirement withdrawal strategy in place before you reach age 72 (73 if you reached age 72 after Dec. 31, 2022)¹, the age at which you need to start taking RMDs.

Having money in both an IRA and a 401k is common. We typically find that people have five retirement accounts by the time they stop working. Those may be IRAs, 401(k)s from multiple prior employers, a 403(b) and others.

So, in this example, your retirement withdrawal strategy must include separate RMDs from both accounts. Taking the RMD amount for the 401k portion from the IRA would trigger the penalty. Even though you took the proper total amount from all the accounts, the IRS will recognize you didn’t take it from the proper place.

If you eventually decided to roll your dormant 401k into an IRA – you would first need to take the current year’s minimum distribution from the 401k – then you could take the total withdrawal from just one of the IRAs in subsequent years. But be aware there are strict rules about rollovers, so to avoid facing any penalties, be sure to speak with the plan administrator or a financial advisor before choosing this option.

HOW MUCH IS THE REQUIRED MINIMUM DISTRIBUTION?

IRS Publication 590b contains a table showing the amount that must be withdrawn each year, but there’s another trap you should avoid. The amount is based on the account value as of the prior Dec. 31, not on the value at the time the funds are withdrawn.

Although you can take out more than the required minimum distribution, if your calculations are off and you take out too little, that’s where the potential 25% penalty comes in. The SECURE 2.0 Act reduces the tax rate to 10% if the error is corrected within two years. The account owner should file Form 5329 with their federal tax return for the year in which the full amount of the RMD was required but not taken.²

The rules are different for IRAs and 401k plans. If you had five IRAs of different values, you could add up the total RMDs and withdraw the entire amount from just one of the IRAs. But with 401k plans, you must take your RMD separately for each 401k you have.

It is also important to note that the RMD rules apply to more than just IRAs and 401(k)s. They also apply to a number of employer-sponsored retirement plans such as profit-sharing and 403(b) plans, plus IRA-based plans such as SEPs.

OPTIMAL WITHDRAWAL STRATEGY FOR RETIREMENT INCOME PORTFOLIOS

There are many elements to consider when deciding which accounts to draw from. For example, should you be withdrawing from a single retirement account or proportionally across all your accounts?

One approach is to withdraw from a taxable account first. This keeps assets in your tax-deferred accounts, allowing them to stay invested longer and potentially make more money. But this isn’t always the best approach because it could create a bigger federal tax bill down the line when RMDs kick in, possibly moving you into a higher tax bracket. In addition to federal income tax, depending on which state you live in, there can be potential state income tax implications.

Your withdrawal rate and the accounts from which you make withdrawals can also impact if or how much of your Social Security benefits are taxable, or the amount you pay for Medicare. The difference can be significant. In 2024, the cost for Medicare Part B is between $174.70 and $594.00 per month depending on your income level two years prior.³ Your planner can join a call with your tax professional to determine an option that can work for you.

Helping to explore tax-efficient retirement withdrawal strategies is just one of the ways we serve our clients. Talk with an Edelman Financial Engines advisor to see how our integrated approach to retirement planning and wealth management can help you.

3 KEY COMPONENTS OF A RETIREMENT WITHDRAWAL STRATEGY

The co-hosts of Everyday Wealth are not employees or clients of EFE. They receive fixed cash compensation for acting as host, and have an incentive to endorse EFE and its planners.

¹ IRS. (2024, February 28). Retirement plan and IRA Required Minimum Distributions FAQs. Retrieved May 31, 2024, from https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs#:~:text=What%20are%20Required%20Minimum%20Distributions,Dec.%2031%2C%202022).

² IRS. (2023, December 20). IRS reminds those aged 73 and older to make required withdrawals from IRAs and retirement plans by Dec. 31; notes changes in the law for 2023. Retrieved April 12, 2024, from https://www.irs.gov/newsroom/irs-reminds-those-aged-73-and-older-to-make-required-withdrawals-from-iras-and-retirement-plans-by-dec-31-notes-changes-in-the-law-for-2023

³ CMS. (2023, Oct 13). 2024 Medicare Parts A & B Premiums and Deductibles. Retrieved April 17, 2024, from https://www.cms.gov/newsroom/fact-sheets/2024-medicare-parts-b-premiums-and-deductibles