There is a lot of information on how to save for retirement but not much on how to withdraw money from your savings when you retire.
Your retirement savings and Social Security (and pension if you are lucky) are all the money you have in retirement. And these savings need to last and support your lifestyle during the next 20 or 30 years.
As a pre-retiree, I already know that I cannot withdraw whatever I want from my retirement funds and expect my savings to last for a long time. Life does not work that way. Without a withdrawal plan, Roman and I will run out of money fast, and then it will be too late to go back to work.
Retirement Savings Withdrawal Rules:
In general, retirement planning consists of two phases – the accumulation phase and the withdrawal phase. After decades of working hard and saving for retirement, you need to shift gears and learn how to spend what you have saved.
Traditionally people work and save 15 percent into their retirement funds and then retire on average at age 65 or older. When you retire, your earned income will disappear, and you will need to pay for the cost of living out of your savings and Social Security.
In addition to that, you need to figure out how to convert your retirement savings into a reliable stream of income that can support you through your 90s.
Unfortunately, you cannot keep your money in retirement accounts forever.
The federal government is going to force you to start taking money out at age 72 if you are not working anymore. If you are still working at age 72, you have to start taking money from your IRA and old 401(k) from your previous job. But you can delay taking withdrawals (RMDs) from your current 401(k) until you stop working.
A general rule to remember – keep the money in your 401(k) or IRA until you reach age 59 ½. If you withdraw any money before that age, you will be hit with a 10 percent penalty fee on top of the regular income tax.
In this post, I want to show you the 5 best ways to withdraw from your retirement savings so your money will last for a long time.
1. Follow the required minimum distribution (RMD) rules.
The IRS requires us to start taking a minimum distribution (RMD) from tax-deferred accounts when we turn 72 years old unless we are still working.
If you do not make it on time and fail to withdraw the required amount each year, you will owe IRS a large penalty fee. In addition to the penalty fee, you will still need to withdraw the required amount of money, and pay income tax on it.
The withdrawal amount depends on your age, life expectancy (the longer your life expectancy is, the less money you must take out), and your account balance.
There are two types of retirement accounts:
- Tax-deferred – 401(k), IRA, Roth 401(k)
- Tax-free – Roth IRA
The minute you start taking money out of 401(k) or IRA, you will have to pay taxes on your withdrawals. If you are in a high tax bracket, you will owe a good chunk of money to IRS. Although, if you are wealthy enough and do not need money from your retirement accounts, you still must withdraw them to follow the rules of RMD.
Keep in mind that many financial firms can help you calculate an RMD.
2. Minimize mandatory distributions.
One of the best ways to withdraw money from retirement accounts and lower your taxes is to minimize mandatory RMDs. Because when you start taking money out of tax-deferred accounts, you will face an increase in your taxes.
Remember – that was the deal you had signed up when you got a tax break on the money saved in a traditional 401(k) or IRA. It was deducted from your taxable income, and retirement is the time to pay it back.
In retirement, you would owe income tax on withdrawals.
That means, preserving your tax-deferred accounts until an RMD kicks in is not a great idea.
Someone who is 70 years old will have an RMD of approximately 3.5 percent of the account value, but by the age of 75, an RMD will be 4.5 percent. And at the age of 80, you will require to withdraw at least 6 percent. These numbers are just an example to show the more money you have the more you have to withdraw.
Keep in mind that an RMD will be much higher to withdraw as you grow older unless you start withdrawing money when you retire. And as I mentioned above you might be pushed into a higher tax bracket.
The main thing to remember is that every year you will need to take an RMD from your tax-deferred accounts if you do not want to owe IRS a large penalty fee.
3. Consider a Roth IRA conversion.
One of the best ways to reduce your taxes in retirement is to convert some of your traditional 401(k) or IRA into Roth IRA money.
A Roth IRA conversation is a process of switching between retirement accounts.
You take money from a 401(k) tax-deferred account and roll it into Roth IRA. The Roth account is funded with after-tax money, so when you go with the conversion it will trigger the tax bill.
But you will pay taxes only on the converted money. Once you make the move, all the funds in the Roth account will grow tax-free.
The best part is that you are not required to take a minimum distribution on the Roth IRA money, so it will grow and accumulate longer.
So, the important thing to remember is that money in a Roth IRA account grows tax-free and can be withdrawn tax-free.
However, you will need to pay taxes on any amount converted from 401(k) or IRA to a Roth account.
Even though you must take money out and pay taxes on tax-deferred accounts, your Roth IRA money will stay intact, grow, and accumulate with years. It could be used as an emergency fund or passed on to your heirs.
As a financial goal, I plan to move 50 percent of all our tax-deferred accounts to a Roth IRA account before we turn 72. I am planning to do it gradually so it will help control RMD withdrawals and reduce our taxes in retirement. Besides, if we want to delay the start of our Social Security, we will have several years of low income, which can be a good time to complete the Roth IRA conversion.
4. Withdraw from accounts in the right order – taxable vs. tax-deferred.
The saying “it is not what you earn, but what you keep” is true when it comes to withdrawing money from your various accounts.
In retirement, we need to be smart about taking money out of our retirement funds, otherwise, the big chunk of it might be eaten by taxes.
Here is a helpful article from Fidelity Investments you might want to read:
As a general rule, it is better to sell investments held in taxable (investment) accounts first instead of taking money out of tax-deferred accounts.
The main reason is that the withdrawals from the traditional 401(k) and IRA accounts are taxed as ordinary income. And typically, ordinary income is taxed at a higher rate than the long-term capital gains from the taxable (investment) accounts.
On another hand, if you withdraw money from your taxable accounts before tax-deferred, it might increase an RMD rate and that reduces your tax efficiency.
This is one of the best ways to withdraw money for tax efficiency:
- First – pull money from your taxable (investment) accounts
- Second – withdraw money from your tax-deferred accounts – IRA and 401(k)
- Lastly – take money out of tax-free accounts – Roth IRA
5. Figure out how to take distributions from multiple accounts.
Over their lifetime, many people accumulated multiple retirement accounts – traditional 401(k)s, IRAs, and Roth IRAs. Before an RMD rule kicks in, you need to figure out how much and in what order to withdraw money from all these retirement accounts.
The problem is you cannot tap into all your retirement accounts at once.
For example, if you own a few traditional 401(k) accounts you have to withdraw from each of them individually. The same rules apply to IRA and Roth IRA accounts. That means that you cannot make withdrawals from an IRA account to meet your RMD requirements for a 401(k) account.
On another hand, you cannot combine all these accounts into a single account so it will be easier to control your money and withdrawals.
The best way is to consolidate your multiple IRAs into a single account.
However, you cannot combine 401(k) and IRA accounts into a single account, but you can roll over 401(k) into IRA.
If you are still working and have several 401(k) accounts from your previous jobs, you should be able to merge the old 401(k) into your current employer’s 401(k) plan. However, if you cannot combine old and new 401(k) plans, you can rollover old 401(k) accounts into an IRA account.
I am still a few years away from the RMD rules, but I have already begun thinking about merging all our retirement accounts into a single account.
Roman and I have multiple retirement accounts with different financial institutions:
(2) 401(k) accounts, (1) Roth 401(k), (3) Traditional IRAs, and (2) Roth IRAs.
Personally, I feel that calculating and taking money out for multiple RMDs sounds very complicated. That is why I am planning to consolidate all accounts under one roof with 401(k) and IRA rollovers which can make my life much easier to manage RMDs and to keep track of our investments and taxes.
Final Thoughts
There is so much information on how to save and invest for retirement. But when it comes to the withdrawal strategy things start looking complicated. There are many strategies, ideas, and rules to remember when you start planning for retirement.
With the knowledge of how to withdraw from retirement savings, you can minimize your taxes and keep your retirement funds working for you longer.
However, it is a complicated matter, and finding an account or a financial advisor who will help you navigate everything will be the best decision.
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