There’s a lot written about retirement savings, but not so much about spending what you’ve saved: a Google search has yielded more than 15 times more results for “how to save for retirement” than for “ how to withdraw money during retirement ””.
And, in fact, you can save and invest for retirement throughout your working life (40 to 50 years). But you may also need to rely on retirement savings for 20 to 30 years and the way you take that money can make a big difference in the length of your nest egg.
Conventional wisdom holds that you should first withdraw from your non-withdrawn financial assets, then from your tax-deferred accounts (IRAs and 401ks) and then from tax-exempt accounts (such as Roth IRAs). It seems reasonable because, first of all, it’s easy to implement, and by not withdrawing from IRAs or 401ks, you’ll allow them to grow and delay paying taxes until you need to.
But more research shows that it is not an optimal strategy, as it does not take into account the impact of higher-than-expected taxes, especially when people are waiting to take out Social Security. Lesser-known but more tax-efficient retirement spending strategies can, by reducing income tax, extend the life of the next egg and this could mean the difference between running out of money and leaving something to your heirs. .
Greg Geisler, a professor of accounting at Indiana University’s Kelley School of Business, has studied retirement retirement (or “decumulation”) for years. In a recent article, he and other researchers compared several strategies, most notably in their long-term fiscal efficiency.
Taxes, Geisler told me in a phone interview, are often overlooked in planning retirement account withdrawals. Most people assume that taxes will go down when they grow up and leave the workforce. And sometimes they do. But the big surprise comes in the early 1970s for retirees, especially if they wait until the 70s to take out Social Security and until the 72s to start withdrawing mandatory minimum distributions (RMDs) from their IRAs, 401ks and other traditional accounts. deferred tax retirement. This increase in revenue can turn them into a higher tax bracket.
“They look at their tax returns and they say,‘ Oh God, I’m in the 22% or 24% or 32% tax bracket, ’Geisler said.
The reason for this is the “tax torpedo”, in which “provisional income”, which includes withdrawals of tax-deferred retirement accounts, and Social Security benefits can increase marginal tax rates by 50% to 85%. This is how people with fairly modest incomes find themselves paying taxes at a much faster rate than they expected.
“A lot of retirees who have a good amount of social security and [retirement accounts they’ve built up] over the years, they are all between 22%, every year, once they reach the age of 72 or more, ”said Geisler. And the tax torpedo can boost federal marginal rates from 22% to 40.7% once 85% of Social Security benefits are taxable.
Therefore, people may have to dig deeper than they expected the nest eggs to pay for these unforeseen taxes, making them more likely to run out of money. But you can avoid it, Geisler said, with a fiscal efficiency strategy.
In the years from 65 to the first 70 years, before taking on Social Security and RMDs, you should consider taking advantage of your non-retirement accounts to sell stocks, funds or ETFs valued to cover the living expenses. Then withdraw money from your deferred tax accounts and change the funds to a Roth IRA. But make sure both moves keep your taxable income below $ 40,400 if you’re single and $ 80,800 if you’re married, filing together (after getting the standard deduction of $ 14,250 and $ 27,800, respectively, if taxpayers are over 65). Below this general threshold, capital gains are taxed at 0% while income is taxed at 12% at the federal level.
By spending profits on retirement accounts and exchanging money for tax-free Roth accounts, you can keep taxable withdrawals at least later by taking advantage of the set of tax-free money you accumulated during your early retirement years. (If you need cash flow, though, you should consider taking money out of your IRA or 401 (k) instead of funding the Roth, Geisler said).
This strategy, according to Geisler’s paper, can extend the life of retreat nest eggs by up to 11% or three years. “It’s not just saving some money on taxes,” Geisler said. “It helps the whole nest egg last longer.”
Of course, many people do not have the assets or flexibility to run this strategy, and because taxes are so individual, consult your tax advisor first and perhaps a financial advisor with experience in tax planning.
But taxes are often a forgotten aspect of a neglected part of retirement planning and can have a greater impact on retirement security than one would think.