4 Post-Tax Strategies for Retirement Withdrawals
Planning for your retirement years isn’t just about saving money. It’s also about figuring out how to use your savings effectively. How do you make the most of that hard-earned money after you retire? Thinking about this now could help avoid paying unnecessary taxes later and running out of money too soon.
Methods to Consider
There’s more than one way to withdraw your savings for income purposes. No single approach is right for everyone, and each method has pros and cons. You can even use multiple methods throughout your retirement to your advantage. Here are a few to consider:
Earnings Only: You can keep the money you initially invested and only withdraw its earnings. This means that the original amount you invested, known as the principal, remains untouched for continued growth potential. This method relies on your portfolio producing a large enough income to cover your living expenses in retirement. It can also result in unpredictable income due to irregular market performance. Qualified retirement plans like a 403(b) plan have tax rules that determine what portion of the amount withdrawn is treated as principal or earnings. Due to this, some amounts may not qualify for this withdrawal method.
4% Rule: This suggests that you withdraw 4% of your entire retirement savings in the first year of retirement, and then adjust the amount for inflation each year. For example, if you have $750,000 saved, you will withdraw $30,000 ($750,000 x 4%) in the first year. If there is 3% inflation, the following year you would withdraw $30,900 ($30,000 x 3% increase = $900). This approach is simple and is intended to keep up with inflation. However, it doesn’t consider market fluctuations and interest rate changes.
Tax-Efficient Distribution: You would withdraw from your taxable accounts first, tax-deferred accounts second, and tax-free accounts last. Doing this allows you to optimize your tax situation by minimizing taxes on what you take out and leaving the remaining funds invested for continuing growth potential. However, this strategy may be impacted by changes in tax law over time. Tax rates, deductions, and retirement account rules can all be subject to legislative changes. Distributions are generally structured to make the most of your assets while limiting taxation over time and may require the help of a tax professional.
Fixed-Dollar Withdrawals: This refers to taking the same amount from your retirement accounts each year, regardless of market conditions or performance. This allows you to have a consistent income stream throughout your retirement and can help with budgeting and planning your expenses. The downside to this approach is that it may result in a loss of buying power due to the impact of inflation over time. Additionally, if your fixed dollar amount is equal to or higher than your rate of return or interest, you run the risk of exhausting your money too soon.
Which Option is Right for You
While there are many different methods and strategies for withdrawing your money, you should take the time to think about which one is right for you. Consider your circumstances, risk tolerance, and retirement goals. A tax professional can offer guidance sorting through the taxation issues and help you determine the most suitable withdrawal strategy that aligns with your needs and allows you to enjoy your golden years.
This blog is up to date as of January 2025 and has not been updated for changes in the law, administration or current events.
