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Ask an Advisor: What’s the best strategy for drawing down my retirement savings at the age of 72?
How to Strategically Draw Down Retirement Savings at Age 72
As you enter the next phase of retirement, managing withdrawals from your savings becomes crucial, especially as Required Minimum Distributions (RMDs) start to apply. Many retirees have a combination of Traditional IRAs, Roth IRAs, taxable brokerage accounts, and possibly annuities. Each account has unique tax implications, and withdrawing in the right order can significantly impact your retirement income, ensuring your hard-earned savings last as long as you need them.
This guide outlines a tax-efficient, step-by-step strategy for drawing down your retirement accounts. By following this approach, you can keep taxes manageable, preserve flexibility, and avoid the risk of outliving your savings.
Step 1: Establish Your Retirement Income Needs
The first step is to clarify how much income you’ll require to cover your expenses after accounting for any Social Security benefits, pensions, or other fixed income sources. For instance, if your annual income target is $90,000 and you and your spouse receive $60,000 from Social Security, you’ll need to generate the remaining $30,000 from your savings.
Because withdrawals from Traditional IRAs and 401(k)s are taxed as ordinary income, you’ll need to factor in taxes, targeting a pre-tax amount of around $40,000–$45,000 to net $30,000. With this target in mind, let’s examine the most tax-efficient way to withdraw funds from your accounts.
Step 2: Start with Required Minimum Distributions (RMDs)
At age 72, the IRS requires RMDs from your Traditional IRAs and 401(k)s. These withdrawals are calculated based on the account balance and life expectancy, starting at approximately 3.9% of your balance and increasing over time. For example, a $1 million Traditional IRA would require a first-year withdrawal of around $39,000. Since this is taxable income, RMDs are often your primary source of retirement income.
It’s crucial to fulfill your RMD obligation each year to avoid a substantial 50% IRS penalty on any undistributed amount. Even if you don’t need this income for current spending, consider reinvesting it in a brokerage account or using it to fund other financial goals.
Example:
If your RMD is $39,000 but only nets $32,000 after taxes, this amount will cover most of your remaining income needs. If a shortfall exists, your next best option is your brokerage account, as explained in the next section.
Step 3: Supplement with Withdrawals from Your Brokerage Account
After fulfilling RMD requirements, consider using funds from your taxable brokerage account. Withdrawals from brokerage accounts only incur taxes on interest, dividends, and capital gains when investments are sold, allowing for more tax-efficient income. Long-term capital gains, in particular, are typically taxed at rates lower than ordinary income, generally 0%, 15%, or 20%, depending on your taxable income level.
This tax efficiency makes brokerage accounts an ideal secondary source of income after RMDs. By choosing low-gain assets or using investments with long-term capital gains, you can avoid pushing yourself into a higher tax bracket unnecessarily.
Example:
If you need an additional $10,000 to meet your spending goals after your RMD, withdrawing from your brokerage account could allow you to keep taxes low. Selling investments with minimal appreciation can further reduce your tax burden, preserving more of your retirement savings.
Step 4: Utilize Roth IRA Withdrawals Strategically
The Roth IRA is a valuable asset in your retirement portfolio, as withdrawals are tax-free and there are no RMD requirements. This allows you to leave Roth IRA funds untouched, letting them grow tax-free as long as possible. However, in years where you face high expenses or wish to avoid additional taxable income, Roth withdrawals can provide flexibility without affecting your tax bracket.
Because Roth withdrawals don’t increase your taxable income, using this account in high-expense years can be a way to manage tax obligations effectively. Roth IRAs also offer an attractive legacy planning benefit, as inherited Roth accounts remain tax-free for your beneficiaries.
Example:
Imagine covering all basic expenses with RMDs and brokerage account withdrawals. Then, an unexpected medical expense arises. Instead of drawing additional taxable income, you could use funds from your Roth IRA to avoid an increase in your taxable income.
Pro Tip on Roth IRAs: Consider Roth IRAs as a longer-term reserve for later stages of retirement or for legacy planning.
Step 5: Delay Activation of Your Deferred Income Annuity
A deferred income annuity can serve as a dependable income stream in later years of retirement, providing a safeguard against longevity risk—the risk of outliving your assets. Since annuity income is taxable, delaying activation until your late 70s or early 80s can help manage your tax liability by keeping taxable income lower in the earlier years.
Activating the annuity at an older age can complement your income as RMDs increase, and help cover potentially higher healthcare costs or other expenses that may arise later in life.
For example, if you’re comfortable meeting expenses through RMDs and brokerage account withdrawals, consider waiting until age 80 to activate the annuity. By then, RMDs will require more substantial withdrawals, and the annuity can provide additional income stability, helping to manage costs or offset any market downturns.
Annuity Activation Strategy:
- Delay activation until age 80 or beyond, allowing you to reduce early retirement taxable income.
- Use annuity payments as a stable income source later in life, when your needs may shift.
Step 6: Manage Social Security Taxation Strategically
Social Security benefits become taxable when combined income exceeds certain thresholds. Combined income includes half of your Social Security benefit plus all other taxable income, including RMDs and investment income. Up to 85% of Social Security benefits can be taxable if your combined income surpasses these limits, which is why minimizing taxable income is so important for many retirees.
By relying on tax-efficient withdrawals from brokerage accounts or tax-free Roth withdrawals, you can keep your combined income within reasonable levels, avoiding unnecessary taxes on Social Security benefits.
Pro Tip on Managing Social Security Taxation:
- Use brokerage and Roth IRA withdrawals as needed to keep total taxable income lower.
- Coordinate withdrawals to smooth out income fluctuations and prevent “income spikes” that increase Social Security taxation.
Step 7: Plan for Inflation with Growth Investments
Over a long retirement, inflation can significantly impact purchasing power. To address this, consider keeping a portion of your brokerage account or Roth IRA in growth assets, such as stocks. Historically, stocks have delivered returns that exceed inflation, making them effective for maintaining your purchasing power over time.
Balancing growth assets with income-producing assets ensures you can address both current spending needs and future inflation. This strategy also complements your fixed-income sources, such as annuities, which provide stability but may not keep pace with inflation.
Example:
Consider allocating a portion of your brokerage account to growth-oriented investments like stocks or index funds. These assets can provide long-term growth, helping your retirement savings keep up with inflation over the years.
Inflation Protection Tips:
- Retain a growth component in your brokerage or Roth IRA for long-term inflation protection.
- Utilize the annuity as a predictable income base, supplementing it with growth assets in other accounts.
Coordinating Your Retirement Withdrawal Strategy: A Yearly Guide
To streamline your retirement income plan, here is an annual withdrawal order that maximizes tax efficiency:
- Begin with RMDs from Traditional IRAs and 401(k)s: Required by the IRS and counted as taxable income.
- Supplement with brokerage account withdrawals as needed: Focus on low-gain assets or long-term capital gains.
- Delay annuity income activation until age 80 or beyond: Use it as a reliable income source when other assets are lower.
- Rely on Roth IRA for high-income years or unexpected expenses: Tax-free withdrawals help control taxable income.
This order allows you to keep taxes manageable, minimize Social Security taxation, and sustain your assets over time.
Staying Flexible and Adapting Your Strategy Over Time
Flexibility is a cornerstone of successful retirement income planning. Economic changes, personal needs, or unexpected events may require adjustments to your strategy. By regularly reviewing your withdrawal order, tax implications, and long-term goals, you can continue making the most of your retirement savings.
Engaging with a fee-only financial planner can help ensure that your strategy remains aligned with your goals and adapts to any changes in tax laws or personal circumstances. They can assist with decisions about Roth conversions, portfolio adjustments, or other strategies to optimize your retirement income.
With a proactive approach and a carefully coordinated strategy, you’ll be able to focus on enjoying your retirement with greater peace of mind, knowing that your income plan is both tax-efficient and adaptable.
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This article was originally published on Wealthtender and is intended for informational purposes only and should not be considered financial advice. You should consult a financial professional before making any major financial decisions. Wealthtender earns money from financial professionals, which creates a conflict of interest when these professionals are featured in articles over others. Read the Wealthtender editorial policy and terms of service to learn more. Wealthtender is not a client of these financial services providers.
