Please note the information below is intended to provide generalized information that is appropriate in certain situations.  It is not intended or written to be used, and it cannot be used by the receipient, for the purpose of avoiding federal tax penalties that may be imposed on any taxpayer.  The contents of the information provided below should not be acted upon without specific professional guidance.  Please call us if you have any questions.

Retirees often need money from their investment portfolio, if they have little or no earned income. For many seniors, tax-efficient withdrawals require two levels of decisions. First, should the dollars come from regular taxable accounts or from tax-deferred accounts such as IRAs? Second, regardless of where the money is coming from, how will a portfolio be liquidated to provide spending money?           

Taxable or tax-deferred? 

Some people enter retirement holding an IRA as well as a taxable account. If cash is needed, they often choose to take the money from the taxable account.

            Example 1: Joy Larson needs $4,000 a month from her portfolio in retirement to supplement her Social Security income. The money in her traditional IRA was rolled over from Joy’s 401(k) plan at work. All the money in her 401(k) was pretax, so IRA withdrawals will be taxed at ordinary income rates. Consequently, Joy decides to take money from her taxable account. Those withdrawals may be tax-free, if no investment gains are triggered. And, even if Joy takes some gains, they may be taxed at favorable long-term capital gains rates.

            Drawing down the taxable account may be a common practice for retirees. However, there may be drawbacks. In time, the taxable account might be depleted, leaving only pretax IRA money for distributions later in retirement. Those distributions may be heavily taxed at whatever tax rates apply in the future.

            In addition, holding on to IRA money can lead to a sizable amount of tax-deferred dollars left to your heirs. Your beneficiaries will have required minimum distributions (RMDs) from the inherited IRA, and those distributions probably will be taxable. (Special rules apply to IRA money left to a surviving spouse, but those dollars eventually may pass to younger relatives.) If the IRA beneficiaries inherit while in their prime working years, the tax on those distributions could be especially steep.

            On the other hand, if you take some cash from your IRA and leave highly appreciated assets in your taxable account, you may be able to pass those appreciated assets to your heirs. Under current law, they’ll get a basis step-up, usually to a date-of-death value. Then, your heirs can sell the assets and avoid paying tax on the appreciation during your lifetime.

            The bottom line is that you might want to use some IRA money as well as money from taxable accounts to cover living expenses in retirement. This approach may be helpful before you reach age 70½, when RMDs from your IRA begin. Withdrawing some money from your IRA before 70½ may help you hold down taxable RMDs in the future. 

Know how to fold ‘em 

Regardless of where the money will come from, you should have a plan for drawing down your portfolio in retirement. Your specific circumstances will influence your decisions, but one approach is to start retirement with a sizable “cash bucket.” This money can be used for living expenses, regardless of what happens in the financial markets.

            Example 2: In example 1, Joy Larson needs $4,000 a month from her portfolio, in retirement, or $48,000 a year. Joy decides she wants enough cash to cover three years’ outlays, or $144,000. Therefore, in advance of her retirement, Joy puts together $144,000 in bank CDs and money market funds. This money can flow into her checking account, to help pay her bills.

            From time to time, Joy will liquidate other assets to replenish her cash bucket. There are many ways to do so, so Joy should have a plan. For instance, she may check her asset allocation every year, to see whether it’s still in keeping with her current wishes. Suppose Joy wishes to keep a 50-50 asset allocation between stocks and bonds, but a stock market slide has tilted her portfolio towards bonds, which have been stable. Then, Joy might sell some bonds and bond funds, putting the proceeds into her cash bucket while bringing her portfolio into a better balance.

            No portfolio drawdown plan will work for everyone, but you should approach retirement with a well-reasoned plan and attempt to stick with it. Having a substantial amount of cash may enable you to ride out any market downturns, while having a thoughtful mix of equities and fixed income can provide income and growth potential throughout your retirement.