Summary
- Your retirement portfolio may become more conservative after you’ve retired, with more money allocated to cash, cash alternatives, bonds, and other low-risk investments.
- Taxes are important to consider, and the optimal order for taking money out of retirement accounts should start with your brokerage account, followed by traditional retirement accounts, and then Roth accounts.
- Required minimum distributions may increase your tax bill if you wait too long to start taking them.
- Need help with your retirement investment strategy? Unbiased can connect you to a financial advisor to answer all your questions about the tactics to preserve your nest egg.
How your investment strategy should change at retirement
Retirees typically shift strategies to access cash and low-risk investments while preserving enough capital to continue growing investments in retirement.
It’s more conservative in nature, so retirees don’t worry about losing a great deal of their nest egg in more volatile equity markets.
Where to put your retirement money
The places to hold your retirement fund may not change in retirement, but how much money you dedicate to your different investments (the allocation) likely will.
Some of the changes you’re looking at may involve cash and short-term reserves, bonds and fixed income, and stocks and growth investments.
Cash and short-term reserves
Cash and short-term reserves are for holding money that you’ll need in the near future. They’re highly liquid so you can quickly access them for any purpose. Experts recommend between 0% and 20% be dedicated to cash.
Bonds and fixed income
Bonds are virtually guaranteed income, albeit at a much lower rate than stocks and other growth investments. Your retirement income needs the certainty of investments like bonds. 40% to 60% of your portfolio may be allocated to bonds and fixed-income investments.
Stocks and growth investments
Retirement can last 30 years or more, so you’ll still need to allocate a portion of your portfolio for growth. Keep some of your money invested in the market. Some experts recommend as much as 30% to 50% for stocks in retirement.
Common retirement withdrawal strategies
A withdrawal strategy is important to ensure your savings last and your investments continue to grow through your retirement.
Consulting with a financial advisor is the best way to put a solid plan in place for ensuring there’s enough money in retirement.
These are a few strategies that may come into play.
The 4% rule
As a general rule of thumb, a 4% withdrawal rate is suggested for those with a 30-year retirement with investments split 50-50 between bonds and stocks. In other words, 4% of your total portfolio is what you can withdraw each year and still expect your retirement to last 30 years.
The 4% rule does have its limitations. For example, it doesn’t take into account taxes or inflation. It also assumes a 30-year retirement with a specific portfolio composition split evenly between stocks and bonds. If your portfolio is constructed differently, you may see a different outcome.
The bucket strategy
A bucket strategy divides your money into buckets based on when you’ll need the money. Visualizing buckets is helpful for explaining where money should come from. The purpose of buckets is to meet cash flow needs regardless of interest rates, and to preserve investments for long-term growth.
- Bucket one: Immediate needs (1 to 2 years). Highly liquid. Stash money in cash and cash alternatives. Hold at least a year’s worth of expenses in this bucket, less any certain payments such as Social Security and pension payments.
- Bucket two: Short-term needs (3 to 10 years). Lower-risk investments such as money market accounts, certificates of deposit, and short-term fixed-income investments live here.
- Bucket three: Long-term growth (10+ years). It’s for investments that grow from year 11 and beyond. Extra time helps you ride out market swings.
What order should you withdraw from your accounts?
The order you withdraw money from different account types may affect how much you pay in taxes in retirement. While much depends on your individual situation, generally speaking, the optimal order for tax efficiency is as follows:
- Taxable brokerage accounts: Withdraw money from your taxable brokerage account first. There are no age-based rules, and you won’t be penalized for taking money from these accounts early like you are with IRAs and 401(k)s.
- Traditional IRAs and 401(k)s: Withdraw money from traditional IRAs and 401(k)s next. These withdrawals are taxed as ordinary income. Waiting until you’re required to take distributions (RMDs) can create larger distributions and a higher tax bill.
- Roth IRAs and 401(k)s: Withdraw money from Roth accounts last. You don’t pay taxes on qualified withdrawals. You get flexibility and more time to grow investments in these accounts.
Withdrawing in this order helps preserve tax advantages.
How RMDs affect which account you’ll withdraw money from
Required minimum distributions (RMDs) are the amount you’re required to withdraw from your traditional retirement accounts once you reach the IRS-mandated age. Currently, that age is between 73 and 75, depending on when you were born. You have to take the money whether you need it or not, and it can affect your taxes in a big way.
Once you get to the age where you’re required to take a distribution, the distribution can be very large and increase your taxes. Taking distributions from these account types earlier helps so you don’t get hit with a larger tax bill down the road.
How much can you safely withdraw in retirement?
The amount you can safely withdraw in retirement depends on the amount and type of investments you’ve set aside, life expectancy, inflation, and market conditions.
To calculate a sustainable withdrawal amount, divide your planned annual withdrawal by your savings. If you want to withdraw $40,000 and your portfolio balance is $1,000,000, divide $40,000 by $1,000,000. You get 4%, which is a generally acceptable distribution from your investments.
The bottom line
A lasting retirement nest egg is critical, and there are a lot of variables that can change the basic ideas outlined in this article.
To get a more personalized financial plan and view on retirement, Unbiased can connect you to a financial advisor. Get all your questions answered. Connect with an advisor today.