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Making your first retirement account withdrawal is like hitting most other financial milestones; This requires organization and planning.
The plan ensures that retirees make withdrawals with the intention of reducing taxes and avoiding penalties. Preparing ahead also helps preserve savings, reduce tax burden, and make the most of retirement income.
Here are three things retirees should do before making their first retirement account withdrawal.
plan ahead
Retirees should start by understanding their income needs, tax bracket, and timing of required minimum distributions (RMDs). Regular withdrawals provide flexibility, whereas RMDs are mandatory after a certain age and follow specific rules.
Tyler Meyer, Certified Financial Planner (CFP) and Founder retired to abundanceThat said, retirees should prepare by setting up a spending plan, consolidating and simplifying accounts and building a tax-advantaged cash reserve.
“Streamlining your finances by rolling an old 401(k) into an IRA can make withdrawals easier to manage,” Meyer said. “Keep 12 to 24 months’ worth of living expenses in cash or cash equivalents to avoid selling investments during a market downturn.”
Create an exit strategy
Next, you’ll want to make sure you have an withdrawal strategy set up. expert of us wealth managementOne financial advisory firm said one of the strategies retirees can consider is to withdraw 4% of their savings during the first year of retirement.
In later years, retirees can use the 4% as a baseline and scale the amount up to account for inflation. The advantage of this “4% rule” is that it works for most people in most markets and it is a financial goal that is easy to understand and achieve.
However, if other factors, such as anticipated retirement longevity or investment allocation, require a more customized plan, the 4% rule may have drawbacks.
“Estimate life expectancy and adjust withdrawal rates accordingly, keeping in mind that many people underestimate how long they will live,” Meyer said.
Additionally, Mayer recommended overlaying retirement income guardrails and running a stress test of the withdrawal strategy.
“The guardrail dynamically adjusts the withdrawal amount based on portfolio performance and spending needs,” Mayer said. “They provide structure while reducing the risk of running out of money. Run a stress test to model the withdrawals under different market conditions to see how long the portfolio will last.”
Consider Tax Implications
Making first-time withdrawals from your retirement account has significant tax implications depending on the type of account and your age.
“Many people are looking for ways to help reduce the taxes they will pay during their retirement,” said Andrew Bachman, director of financial solutions at Fidelity Investments. Article About the topic. “Timing is important. So how and when you choose to make withdrawals from different accounts — 401(k)s, Roth accounts, and other accounts — can affect your taxes in different ways.”
Traditional IRAs and 401(k)s are generally taxed as ordinary income. However, retirees under age 59 1/2 may have to pay an additional 10% penalty unless there are certain exemptions, such as disability or a court-ordered withdrawal to a former spouse or dependent.
Roth IRA withdrawals are tax-free if the account is at least five years old and the retiree is over age 59 1/2. If the timing of the first withdrawal does not meet these conditions, retirees can expect to pay taxes and penalties.
For retirees born after 1950, mandatory withdrawals from traditional accounts begin at age 73 and are taxed as ordinary income. If retirees aged 73 years and above do not withdraw from their account, they may have to pay a 25% penalty. Roth IRAs are exempt from RMDs during the lifetime of the account holder.
Meyer said retirees should start withdrawing from taxable accounts and then move to tax-deferred accounts.
“Save the Roth IRA for last to allow tax-free growth,” he said. “Adjust the order based on your tax bracket and income requirements for the year.”
Finally, Meyer suggested checking Medicare premiums and Social Security limits before making the first retirement withdrawal. Withdrawals could affect taxable income, leading to higher medical costs or higher taxes on Social Security benefits, he said.