Is The 4% Withdrawal Strategy in Retirement Right For You?

Is The 4% Withdrawal Strategy in Retirement Right For You?

01/27/2022 Tags: Announcements, In the News


One of the most popular approaches to how much you can withdraw annually without running out of retirement funds has been the 4% rule.

Stated simply, you withdraw 4% of your retirement savings the first year and then increase that amount 1% to 2% each year to adjust for inflation.

It’s an easy strategy to follow. But lately, there’s concern that taking that approach won’t help you keep up with inflation or offer a predictable amount of income.

CHOOSING THE RIGHT ACCOUNT

Most experts agree that diversifying retirement savings across accounts with different tax treatments is ideal. But that’s where the consensus stops when it comes to which accounts to draw from first.

That’s when the recommendation of a financial professional who knows you and understands your needs and goals can help you plan the best strategy for you.

Let’s look at some examples.

WHEN ACCUMULATION IS A PRIORITY

You could withdraw from your investment accounts first. That gives you more time for assets to accumulate in your 401(k) and IRA accounts.

This approach lets you take advantage of tax-free compound earnings as long as possible.

Note: You will need to take your Required Minimum Distributions before any investment account withdrawals to avoid any penalties.

RMDS AND A HIGHER TAX BRACKET

Suppose you have substantial funds in taxable, tax-deferred, and non-taxed accounts. In that case, you run the risk of paying considerable taxes when RMDs hit.

By taking any additional retirement income from your Roth account, you can potentially avoid significantly higher capital gains tax than you would with the first approach.

AVOIDING AN UNEXPECTED TAX BILL

Withdraw a portion of your income from taxable (investment) and tax-deferred traditional and 401(k) accounts and leave any Roth IRA accounts for last.

This approach helps you avoid a potentially higher tax bracket — because of RMDS — during the middle of your retirement. Instead, you spread taxes more evenly across your retirement years for a more predictable budgeting process.

A CURRENT HIGH TAX BRACKET

With this approach, you pull from tax-free accounts when you’re in your highest anticipated bracket and from tax-deferred accounts when you’re in your lowest bracket.

Much like the previous strategy, the goal is to minimize your tax liability and balance tax payments over a longer period.

AVOIDING HIGH TAXES ON YOUR HEIRS

If you’re confident you’ll have enough money in retirement, it might be better to focus on the impact your estate could have on your heirs. By taking from Traditional IRAs and 401(k) s first, you can leave your Roth IRA to loved ones to minimize their taxes.

TAX-SMART STRATEGIES

Applying tax-smart strategies can help build wealth and safeguard your retirement no matter what type of withdrawal method you use. Some alternatives you might want to discuss with your financial professional include:

  • Using the fixed withdrawals method, you simply take the same amount annually as a flat rate or a percentage of your investments. This approach doesn’t account for inflation, however. If you need to withdraw money during a down market, you could deplete your income more quickly than you want. That’s when withdrawing from investment accounts first can help you accumulate more with compound earning in your retirement accounts.
  • The total return strategy means you take out enough living expenses for three to 12 months at a time. After that, you take additional funds only as needed. This strategy can help build assets, but it’s also subject to market risk and not an ideal strategy if you are uncomfortable with risk or don’t have enough to forgo withdrawals during a market dip.
  • The bucket strategy is a way of dividing retirement assets among three “buckets” — one for more immediate spending, one for money you’ll need during the next seven to 36 months, and one where you won’t need assets for at least two years. The first bucket holds extremely liquid assets like a savings account. The second bucket is moderately liquid such as a high-yield CD, and the third bucket is invested for growth in the stock market. Once the first bucket is depleted, you shift money from bucket No. 2 and so on. This approach splits the difference between safety and growth but can be time-consuming and difficult to apply without the help of a tax expert.

DON’T WAIT

Building a tax-smart strategy for retirement account withdrawals isn’t something that should wait until you hit retirement. Meeting with a financial professional now could significantly impact your overall wealth. Let us know how we can help.

Image of John Mitchell



MELANIE JOBGEN

Income Partner and CPA



Investment advisory services are offered through Avantax Planning Partners℠. Commission-based securities products are offered through Avantax Investment Services℠, Member FINRA, SIPC. Insurance services offered through licensed agents of Avantax Planning Partners. 3200 Olympus Blvd., Suite 100, Dallas, TX 75019. The Avantax entities are independent of and unrelated to CP Financial Services, LLP. Although Avantax does not provide or supervise tax or accounting services, our Financial Professionals may offer these services through their independent outside business. Not all Financial Professionals are licensed to offer all products or services. Financial planning and investment advisory services require separate licenses.



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