When I began my journey of helping people navigate retirement over 15 years ago I quickly learned one of the most important things for a retiree is knowing that their income will be in their bank account on the specific date each and every month. Sounds simple, and it is for the retiree if the money is there and ready to be enjoyed! The truth is, a lot that goes on behind the scenes that we do to make it happen, or should I say, to make it happen correctly.
How you distribute income from your retirement nest egg is a huge factor in making your wealth last
Many retirees have several different types of accounts that make up their nest egg. I call these accounts buckets. There is the investment/taxable bucket, the Roth IRA bucket, Traditional/Rollover IRA bucket, and the cash bucket. To create income for a retiree we need to decide which bucket to pull from, or even what combination of buckets to pull from, to best generate the income desired. The reason for this is that each type of bucket triggers a different type of tax liability. Rollover IRA distributions are taxed as ordinary income. Investment accounts have capital gains. Distributions from a Roth IRA are tax-free. Plus there are many outside factors that must be accounted for.
Pensions and Social Security
These other sources are important to note. Pension income obviously increases your taxable income. Though some pensions are not taxed by your state. How you distribute your assets also plays a big role in how much of your Social Security is taxable. So, if you are doing it wrong, you could be paying too much in taxes.
Current tax rate versus potential future tax rate
Sometimes a retiree may initially have surprisingly low-income levels which means a low tax rate. This could present an ideal time to pull money out of the Traditional/Rollover IRA bucket at a favorable rate. This will also benefit you a little further down the road when your Required Minimum distributions kick in at 70.5 years of age.
Highly appreciated assets in investment accounts
Much research applies to the rule of thumb that taxable assets are best used first and tax deferred used last. How do highly appreciated assets factor into this and the potential for capital gains tax? Capital Gains impact your AGI which can impact taxes on Medicare premiums.
Balance of Tradition/Rollover relative to overall nest egg
As mentioned earlier, Required Minimum Distributions begin at 70.5 years of age for all Traditional/Rollover IRA’s and 401k’s (if you are not still working for the company). Having a large balance in your IRA may be a good thing but could be painful tax wise if you wait until 70.5 to distribute anything from that account. The overarching goal is to distribute assets as efficiently as possible. In other words, minimize the amount of taxes we pay and keep more of your money in your buckets. Paying close attention to all the different tax implications of distributing your assets can make a significant impact on the size and longevity of your nest egg.
There is a lot more than meets the eye when it comes time for a retiree takes their distribution. Thankfully our clients only have to worry about how to spend the distribution and not how to put it together.