After a lifetime of accumulating savings, you’re nearing retirement’s door. “Now what?” you might ask. You might wonder when you can begin taking distributions from your retirement account or how much you can safely withdraw from your retirement portfolio. Or you might have questions about paying taxes, now that an employer is not taking them out for you with each paycheck. For many people, the transition from being in an accumulation mode to a spending mode can be scary. Below are a few “rules of thumb” that can be useful when thinking about your retirement distributions from your Traditional IRA.
When can I begin taking distributions from my Traditional IRA?
Distributions from a Traditional IRA can be taken any time, but your age at the time of the distribution is important. Your distribution will be included in your taxable income and it may be subject to a 10% additional tax if you’re under age 59 ½. Because of the 10% penalty tax, it is best to wait until after the age of 59 ½ to begin distributions, if at all possible.
Once you reach the age of 70 ½, you are required to take distributions from your Traditional IRA. The amount of your required minimum distribution (RMD) is determined by your account value on December 31st of the previous year and your age. Your account value is divided by a number provided by the IRS and is based on actuarial data for life expectancy. Consult your tax advisor or advisor for help in calculating your RMD.
How much should I take from my retirement account each year?
William P. Bengen published research in 1994 putting forth a theory that a retiree could be reasonably sure that his money would last his lifetime if he withdraw approximately 4% of his retirement portfolio in the first year of retirement and adjusted the amount annually for inflation. This research prompted a new rule of thumb in the industry, which became known as the 4% rule.
Over 20 years later, many in the industry still believe that a withdrawal rate between 3 and 4 percent is a “safe” withdrawal rate, meaning the client is unlikely to outlive his or her money.
Using 3 to 4 percent as the withdrawal rate, a person with a nest egg of $500,000 at retirement could plan to withdraw $15,000 to $20,000 in the first year, and modify that amount up or down each year, depending on the inflation rate.
It’s important to remember that as people live longer, it requires more money over time to support them. It’s called longevity risk. Longevity risk could mean that retirees should withdraw less to ensure the money lasts longer.
Determining how much to withdraw is critically important, and is a decision that should not be taken lightly. After all, it’s a decision that impacts your financial security for a lifetime.
How do I pay my taxes in retirement?
Most money from your IRA will be taxable. Our tax system is a “pay as you go” system, where we are required to pay taxes on income as it is received. There are two ways to pay your taxes once your employer is no longer taking taxes out of your paycheck. One way is to ask your IRA custodian to withhold federal tax from your distributions. Another way is to pay quarterly estimated taxes to the IRS, either directly to the Treasury online or by mailing your payment to the IRS.
Andrea L. Blackwelder, CFP®, ChFC and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with Wisdom Wealth Strategies.