You might think you should draw straight from your taxable accounts as soon as retirement comes around. And while it’s usually a good idea, it isn’t the best strategy for everyone.
Tax deferral is appealing for obvious reasons, causing retirees to draw from taxable accounts first. However, it shouldn’t be considered a rule of thumb. Instead, deciding which accounts to tap first requires thinking about specific investments and the accounts’ characters.
By considering the above, Kevin Canterbury explains that you can make educated decisions related to risk tolerance, income needs, and timeframe.
#1 The Cash Bucket
First, you should start by creating a cash bucket containing two to five years of living expenses. Put the money in liquid investments like Treasury bills, market funds, CDs, or short-term bonds.
Diversified portfolios can be volatile. So, ensuring you have a well-filled cash bucket reduces risk by giving you guaranteed mortgage and grocery payments.
Set aside whatever cushion is necessary before building your retirement portfolio. You’ll have to replenish the bucket every year, at which point you must decide which accounts to tap.
#2 Minimum Distributions
At 72 years old, you must begin taking minimum distributions. The problem is that the larger your account, the bigger the distributions and tax.
Before turning 72, you can optimize withdrawals to achieve the perfect balance between enough income and low tax. After 72, you probably won’t have that control.
If your account is considerable, you might fall into a higher tax bracket, meaning you pay more tax than if you’d drawn down earlier and paid tax sooner at a lower rate.
#3 Growth Stocks
You can achieve tax deferral with a taxable account by purchasing and holding growth stocks. If your risk tolerance is high enough, you could technically turn the taxable account into a tax-deferral machine and receive income from the IRA.
Depending on your assets, you won’t need to sell your growth stocks, making your heirs ultra-happy as they won’t owe capital gains tax on the appreciation experienced during your life.
That said, if you’re highly risk-averse, you probably want a mostly income-oriented portfolio (i.e., bonds or high-dividend stocks). In this case, you can take retirement income from the taxable income inside the taxable account. This will postpone taking minimum distributions, provided you’re under 72 years of age.
#4 Roth
You should save your Roth IRA for last. Why? Because there aren’t any minimum distributions at 72. Let it sit for as long as possible for the best results.
Arguably, deciding whether to convert your Roth IRA is one of the most crucial parts of your retirement plan. Once established, you shouldn’t touch the money unless you have no other resources.
Many people find it helpful to discuss this aspect with a financial professional — and we suggest you do the same.
The Bottom Line: Be Aware of Regulatory Alterations
At the end of the day, you may have to change your course of action as the law and regulations change. But as long as you consider your income needs, risk tolerance, estate planning, and tax environment, you’re bound to tap the right accounts first.
