Should You Always Withdraw from IRAs Last

SHOULD YOU ALWAYS WITHDRAW FROM IRAs LAST?

 

Conventional wisdom says yes, but there are exceptions.

 

Shouldn’t you delay IRA distributions for as long as you can? According to conventional retirement planning wisdom, you should structure your retirement withdrawals so that money comes out of your taxable accounts first, then your tax-deferred accounts, and then finally your tax-free accounts. Roughly speaking, that means withdrawing income from investment funds, CDs, money market accounts and bank accounts before taking a dime from your IRAs.

The wisdom behind this is easy to discern. By postponing withdrawals from a traditional IRA and/or Roth IRA for as long as possible, you give the assets in those tax-advantaged accounts even more time to grow. You have to take required minimum distributions from a traditional IRA after age 70½, of course; if you have a Roth IRA, RMD rules are inapplicable while you are alive.1

Or should you disregard that approach? Under certain circumstances, it may be a good idea to tap your IRA(s) in the early stages of retirement. While it may seem unconventional, making IRA withdrawals in your 60s might potentially help you enhance your wealth in the long term.

How, exactly? If you start drawing down the assets in your traditional IRA before age 70½, your RMDs could eventually be smaller than they would be otherwise. Smaller RMDs mean less taxable income. Not only that, a smaller RMD might keep you in a lower income tax bracket; welcome relief if you have a large traditional IRA.

Can exemptions & deductions shelter the income? A study from Rider University in New Jersey sees merit in this unconventional strategy. In the big picture, the researchers at Rider feel it may help seniors to level out annoying fluctuations in adjusted gross income and taxable income over the long run.2

The key: sheltering some or all of the early IRA withdrawals with IRS standard deductions and personal exemptions. As an example, take a married couple in which both spouses are at least age 65. The spouses have done their homework and determined that their IRS deductions and exemptions will add up to (at least) $21,800 for 2012. If their taxable income before any IRA withdrawal would fall below $21,800, they could use “withdrawals from tax-deferred IRAs to create tax-free income,” according to Alan Sumutka, one of the researchers behind the Rider study.2

The Rider study compared 15 model scenarios. Each one used a hypothetical married couple (both 65-year-olds) retiring in 2013 with $2 million in investable assets, $80,000 in current living expenses and $30,000 arriving from Social Security. Within the mock $2 million portfolio, 70% of the assets were held in traditional IRAs, 20% in taxable accounts and the rest in Roth IRAs. The portfolio returned a steady 6% annually (again, these were model scenarios).2

What was the most tax-efficient model scenario in the bunch? It played out as follows: from age 65 to age 70, the couple drew down their traditional IRAs right to the limit of their combined deductions and exemptions. Then, they reached into their taxable accounts for the balance of the money needed to meet that $80,000 in expenses, incurring taxes of up to 15% on long-term gains. They didn’t tap their Roth IRAs.2

After age 70½, they altered their approach: they took required distributions from their traditional IRAs, withdrew money from taxable accounts until those were exhausted, and then they turned to Roth accounts with the remaining balances on the traditional IRAs representing the last of their retirement savings.2

After all that, the hypothetical couple still had $1.61 million in their portfolio at age 95. The conventional withdrawal strategy (taxable accounts first, then tax-deferred accounts, then tax-free accounts) left them with just $1.17 million at that age, and it also led to them spending 23 years in the 25% tax bracket.2

The Rider study found that this approach was ill-suited to very large portfolios (ones with assets above $8 million) and portfolios with roughly 50% in taxable assets. It was also a bad fit for couples with sizable taxable pensions.2

It is worthwhile to review your retirement assumptions. As the American vision of retirement has changed in the last generation, so have retirement planning precepts. The recession and the financial pressures facing the baby boomers have upended some of the conventional thinking. A talk with a retirement planner may lead you toward some new financial options and some good ideas worth exploring.

 

Mike Fassi, CLU, CHFC  is a Representative with Centaurus Financial Inc. and may be reached at Fassi Financial, 970-416-0088 or mike@fassifinancialnetwork.com.

 

This material was prepared by MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. Marketing Library.Net Inc. is not affiliated with any broker or brokerage firm that may be providing this information to you. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is not a solicitation or a recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Required-Minimum-Distributions#3 [8/2/12]

2 – money.msn.com/retirement-plan/when-should-you-tap-your-iras [11/16/12]

Alternative Approaches to Retirement Planning

Alternative Approaches to Retirement Planning

Is the conventional wisdom for everyone?

 

Questioning traditional assumptions about retirement planning can be illuminating. Some retirement planners and economists argue that they need to be reexamined.

Does most retirement planning focus on the future at the expense of the present? One noted economist makes that case. Laurence Kotlikoff, the former White House economic advisor who writes for PBS NewsHour, contends that your retirement savings effort should be structured in a way that allows you to protect your standard of living today and tomorrow.1

A key question in retirement planning is “How much will you need to spend in the future?” Kotlikoff thinks the appropriate question should be “How should you gradually adjust your household spending as you grow older?” He argues that basing your retirement planning on a projected retirement income target is faulty.1

As an illustration, he references the example of what you do when you have errands to run before you catch a flight. The wisest thing to do is to start with your departure time and think backward. (How early do you have to be at the airport? How much time will you need to complete errand A and errand B? How much time should you allow for travel between A & B and after B?) This is what we usually do, and how we figure out when to leave home with enough time to accomplish everything. You plan by looking backward from the future.1

Kotlikoff thinks that typical retirement planning only looks forward. It projects an income target and implies that you have to save $X per year or per paycheck for X years to build a sufficient nest egg to generate that income. This amounts to mere guesswork, he believes, and invites two potential problems. One, if the retirement income target is set too high, you can end up saving more for retirement than you really need and injure your standard of living before retiring. Two, if the retirement income target is set too low, you can end up spending more than you should before you retire and saving less than you need. (And there’s another question. Will your household spending in retirement match what it was years before? Maybe, maybe not.) Kotlikoff thinks that lifetime spending and saving plans have more merit – again, planning by looking backward from the future.1

Is saving overrated? It is pounded home that Americans aren’t saving enough for retirement, but some people don’t think saving is the only step to retiring well. In 2013, retirement planner Joe Hearn (one of MarketWatch’s RetireMentors) posted a column noting several other tips to entering retirement in better financial shape. One, retire without debt. Two, retire with a paycheck (start a small business or work part-time). Three, don’t claim Social Security at 62. There were other pointers, such as retiring to a cheaper part of the country (or world) and going overseas for major surgeries. (As an example, the largest cardiac hospital in the world is India’s Narayana Hrudayalaya Health Center, which is highly regarded and charges about $2,000 for open heart surgery.) If you haven’t saved much for retirement, alternative financial moves like these (and others) could conceivably leave you with lower expenses and more money to live on or invest.2

Should you borrow money & invest it for retirement? This idea definitely isn’t for everyone; it was championed in 2010 by Yale University economists Ian Ayres and Barry Nalebuff. As twenty-somethings have time on their side but not usually a lot of money, Ayres and Nalebuff contended that young people would do well to borrow money and invest it in equities. You don’t need to see a loan officer to make this happen, as there are ways to do it through brokerages; a family loan could also be made pursuant to the same goal. As the risks are potentially major for borrower and lender, you don’t see many such arrangements.3

How about asking your employer for a second retirement plan? Some people have the leverage to pull this off. In particular, doctors and executives without much in the way of savings can make a valid argument that they need (and should have) a deferred compensation plan in addition to the usual qualified retirement plan, as Social Security payments won’t seem large enough when retirement comes. It helps, of course, if they have worked for the employer for quite some time. A reasonable benefit from such a plan would = number of years that the executive or doctor has worked for the employer x 2.0%.

With many people finding it a challenge to save for their futures, it isn’t surprising that these unconventional moves are getting a look.

Mike Fassi, CLU, CHFC  is a Representative with Centaurus Financial Inc. and may be reached at Fassi Financial, 970-416-0088 or mike@fassifinancialnetwork.com.

 

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – pbs.org/newshour/making-sense/make-your-standard-of-living-the-basis-for-all-financial-planning/ [3/31/14]

2 – marketwatch.com/story/7-alternatives-to-saving-for-retirement-2013-09-27 [9/27/13]

3 – money.usnews.com/money/retirement/articles/2010/07/06/3-unconventional-retirement-investing-strategies [7/6/10]