Planning for retirement is important. Fortunately, 60% of working Americans are saving something toward their retirement.

Outliving Your Money In Retirement

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Do you know what the top concern is once people reach retirement? It’s the fear of outliving their income. Yes, they worry about running out of money. That’s why practical retirement withdraw strategies are important!

Are you still pretty far from retiring? Well, don’t go anywhere because this information can have an impact on you too! Understanding and planning your drawdown can have an effect on the age in which you retire and how much of a nest egg you’ll need to cover living expenses in retirement.

Retirement fund drawdown strategies can vary

There is not a one-size-fits-all solution for drawing down investments and spending in retirement. Oh, if only there was!

Lately, a number of people in the financial independence space have written about their retirement withdrawal strategies. (I’ve linked to a number of them near the end of this post if you want to check out how other people plan to manage their retirement spending.) Seeing their plans in writing has motivated me to type out our plan and share it.

Something of note about all these different strategies though: Most of them are future plans. But Karla and I are living it right now. A well-thought-out retirement strategy is key for us RIGHT NOW or we could potentially burn through our money way too quickly.

So, here it is: our Maximize Your Money retirement withdrawal strategy.

What do we consider retirement assets?

We don’t look at our total net worth as part of our retirement drawdown plan. For example, we don’t consider the values of our house or RV which are paid-for. I know that some people consider everything in their retirement withdrawal strategies but it’s our preference not to.

Additionally, we have money invested in a number of startups that aren’t included in our planning. (Decent chance we’ll never see that money again, but I believe it’s nice to support small startup businesses when you can.)

If something goes wrong with our plan(*) we can change our perspective on one or more of these assets, but for now we just ignore those illiquid items in the plan.

*Might something go wrong? (A short tangent…)

Honestly, financial planning is about ruthless prioritization and adjusting to life situations. There are no absolute guarantees. Investments might do better or worse than planned. We try to take care of ourselves but honestly have no idea what might happen to one of us in the future. We might want to travel more someday. Or we could get tired of traveling and cut that out of the budget.

We just don’t know for sure what the future will hold. Neither do you. And that’s okay.

Make a plan based on the best data available at the moment and make adjustments in the future as needed. It’s all you can do – and it’s perfectly fine.

Here is our retirement asset breakdown

Retirement Withdrawal Strategies - Our Asset Allocation

You can see we don’t own any bonds right now in our investments. We do hold about 10% in cash though. We also have about 1% of our money in an HSA account.

Why so much cash?

I’m glad you asked!

This is a key part of our retirement drawdown planning. Stock market corrections happen. In fact market down cycles happen every few years and tend to last 18-24 months on average. Before you get scared though, remember that, even with all these swings over the years, the market still has a cumulative average return of around 10%.

Retired investors need to be prepared for these situations. We don’t want to get caught in a market of under-valued stock prices and be forced to sell. To help us avoid that we hold between 2-3 years’ worth of living expenses in cash. When markets correct again we’ll sit tight and spend down our cash while waiting for the recovery to begin. Once the market recovery starts then we’ll draw from investments to replenish our cash reserves.

About the Health Savings Account (HSA)

We can technically spend from the HSA account anytime we have qualified medical expenses. But since the HSA works very similar to a Roth-IRA – no taxes on growth or withdraws in retirement – we’ll let that sit for as long as we can. We’ll also continue adding to this in the future as much as allowed.

Stocks: The best potential return but not for everyone

I’ve documented our specific investment portfolio here. You can see that we are 100% stocks to maximize the return and growth potential of our investment accounts.

This aggressive allocation isn’t for everyone though. Mathematically it is the best, but some people just can’t handle it emotionally. If you panicked and sold during any of the past downturns, 100% stocks isn’t for you. Investors who can’t ride out the swings without selling likely need to temper their portfolio with some bonds or other conservative investments.

The taxable breakdown of our retirement assets

Not all of our retirement money is in retirement accounts.

Here is how our allocation looks:

Retirement Withdrawal Strategies - Our Asset Tax Allocation

Retirement accounts: IRAs

Just under half of our money is invested in tax-favored retirement accounts. This is great because we got nice tax deductions when initially funding these accounts, and the balances are growing without generating taxable income. (Taxable income from investments? Yeah, like dividends.)

When money is withdrawn from these accounts during retirement the entire amount taken out is taxed as regular income. It makes sense since no income taxes were paid on it initially.

The downside to IRAs (and 401ks, etc) is that you cannot access the money prior to turning 59 1/2 without paying a penalty.

Someone with serious plans toward early-retirement – sooner than 59 1/2 – needs to keep this in mind. For early-retirement situations, the investor will want to find a balance between the tax-advantaged IRA accounts and accounts that can be accessed at any time.

Taxable investment accounts

The rest of the money is invested in a taxable investment account. Since we don’t hold any bonds, we don’t have interest payment income (which is taxed higher than qualified dividends).

We do pay taxes on dividends, but most of them are qualified dividends taxed at a low rate. Taxes are also due when investments are sold, but only on the amount of the GAINS. Since we paid taxes on the initial deposits we don’t get taxed on them again. Also, as long as we hold the investments at least a year they are considered long term capital gains and have a very low tax rate.

So what’s our 2.5-step plan during early-retirement?

1. First, we have our target amount. Since we budget we know exactly how much money we’ll need to support ourselves. For us, the annual budget target is $75,000.

2. Since we’re younger than 59.5 we’ll need to take that money out of our taxable investment accounts. The plan is to withdraw a year’s worth of living expenses and put it in our cash reserves each May.

2b. If the market is in correction mode (down 10% from peaks) we will pause withdraws and live off our cash. As mentioned, we hold 2-3 years’ worth of cash. It’s three years worth right after a withdraw and we spend it down over the next 12 months.

If the market is correcting, we have two years of cash to use – longer than the average time until a recovery starts.

3…. there is no 3 right now with our early-retirement plan. This will adjust some once we hit 59 1/2 though. More on that below.

Early-retirement tax planning

One thing that can get tricky is tax planning. We, of course, want to minimize the amount of taxes that we have to pay each year. The goal is to pay as little as legally possible.

Retirement Tax Planning

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We’re going to work with our accountant on the details of this, but here’s a high-level overview of our plan right now on taxes…

Since we don’t have any “earned income” right now, we start in a 0% tax bracket. We’ll have dividends that are taxed and any gains on investments we cash-in will get taxed.

Here’s the thing: If you are in the 15% tax bracket, long-term capital gains and qualified dividends are actually tax-free! Yes, a 0% tax on them (at least in 2017).

So the goal will be to minimize our income to stay within the 15% tax bracket and minimize taxes. Easy, right? Because we don’t have earned income.

Yes, but…

Roth conversions for tax optimization

A married couple filing jointly can have up to $75,900 (2017) of earned income and still be in the 15% tax bracket. We don’t have any earned income, so our plan is to create some. No, not by working, but by doing an IRA->Roth conversion.

Since money in an IRA was never taxed, when you withdraw it or convert it, it is treated as normal income for tax purposes. Our plan is to work with our accountant to determine the most we can rollover from an IRA into a Roth IRA and still remain in the 15% tax bracket.

I have a hard time thinking we’ll have future opportunities to pay less than 15%, so I’d like to “lock-in” that rate now as much as we can.

Why Roth?

Without getting too deep into Roth IRAs with this post, I’ll just summarize to say that money in a Roth IRA grows tax-free forever. Taxes are not owned when money is withdrawn beyond age 59 1/2 – not on the original money OR the gains. Roth-IRAs also don’t have required minimum withdraws as IRAs do at age 70.

So there are a number of reasons it makes sense to pad the Roth when possible.

What’s our plan during standard-retirement?

Once we hit 59.5 things change a little bit because we can access the IRA money when we want.

The plan mostly stays the same but we’ll spend more time figuring the best way to minimize taxes. Instead of rolling money into a Roth, we’ll take strategic distributions from IRAs – still trying to hold onto the 15% tax bracket.

Retirement Investment Growth

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Over time our investments will continue to grow – as will our dividends. This might create some challenges getting the $75k (inflation-adjusted) we need but staying in that ideal 15% tax bracket. I don’t know the answer just yet, but it will be a balance of drawing from an IRA, a taxable account, and possibly the HSA or Roth if a top-off is needed.

We won’t know the details until we get right to the point, but I know there will be a “best” (tax optimized) manor in which to draw down from the accounts.

What about Social Security?

Do you know how much you are on track to get in Social Security benefits? If not, check on this post that shows exactly how to estimate your benefits.

We’re aware of our potential benefits and our goal is to delay taking Social Security as long as possible. The difference in amounts from taking benefits at 62, 67 (our full retirement age), or 70 is huge. Current estimates show we won’t “need” that money, so we plan to defer it. That said, as mentioned above, plans could change and we might shift tactics. This is another area where we’ll have some buffer to adjust if needed.

What about you?

Do you have a retirement plan in place? Are you executing on it consistently? How about a drawdown plan for when you reach retirement? Share your thoughts below – we’d love to hear from you.