Retirement is something many people look forward to. They finally no longer have to go to work everyday, so that somebody else can make millions. They can finally enjoy long lie ins, have breakfast in the garden at a leisurely pace, and get rid of the car that they have commuted in for so long. Retirement is a time to enjoy, spending time with those who matter, doing things you actually want to do.
Unfortunately, retirement is expensive. After all, you suddenly stop receiving the income you have enjoyed for so long. So, while retirement is a time to be congratulated on, and something to enjoy, it can also be a very frightening time. You suddenly have to completely rethink where your money is going to come from, and how you will make sure that there is enough to enable you to actually enjoy the fact that you no longer have to work.
Where Will Your Money Come From?
Once you retire, there will be multiple sources of income available to you. Social Security is one of them, which everyone is entitled to. In addition, you may also have taxable savings, pensions, investment accounts, and tax-deferred savings accounts, such as the IRA and the 401(k). But with all those sources of income, you need to figure out which one you want to withdraw from, for which bills, and when. After all, the goal is to make sure that your nest eggs sees you through until you pass away, and perhaps even leave some behind for your children. While nobody is expecting you to suddenly become a financial advisor in your old age, you do have to learn a little bit about investments so that you can use them in a tax efficient way as much as possible.
Spend Your Money Wisely
As a rule of thumb, you should always spend money that you hold in investments first. This is money that is completely taxable. Definitely spend that moey before you dip into your IRA or 401(k), which are both tax-deferred saving accounts. In fact, before you touch your 401(k) or IRA savings, you should use any savings that you have first, again starting with those on which you pay tax, then moving on to the ones on which you don’t pay tax. If you do this, and you can live on that for long enough, you can wait with collecting Social Security until you are 70. If you can do that, the monthly benefit you will get – for life – is the highest possible.
Just to complicate things a little bit, however, there are actually situations in which you should start withdrawing from your IRA or 401(k) before you other savings, such as:
• If you have heirs who are in a high tax bracket, but you are in a low one. In that case, your IRA money will be worth more now than latter.
• If you have reasons to shrink your IRA. An IRA must be withdrawn by the time you are 70 and a half. If you have a lot of money in there, you will have a huge withdrawal, which means you will have to pay more taxes on any Social Security you receive. In that case, withdrawing some of the money now, shrinking it down, is a good idea.
• If your tax bracket is at 15%, you may want to consider taking money out of the IRA or 401(k) stock funds, even if you aren’t short on cash. You will have to pay income tax on it, and it may be better to do that now. The money can then be reinvested using a taxable account such as a Roth. This means that, if the value rises, it will be taxed at the capital gains rate, which may be lower than your income tax.
• If you have multiple accounts, some of which are tax deferred and others that are taxable, using these for a long term investment. In that case, make sure your stocks remain in the taxable account. In so doing, you make sure that you pay low capital gains tax on the profits that you make. Bonds, which are taxable, including Treasury funds, should be in your tax-deferred option. This is becomes income made from interest is taxed the same way as regular income.
• If you have a tax-deferred IRA and a Roth IRA, you should spend the tax-deferred one first. This is because the Roth will grow tax free, so it is better to leave it growing for as long as possible. The exception is if you are currently in a high tax bracket, but you expect this to go lower in the future.