In the course of my work as a financial planner, I deal with many individuals who are looking to retire within the next few years. Based on my experiences advising these clients over the years, here are some thoughts for you to consider as you approach retirement.
The $1 million in your retirement plan account is not really $1 million. Withdrawals from 401(k)s and 403(b)s and lump-sum distributions from deferred compensation or pension plans are fully taxable at ordinary income tax rates. Even assuming that you roll over eligible accounts (this excludes some types of deferred compensation arrangements), withdrawals from a traditional IRA are also subject to ordinary income taxes. Your $1 million might actually be closer to say $$750,000 or less. The point here is that you need to take taxes into consideration when planning your withdrawal strategy.
It is important to decide which accounts to tap first. If you have both taxable and tax-deferred accounts, you need a strategy for which accounts to tap first for withdrawals. Tapping only taxable accounts first, presumably with assets that may be taxed at lower capital gains tax rates, might seem intuitive. This is, however, not always the right answer. In some cases it might be wise to take some assets from tax-deferred accounts, depending both upon which tax bracket you are in and where within that bracket you fall. Many financial planners and tax advisers advocate “filling out” your tax bracket, which might involve tapping a tax-deferred account as well.
Should your investing strategy change the day you retire? This is one of the biggest myths I see among many pre-retirees. Moving into retirement should be seamless from an investing perspective. This is not to say that what you need out of your investment portfolio during retirement might not be different than when you were working. In fact, your needs likely will be different. We generally begin to adjust clients’ portfolios into retirement mode a few years prior to retirement. For most clients we want to have a layer of very liquid, low-risk assets to tap first so they will not have to sell equities in a down market. However, most clients also still need a growth component in their portfolio to combat future inflation and to help ensure that they don’t outlive their assets.
Social Security takes planning. If you take Social Security at age 62 today, you will lock in a permanent 25 percent reduction. This gradually increases to 30 percent for those born in 1960 or later once they retire. Planning in this area is more complex when a married couple is involved, especially if both are entitled to a benefit. I mention this to spur your thinking; the particulars are far too detailed for an article like this one. There is much information on the Social Security website as a starting point; you might consider seeking the assistance of a qualified financial planner here, as well.
Retirement planning isn’t easy. It takes work and a lot of thought. The planning and monitoring don’t end at retirement either. You will need to continually monitor your situation and make adjustments along the way as warranted.
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. He recently cofounded Retirement Fiduciary Advisors to provide direct investment and retirement planning advice to 401(k) plan participants. Follow Roger on Twitter and LinkedIn. Roger also blogs at Chicago Financial Planner.