Making the switch from the workforce to retirement is a significant shift, and not just from a mental/emotional/lifestyle perspective; while it’s easy to anticipate a change in how you spend your time, people often overlook the need to change their wealth strategy. You may be leaving your peak earning years, but that doesn’t mean your financial plan can switch to cruise control. Without considering factors like inflation, risk tolerance, retirement income, and taxes, you risk outliving your savings or losing the ability to leave an inheritance for your family. There are three things you need to keep in focus once your working years are in the rearview mirror: managing retirement assets, navigating withdrawals, and allowing for continued growth.
How to Manage Investments In Retirement
Even if you’re no longer contributing to your retirement accounts, those assets still have the capacity to continue generating returns, as long as you position them wisely. The opposite is equally true. Your assets could lose value, which means adjusting for your risk tolerance is an important priority, especially in the years immediately before and during retirement.
When you’re saving for retirement, you may have 30 years, 40 years, or even longer to let your investments ride out market fluctuations and grow. Historically speaking, the market trends upward, with a few highs and lows along the way. The longer you can keep your investments, the better the odds of seeing positive returns. Once you’re retired, you don’t have as much time to let your portfolio recover, which is why it’s important to analyze and adjust to lower-risk holdings. Typically, you should start adjusting your ratio of stocks to bonds at least three years before retirement. Once you’re retired, work with your advisor to rebalance your portfolio on a quarterly basis.
This can be quite the balancing act. On one hand, you want to be conservative enough to protect the longevity of your retirement savings. On the other hand, being too conservative can leave you vulnerable to the impacts of inflation. Consider: if inflation sits at 2.5% for the next 25 years, the spending power of cash that isn’t growing will be reduced by 46%. Put another way, if your investments aren’t earning at least a 2.5% return in this scenario, you are actually losing money, thanks to inflation. So, while you need to be risk-conscious, you can’t be entirely risk-averse. One common strategy is to use fixed income sources, like Social Security and dividend stocks, for your immediate income needs while using your other assets for growth and protection against inflation.
How to Plan Withdrawals In Retirement
Once you start withdrawing from your retirement savings, you’ll have to take enough to enjoy retirement but not so much that you erode the compounding power of your nest egg. It’s a good idea to start with a budget and determine what kind of monthly retirement income you need. Next, work with your advisor to determine how much you can pull from your savings each year. The 4% rule, in which you withdraw 4% of your entire portfolio each year and adjust for inflation, is generally considered a good way to help your savings last for 30 years. However, flexibility is the key to this approach; you don’t want to accidentally land yourself in a higher tax bracket. Additionally, if you’re withdrawing during an economic downturn, the cash value of that 4% may not be enough to cover your living expenses. This is why we recommend working with an advisor who understands your goals and financial situation, plus diversifying your retirement income to give yourself options.
Knowing how much to withdraw is one thing, but what about deciding where to withdraw from first? Retirement savings fall into three categories, depending on how they’re taxed:
Taxable investment income. Think brokerage accounts, which are subject to capital gains taxes. As long as the assets are held for at least a year, profits from selling will be taxed at 0%, 15%, or 20%, depending on your tax bracket (if they’re held for less than a year, they’ll be taxed as ordinary income).
Traditional retirement income. This is your traditional 401(k) or 403(b), IRA, or Rollover IRA, which are all subject to income taxes.
Income from a Roth IRA. Contributions to a Roth are after-tax; since you paid taxes on the funds before you put them into your account, you won’t owe any taxes unless you incur early withdrawal penalties.
If you expect to see significant growth in your taxable holdings, you’ll want to use those funds first to keep them from generating high capital gains taxes. For this situation, your advisor might recommend withdrawing from taxable accounts first, then from traditional accounts, and finally from your Roth. If that’s not the case, withdrawing some from all three accounts every year will be more beneficial from a tax perspective and can help your savings last a bit longer.
How to Position Retirement Savings for Continued Growth
We’ve established that your retirement savings need to grow at least a little bit in order to break even with inflation. But you don’t want to be too aggressive in your investment risk, and you don’t want to generate significant tax implications. So how do you balance both?
There’s no offense like a good defense, and managing retirement assets is no different. A savvy tax strategy is one of the best ways to protect your wealth; when you lose less to taxes, you have more to spend on your needs, meaning you don’t need to withdraw as much from your savings to support your lifestyle. While this doesn’t directly contribute to the growth potential of your savings, finding ways to save on taxes in retirement does allow you to leave more of your savings where they’re able to grow.
If it’s more efficient in the long run for you to pay taxes now rather than later, a Roth Conversion might be a good option. Another option is to examine how RMDs impact your tax bracket. If your required withdrawals from an IRA or 401(k) will push you into a higher tax bracket, consider lowering your taxable income, either through charitable giving or estate-planning strategies like establishing a trust.
Making the Most of Your Retirement
Once you retire, you need to think differently about your saving and spending habits. Working with a financial advisor who is invested in your long-term wealth journey offers a significant advantage; wealth preservation in retirement works best when you can lay the groundwork for wise strategies long before leaving the workforce. At CAP Northwest, we consider it a privilege to help you plan for every step of your journey, taking the stress out of financial planning as we work together toward your future goals. When you’re ready to step toward a new season, we’re ready to help you get there. Learn how we can help at https://capnorthwest.com/contact/.
