Many people do a great job of accumulating assets in their retirement accounts but give little thought to how they will tap into that money and manage it after they retire.
Here are the most common mistakes—and strategies for getting it right…
1 Mistake: Not using the minimum distribution rules. When you reach age 70 ½ , federal tax law requires minimum annual withdrawals from most retirement accounts. You must also pay the resulting income tax.
Failure to make these withdrawals results in 5% penalty on what should have been withdrawn.
Until a recent change in the law, you had to make an irrevocable decision about how your mandatory withdrawals would be calculated.
Under new IRS rules, retroactive to January 1, 2001…
- Retirees can use a formula that allows the least amount of money to be withdrawn each year. Divide the total amount in your IRA, SEP IRA and 401(k) retirement plans each year by a joint life-expectancy figure for you and a beneficiary assumed to be 10 years your junior-whether or not you have named a beneficiary or that beneficiary is older o younger than you.
If your spouse is the sole beneficiary and is more than 10 yeas younger than you, use your actual joint life expectancy.
You can find the government’s life expectancy / minimum distribution table in IRS Publication 590, Individual Retirement Arrangements, at www.irs.gov.
- You can change beneficiaries at any time.
- After your death, your beneficiaries have the option of passing on their inheritance to other people or charities.
2 Mistake: Withdrawing too much too soon. Just because federal law permits you to draw on your retirement accounts without penalty starting at age 59 ½ doesn’t mean that you should.
Tap taxable accounts first to keep tax-deferred investments growing. You will pay mostly capital gains tax on these withdrawals, but it is probably far less than the ordinary income tax you would pay on the retirement money.
If you must draw on your retirement funds, take only what you need in periodic withdrawals. Taking too much at once could push you into a higher tax bracket and reduce the amount remaining to invested tax-deferred.
Use your Roth IRA last—it does not have any minimum distribution requirements while you are living.
3 Mistake: Not starting—or not converting to—a Roth Ira if you are eligible. You may think you won’t live long enough to recoup the out-of-pocket tax cost of converting from a traditional IRA. But most retirees underestimate how long they’ll live… and you should be concerned about outliving your money. A Roth Ira is more flexible than a traditional Ira. Because it is not subject to income tax even after your death, your beneficiaries can let it grow subject to their required distribution rules.
4 Mistake: Investing your money too conservatively. Some clients have no equities in their retirement portfolios—just bonds, CDs and Treasury bills. If they run low on money in the future, they plan to reduce their spending. That may not be realistic. Very few people are comfortable reducing their standards of living.
Better: Determine your needs first. Then decide how much risk you must take, and adjust your stock-bond allocation accordingly. We suggest that our 65-year-old clients have a 25-year investment plan—which often leads to a healthy chunk in equities.
