Retirement Drawdown: Create a Retirement Withdrawal Strategy (2024)

YOU’VE WORKED HARD, SAVED, INVESTED — all with the goal of having enough to live the retirement life you want. As the day approaches, are you looking at the balances of your various accounts and thinking, “Now what?”

How much of your savings can you afford to spend if you want that money to last as long as you live? Which accounts should you consider drawing from first — your 401(k) plan account, your IRA, your taxable accounts?

You may have heard some broad guidelines about the “right” amount to withdraw each year and the optimal order for tapping your various sources of income. While there are often kernels of truth in these rules of thumb, they generally gloss over the fact that everybody’s retirement is different — and much too important to be guided by a formula. “You need to come up with a plan for drawing down your income that’s based on your own unique priorities and goals,” says Ben Storey, director, Retirement Research & Insights, Bank of America. “Creating that plan requires you to be thoughtful about what your expenses are going to be and about how you’ll allocate your resources.”

As you consider your personal equation for drawing down your retirement income, three primary questions are worth asking:

1. How much can I spend each year without jeopardizing my savings?

According to one oft-quoted rule of thumb, retirees should look at tapping into about 4% of their savings annually. But that’s just a rough guideline, and one that doesn’t take into account variables such as the age at which you’re retiring and whether your income needs will change as you age, Storey says. “The younger you are when you retire, the lower the percentage you’ll be able to spend each year if you want your savings to last throughout your lifetime,” he says.

Because the likelihood of your money lasting depends on a delicate balance between the rate at which your investments appreciate and the rate at which you withdraw income from them — to say nothing of inflation — your withdrawal rate is in some ways a reflection of your confidence that your investments will continue to grow, or at least not shrink relative to your withdrawals.If you’re comfortable investing more aggressively, you might decide to take a little more income each year. On the other hand, if you desire less risk, you might opt for a lower withdrawal rate. It is important to remember that investing involves risk, and there is always the potential for losing money when investing in securities.

Other factors may come into play as well. Some years you might plan to withdraw more in order to realize a long-cherished goal like travel, for instance. Or you might have healthcare needs that dictate a higher spending rate. Your plans should be flexible enough to accommodate a variety of needs at different times.

2. What’sthe order in which I should tap into my retirement accounts?

In this case,the conventional wisdom goes that you should withdraw from your taxable accounts first, then tax-deferred, then tax-free. That’s because the money you take from a taxable account (such as a brokerage account) is likely to be taxed at the rate for capital gains or qualified dividends. Though that rate varies depending on your tax bracket, it’s generally lower than what you’d pay on ordinary income from 401(k) plans, traditional IRAs and other tax-deferred savings.“Tapping taxable accounts first gives the other accounts the potential to continue growing, shielded from current taxes,” Storey says.

Even if you don’t feel ready to start withdrawing funds from your traditional IRAs and qualified retirement plans, the government generally requires you to do so once you reach age 73.1The amounts of these required minimum distributions, or RMDs, will vary from year to year, depending on the value of your retirement accounts and your age. Failing to take an RMD, or taking an insufficient amount, can result in costly additional taxes. However, if you are still working past the required age to start withdrawing, you can generally delay taking annual RMDs from your current employer’s qualified retirement plan accounts until April 1 of the year after you retire, unless you own more than 5% of that company.1 RMDs are one reason to consider drawing from tax-deferred accounts before taking federal tax-free qualified distributions2 from a Roth IRA or Roth 401(k) account. Roth IRAs and Roth 401(k) accounts don’t require RMDs, so you can keep money — and potential growth — in your account. What’s more, if there’s anything left over in your Roth IRA or Roth 401(k) account, it can be passed on to your heirs, who may be able to draw federal (and potentially state and local) tax-free income from it. Some heirs, such as surviving spouses, may be able to withdraw from the inherited Roth account during their lifetimes; other heirs may be required to withdraw all funds from the inherited Roth account within 10 years.3

While the guidelines for withdrawing income offer a reasonable starting point, Storey says, you’ll also need to look at your unique situation. “It’s helpful to have some flexibility in the way your income might be taxed,” he says. For example, if for some reason you were going to be in a higher-than-usual tax bracket one year — if you realized a significant gain from selling a small business but you still needed additional income, say — you might like to have the option to draw federal (and potentially state and local) tax-free income from a Roth IRA or Roth 401(k) account.

3. When should I claim Social Security benefits?

Delaying the start of your Social Security benefits until age 70 may give you a larger monthly payment than if you claim them earlier, and future survivor benefits for your spouse may be greater.4 But,Storey notes, “after considering all of their options, some people might decide not to wait.” If you are single (or married and survivor protection isn’t a factor) and have a health condition that could limit your life span, for instance, it could make sense to start drawing your Social Security income immediately. And depending on your situation, drawing this income sooner could help you cover essential expenses during retirement, limiting the need to tap other savings.

Complex rules about spousal benefits could also come into play, he adds. “I worked with a couple recently who almost missed out on more than $50,000 in retirement benefits. They were both age 67 and the husband was waiting until age 70 to collect to maximize his retirement benefit and survivor protection for his wife. His wife did not realize that she could collect her $1,400 monthly retirement benefit for three years while she was waiting for her husband to file and then start collecting her $1,750 monthly spousal benefit,” he says. “That adds up.”

As you work out a plan for drawing down your retirement income, “it’s important to work with your financial advisor and your tax advisor to know all your options, and to take your personal situation into account,” Storey says. “You can look at rules of thumb to get a general idea, but you’re different from anyone else, and your differences need to be factored into any thoughtful decision.”

¹ The required beginning date for RMDs is April 1 of the year after you turn age 73. You are required to take an RMD by December 31 each year after that. If you delay your first RMD until April 1 in the year after you turn 73, you will be required to take two RMDs in that year. You may be subject to additional taxes if RMDs are missed. Please see your tax advisor regarding your specific situation. For more information about taking RMDs from your employer-sponsored retirement plan account if you’re still working, review your employer’s plan’s highlights or the most recent Summary Plan Description..

² Generally,because contributions to a Roth IRA or Roth 401(k) account have already been taxed, they can be taken as tax-free distributions at any time, but investment earnings distributed are subject to federal (and possibly state) income tax unless taken as part of a qualified distribution. For a Roth IRA, a qualified distribution may be made after a five-year period has been satisfied (this period begins January 1 of the tax year of the first contribution or the year of the first conversion to any Roth IRA, if earlier) and you are age 59½ or older, are disabled, or bought, built or rebuilt a first home (lifetime limit of $10,000). In situations where the original account owner is deceased, distributions to the beneficiary are also considered a qualified distribution. The qualified distribution rules for Roth 401(k) accounts are similar, except that withdrawals to build or rebuild a first home are not qualified distributions. If you take a nonqualified distribution, the earnings portion of such distribution is subject to regular income taxes, plus a 10% additional federal tax (in addition to possible state additional taxes) if withdrawn before age 59½, unless an exception applies.

³EffectiveJanuary 1, 2024, the SECURE 2.0 Act has eliminated RMDs for designated Roth accounts during the lifetime of the owner.

⁴Youcan begin receiving Social Security retirement benefits as early as age 62, but the benefit amount you would receive is less than the amount you would receive if you were to wait until your full retirement age to begin collecting. The year and month you reach full retirement age — when you become eligible for unreduced Social Security retirement benefits — depends on the year you were born. To find your full retirement age, go to https://www.ssa.gov/benefits/retirement/planner/ageincrease.html.

Investing involves risk. There is always the potential of losing money when you invest in securities.

Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

This material should be regarded as educational information on Social Security considerations and is not intended to provide specific Social Security advice. If you have questions regarding your particular situation, please contact your legal or tax advisor.

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