One of the biggest challenges when it comes to retirement planning is ensuring that your savings last as long as you live. This is becoming even more important as some people choose to retire earlier than the traditional retirement age of 65 and average life expectancy in the U.S. increases.
For example, U.S. men can now expect to live to an average age of 76, while women can expect to live to an average age of 81, according to the National Center for Health Statistics.
Asset Withdrawal Order Matters
The order in which you withdraw funds from your retirement savings accounts can have a big impact on whether or not your savings will last throughout your retirement. One common strategy is to claim Social Security benefits as early as possible, which is generally age 62, and then liquidate investments with the lowest tax impact first to generate additional income as needed.
With this strategy, you would tap nonqualified funds first and wait until later in retirement to tap funds from qualified accounts like IRAs and 401(k)s. However, new research indicates that it might be better to wait until reaching full retirement age to claim Social Security benefits and use funds from qualified accounts to bridge the financial gap while waiting to claim Social Security.
Sequences of Spending
There are three main sequences of spending when it comes to tapping retirement funds:
- Social Security first — This is the sequence described above in which you would claim Social Security benefits sometime between age 62 and your full retirement age. You would tap nonqualified assets to supplement reduced Social Security benefits for as long as possible while waiting to tap qualified assets as needed for income or to meet required minimum distributions (RMDs) when you turn 70½.
- Qualified funds first — Here, you would delay receiving Social Security benefits until full retirement age, or even age 70½ , in order to maximize the monthly benefit amount. You would withdraw money from qualified retirement accounts to meet retirement living expenses before claiming Social Security benefits and wait until later in retirement to withdraw nonqualified funds.
- Roth IRA conversion — With this strategy, you would delay receiving Social Security benefits until full retirement age or later and perform annual Roth IRA conversions to the extent that they don’t increase your effective marginal tax rate. You would use nonqualified assets to meet retirement living expenses before claiming Social Security benefits and pay taxes resulting from the Roth IRA conversions, and tap qualified funds to meet RMDs at age 70½.
Which Sequence is Right for You?
The right sequence of spending will depend on a variety of factors that are different for every individual and couple. In particular, you should weigh the relative importance of these three retirement financial goals:
- Portfolio longevity, or extending the life of your portfolio throughout your retirement.
- Sustainable income, or maintaining your pre-retirement standard of living in retirement.
- Legacy planning, or preserving assets to pass on to your heirs.
Carefully weighing your sequence of spending options can go a long way toward helping ensure that you meet your retirement saving and spending goals.