Saving for retirement was never a simple or thoughtless task.
Over the course of our working years we are encouraged to save for our retirement through a variety of accounts and products, each of which could affect your tax situation in many ways. Some accounts give you a tax benefit the year of your savings, while others forgo the tax benefit until distributions are taken in retirement.
If you think these decisions are challenging, imagine a world in which the more challenging aspect of saving money for retirement isn’t saving at all but rather distributing income from your investments.
If the average retiree waits until age 65 to retire, he or she must plan for the very real possibility that life (and spending) in retirement could last 30 years or longer.
From savings plan to income plan
The savings decisions that income earners make over the years directly impact the amount of savings they can draw from when they retire, and why should your income strategy in retirement be any different?
Saving for retirement can be made easier with the help of a retirement savings plan created with the help of a qualified team of planning professionals. So, too, can a retirement income plan clarify your family’s financial position in retirement and help you navigate the risks of unsustainable distribution levels, unintended tax consequences, and so much else.
Income planning can help you understand when to take income, knowing from which accounts to distribute that income, and how much income you could reasonably take without increasing the risk that you and your family live longer than your savings do.
Single sizeable sum
If retirees looking to receive a lump-sum distribution to replace a roof or to finish an addition, they will want to know that some retirement vehicles represent pre-tax savings and taxation that has been deferred over the course of the account’s growth. This means that taking a lump sum of $30,000 from a pre-tax Traditional IRA or a pre-tax 401(k) will result in $30,000 in income that is taxed at your family’s ordinary income tax bracket. Because of this tax treatment, if someone in retirement wants to trade up in family sedans but doesn’t want to take out a loan to do so, he may consider taking the lump sum out of post-tax accounts, as much of the account’s tax consequences may have already been realized and spread out over the past few years.
Spending in steady streams
If instead, the question about distributions from savings is in service of understanding the most reliable, cost-effective and tax-efficient way to receive monthly income to supplement pensions and Social Security, the thought process is different.
For those who already own and will benefit from pensions in retirements, you know the peace of mind that a guarantee of income can provide. But there is still hope for the growing number of workers who do not have the benefit of employer-sponsored pension strategies.
Some retirees will develop an “informal pension” for themselves by distributing a fixed monthly sum from their investments. The risk here is that a declining market could compound your investment losses if you regularly sell investments for lower and lower prices just to produce a monthly stipend. Ultimately, this might even put a retiree at risk of outliving his or her savings.
Rather than rely on strong market performance to meet monthly expenses, some investors choose to purchase investment products that almost entirely eliminate the risk of outliving one’s income. In exchange for a single, often sizeable payment, many insurance companies will guarantee you a stream of income for your life, for a guaranteed number of years, or some blend of both.
Tax benefit post-mortem
Much of retirement is planned around the fact that retirement ends in death. Because of this, investors must also consider which accounts represent the most tax-efficient transfer of wealth to beneficiaries. Certainly, some investments hold greater value through the promise of continued tax-deferral even after the owner’s death.
When planning how best to distribute income in retirement many investors partner closely with qualified investment and tax professionals so that those years spent saving aren’t squandered by a lack of proper income planning.
Anthony M. Conte is managing partner at Conte Wealth Advisors based in Camp Hill. He can be reached at firstname.lastname@example.org.
Registered Representative Securities offered through Cambridge Investment Research Inc., a broker/dealer, member FINRA/SIPC. Investment Advisor Representative Cambridge Investment Research Advisors Inc., a Registered Investment Advisor. Cambridge and Conte Wealth Advisors LLC are not affiliated.