Stretching Your Retirement Dollars

People have a host of questions about retirement, but one they often fail to ask is, "In what order should I take money out of my nest egg?" It's an important question because the right answers can significantly stretch your retirement dollars.

When you retire, you probably will have several investment accounts to draw on for retirement: annuities, qualified retirement accounts such as 401(k)s and 403(b)s, individual retirement accounts (IRAs), and taxable saving and investment accounts. Which ones to draw on first wouldn't be such an important question, except for one major issue: taxes. Retirees are beginning to realize that taxes can eat up a big chunk of their retirement withdrawals, particularly if they are in a high tax bracket. An orderly withdrawal can minimize the tax bite.

The general rule of thumb is to start withdrawing first from your taxable investments. This provides two benefits. First, it allows the money in your tax-deferred accounts to continue to grow tax deferred as long as possible. That builds the pot faster than accounts taxed annually. Hopefully, most of your taxable investments will be long-term and you'll only pay at a maximum 20 percent on the gains, versus as high as 39.6 percent on previously untaxed funds you take out of retirement accounts. Secondly, your marginal tax bracket may be lower by the time you start taking money out of your tax-deferred accounts.

However, rules of thumb aren't always the best scenario. For example, your cash flow needs for retirement will have a significant impact on your withdrawal strategies. If you have a great pension and you anticipate modest retirement expenses, you may approach the withdrawal issue differently than if you are going to depend heavily on the money you've stashed in your nest egg.

Another factor will be how much, if any, of your assets you want to pass on to your heirs. Say you have taxable stock or other investments with large capital gains that you've accumulated outside of your IRA. It might be better to hold on to these taxable large-gain stocks if you want to leave money to your heirs. That's because the stock passes to your heirs at its market value as of the date of your death. This erases any capital-gains tax liability (they still count toward your estate taxes).

Withdrawals also need to consider asset allocation issues. Say you've invested most of your equities in tax-deferred accounts, while your taxable accounts have mostly bonds, CDs and other cash

equivalents. If you draw down taxable accounts first, your remaining portfolio becomes heavily weighted toward equities-and thus becomes more risky.

Even if you decide to draw first on taxable investments you've got some tough decisions. Assuming you have a mix of bonds, cash equivalents and stocks, you may want to tap into the lower-returning bonds and cash equivalents first if the stock portion is doing well. Letting stocks build up capital gains is essentially like letting funds grow in a tax-deferred account.

Most financial planners recommend that you keep anywhere from one to five years of cash-equivalents, such as low risk bonds and certificates of deposit (CDs), so you won't have to cash in as much stock in a down market.

Generally, the next move is to begin tapping retirement accounts that have been funded with after-tax dollars. This might include variable annuities and traditional IRAs you've funded with nondeductible contributions. However, you may not want to tap your Roth IRA yet, even though it's funded with after-tax dollars. That's because you don't have to pay taxes on the earnings and you don't have to start making mandatory minimum withdrawals beginning at age 70 1/2, as you do with a traditional IRA.

Eventually you'll need to begin tapping your tax-deferred accounts, if for no other reason than the mandatory minimum withdrawal rules (if you're still working, you won't need to begin withdrawals from a company plan regardless of your age). This also might be a good time to cash in your tax-exempt municipal bonds.

Again, keep in mind these are only rules of thumb, and there are many exceptions. This is a very complex area and you'll want to talk to your financial advisor before making irrevocable decisions.