When you shift from saving for retirement to spending in retirement, your financial strategies need to change… but your plan for retirement withdrawals could be full of trap doors! Do you what to look out for? Trapdoors can be hard to spot – you’re moving through life thinking you have got it handled, and then wham! You hit a trapdoor. Joe Anderson, CFP®, and Big Al Clopine, CPA, help you identify and avoid those trap doors when it comes to withdrawing money from your portfolio in retirement.
Withdrawal Trap Doors
- Withdrawal Basics
- Withdrawal Rates
- Withdrawal Location & Order
- Market & Inflation Impact
- Tax-Smart Strategies
Important Points:
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- 0:00 – Intro
- 1:42 – Withdrawal Trapdoors
- 2:56 – Withdrawal Basics
- 3:10 – Trapdoor: Self-Managed Portfolio
- 5:53 – Tax Brackets
- 5:24 – Successful Withdrawal Rates
- 7:15 – Withdrawal Rule: 4%
- 8:23 – Download Guide: Withdrawal Strategy Guide
- 9:16 – True/False: In 2022 a single taxpayer making $100K will be taxed at 24% tax rate
- 9:23 – Marginal vs. Effective Tax Rate
- 10:10 – Traditional vs Proportional
- 13:00 – Trapdoor: Market Performance
- 14:45 – Download Guide: Withdrawal Strategy Guide
- 15:28 – Ordinary Income vs Capital Gains
- 18:34 – Roth Conversions
- 20:22 – Ask the Experts: I retired a year ago, but now I’m worried with the changes in the market that my portfolio is based on old market realities. How often should I rebalance in retirement?
- 21:28 – Pure Takeaway
- 22:36 – Download Guide: Withdrawal Strategy Guide
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Transcript:
Joe: The strategies you use to save money for retirement need to change when you start withdrawing money for retirement because there’s a ton of trap doors. You know where to find them? The show is called Your Money, Your Wealth®. Joe Anderson here, CERTIFIED FINANCIAL PLANNER™, president of Pure Financial Advisors, and of course, right over there is the big man Alan Clopine. How are you, sir?
Al: I’m doing great. Good to be back.
Joe: Look out for trap doors. They’re everywhere, folks. When you look at retirement, how many of you are going to succeed? Not many. According to the employee benefit research institute, 40% of people from 35-64 will run out of money in retirement because they’re falling through these trap doors. Don’t let that be you. That’s today’s financial focus. According to Vanguard–interesting study here–for those of you that have a financial strategy in place, 7 in 10, right, will have their income increase by 23% just by having a financial strategy. Let’s have a professional help us get that strategy for you. Let’s bring in the big man.
Al: OK. Today we’re gonna talk about withdrawal strategies, or better yet, I guess we’ll call it withdrawal trap doors. So number one, let’s get into the basics and the strategies. Let’s talk about tax-efficient or tax-smart strategies. We’ll get into withdrawal rates, how you should think about it, and then finally, the market. The market can sort of have an impact here on your withdrawal strategies. So, Joe, I think this is a topic that’s not talked about a lot. We talk a lot about saving for retirement, but now what do you do when you’re retired? This–a lot of people need to know this.
Joe: Right? It’s a whole new ballgame.
Al: It is.
Joe: You know, it’s all right. When I’m saving money, I’m accumulating, I’m seeing my account grow, but then once you transition into retirement and start taking some withdrawals here, the whole ballgame is completely changed. You’re almost playing a different sport. Let’s get into the basics here. First thing that you have to do is you’ve got to determine what is your spending number, what’s your number, how much money that you want to maintain as a lifestyle for the rest of your life. This could be a monthly, quarterly, annual number. That’s the first step. Then you have to select your strategy. We’re gonna go through a few different strategies in regards to how to create that income. You got to look at your location and order. What we mean by that is where is the money held? Is it in a tax-deferred account? Is it in a brokerage account, maybe a Roth account? Maybe it’s just sitting in cash, and then what order of distribution are you gonna take? And then finally, what assets are you gonna sell? You gonna sell stocks? Are you gonna sell bonds? Are you gonna withdraw cash? I mean, this is the basics, but even going through this, it sounds complicated. What is this? Ha ha!
Al: So, but, yeah, I mean, step one is to figure out how much you need, right, to save. Now, we’ve talked about that at length in other shows, so today we’re gonna talk about you got your nest egg. Now what do you do to create a withdrawal strategy?
Joe: You know, looking at the basics here, Al, just–this is basic, right?
Al: Ha! That’s really basic. Ha ha ha!
Joe: Ha ha ha! It’s like a maze. It’s like, “oh, my gosh!” you know, you miss one step, boom, you’re out the door.
Al: You’re done.
Joe: You’re done. You are done. So let’s say you’re retired. This is kind of the steps that you have to take step by step. First step, open your account.
Al: OK. I like that. I can figure that out.
Joe: OK. Are you on track?
Al: You know, you go to your bank or you go to your custodian or, you know…
Joe: Go online, go to Vanguard, do whatever you want to do, right? Then you got to transfer the money in the account.
Al: Yeah, and that could be a transfer from your non-retirement account to another non-retirement account that has investments, maybe savings, right, or maybe it’s your, your 401(k). Maybe you want to roll that to an IRA. So you’ve got to get those accounts established and get the money in them.
Joe: Right. So some people have multiple 401(k)s, multiple IRAs. A lot of times people would like to consolidate, so you want to roll over, transfer money in here. Then you have to get your investment strategy, how much money you want in stocks versus bonds, what risks do you need to take to make sure that you can provide the income that you need so you don’t run out of money, but you don’t want to take on too much risk, as well, because in volatile times as you’re taking money out, it could be a tough time to get the money back, and then you’ve got to manage it ongoing, right?
Al: Well, you do, and deciding on the investments, that can be a little bit tricky, and so what we suggest is you take a look at what your needs are, what your goals are, how much do you need to spend, what’s your spending minus your fixed income like social security. That’s your shortfall. Figure out how much rate of return do you need out of your portfolio to make this happen. Get those investments then right and then manage them so that you keep the right balance.
Joe: And that’s when–the management of all of this is when to sell the investment, right? Because you need income. So let’s say here you already know you need $40,000 a year. So 40,000 has to come from the investment. Are you gonna sell, are you gonna take dividends, are you gonna take interest? Is that gonna be enough, or what investments do you sell to create that income and then transfer that, like, right into your overall checking account? So here’s the cycle of your distribution.
Al: OK. All right.
Joe: But if you trip up one…
Al: You’re in the trap door.
Joe: You’re done, you’re done, right? Question for you. What percentage can you take from your overall portfolio? What do you think, Big Al?
Al: Well, we talk a lot about the 4% rule, so maybe that’s a place to start, but the real answer is it depends, and so, Joe, let’s go over some different scenarios.
Joe: So it looks like 3 different investors here. You’ve got a conservative investor, maybe you’re a balanced investor, or maybe you’re a growth or like that risk. So it’s like, all right, well, here percentage of failure or percentage of success. So if I’m looking here, I want a 99% success rate. If I’m a conservative investor, you could probably take 4% out of your distribution–you know, 4% distribution. If you’re a little bit more growth-orientated, probably only want to take 3. Why is it lower, al?
Al: Yeah, that’s a great question because you should have greater rate of returns in a growth portfolio, but what happens if the losses occur right at the beginning of your retirement? It’s very hard to recover. So that’s why when you’re talking about a 99% certainty, Joe, you’ve got extra risk there.
Joe: Yes, well said because if that market drops 50%, hypothetically, right, and if I get a 50% rate of return the next year, I still don’t have my money back. I need 100% rate of return just to break even, and if I’m taking dollars from that portfolio, it’s very difficult for me to get caught up. So if you want that 99% certain and if you’re a growth investor, you probably want to take a little bit lower distribution. Now, if I say, “you know what? 50-50. I don’t care. I want to spend a lot more money. I don’t care if I run out,” well, now you can get into some higher numbers here.
Al: Well, you can, and then it’s a lot more than 4%, right? You get up as high as 7% into a growth portfolio, but just realize that’s a 50-50. That’s a toss of a coin. Either you succeed, or you don’t, so just be aware of that.
Joe: So here’s a little easier rule of thumb. We talk about 4%. You don’t want to roughly take out any more than 4% if you want to stay in that 90 percentile. So if you’re assuming a 6% rate of return and you have $1.5 million, likely you don’t want to pull out any more than $60,000 from that portfolio in any given year. If you have 5 million like Big Al…
Al: Ha ha ha!
Joe: Right. Big Al can spend some bucks. He’s got a big wallet. That’s why we call him Big Al. He can spend 200 grand, right? But think about it. You’ve got $5 million. You would think you could spend a heck of a lot more than $200,000.
Al: Well, you would, and that’s what’s so confusing about this, and I will also say the date, the time, the age that you retire is a big factor, too, right? If you retire in your 40s and 50s, 4% is way too high. You’re gonna be endangering running out of money. On the other hand, if you if you retire at 75, you could probably take 5% or 6% out, so it just depends upon a lot of factors.
Joe: Hey, folks. We’re just getting started. If you need help, go to yourmoneyourwealth.com, click on that special offer this week. It’s our “Withdrawal Strategy Guide.” if you’re transitioning into retirement and you need a strategy to figure out your withdrawals, go to our website, yourmoneyourwealth.com. Click on our “withdrawal strategy guide.” that’s our gift to you this week absolutely free. We’ll be right back. The show is called Your Money, Your Wealth®.
Joe: Hey. Welcome back to the show. The show is called Your Money, Your Wealth®. Big Al, Joe Anderson. We’re talking about withdrawing your money and avoiding those trap doors. If you need help, go to our website yourmoneyyourwealth.com. Click on that special offer. It’s our “withdrawal strategies guide.” if you’re looking for a strategy to take distributions from the wealth that you’ve created, go to our website, grab our guide. It’s free of charge. Yourmoneyourwealth.com. Click on that special offer. Now let’s see how you did on that true-false question.
Al: True or false? Well, it’s false. The traditional method is not the best method for taxes.
Joe: Traditional versus proportional. So in here, we’re assuming they’re taking money from their brokerage account, their taxable account, cashes, your cash account because it’s–you don’t want to pay tax, so a lot of advice for many, many years was always defer the tax. Defer, defer, defer, defer, right? You don’t want to pay tax until you absolutely have to and only take the RMD out. Well, I think that advice is flawed because still a lot of people need to live off their retirement accounts, and so–and then tax rates were going sky high, right? And now tax rates have gone down, and it’s like, ok, well what do we want to do? And then now tax rates are gonna go back up. So it gets a little bit more confusing today, but if you took your taxable account and then you waited to take your tax-deferred account and last you took your tax-exempt or your Roth account, you’re probably not very tax-efficient. This is taking an equal portion from each, and this is probably not even very good either.
Al: Yeah, that’s not a great idea either. So the better solution really is to look at your tax bracket, and you’ll get to a point where you flip into a higher tax bracket. So you take enough out of tax-deferred maybe to fill up that tax bracket, and maybe the rest is from taxable and/or Roth money, right, to stay in those lower brackets. It just depends, and so every year, it might be a little bit different depending upon what your income is, but interestingly enough, when you look at this slide, 65,000 is your lifetime tax in the first one, and 41,000 is your lifetime tax in the second one, so you can make your money stretch longer and have a better retirement.
Joe: Yeah, for sure. I mean, it’s a 40% reduction in tax just by being, you know, lazy.
Al: Yeah.
Joe: Right? A third, a third, a third, right? You’re still reducing significant tax if you just put a little bit of thought to it and say, “well, how far can I go from my tax-deferred account maybe to max out that 10% or 12% tax bracket? Oh, I need a little bit more cash to live off of. OK. Well, I have a little bit here in the taxable account. Well, I’ll be taxed at a capital gains rate versus ordinary income, and then, oh, I need a little bit more cash?” well, you can grab tax free, right, and you’re not paying tax at all. So, you know, you’re looking at the two strategies here. All right. I’m gonna–the first strategy I’m gonna take all from my taxable account, ok? So that’s your brokerage account that’s taxed at a capital gains rate. Your tax rate is very, very small here, right? Because if I’m taking from a taxable brokerage account, it’s a cap gains, and if you’re in the 10% or 12% tax bracket, it’s 0% taxes.
Al: Right.
Joe: So if you say, “all right. Well, here, maybe I take a little bit from my tax-deferred account that’s taxed at ordinary income rates.” well, you pull enough up there just to get maybe to that 10% or 12% tax bracket, then you pull from your taxable account, but if you do a third, a third, a third, right, it gives you several more years of extra income.
Al: Yeah. Well, that’s the key. You have a better retirement because you have more use of your cash, but I’m gonna repeat that because I think it’s so important is this–if you can stay in the 12% bracket, right, from pulling enough money out of your deferred account and then maybe the rest out of your non-taxable or your taxable account, meaning your brokerage account because capital gains are taxed at 0% as long as your total taxable income is in the 12% bracket. So think about that. You pay very little tax, and if you still need money, take it out of the Roth.
Joe: Looking at another item here is that let’s say the market dropped 19% the year you start your strategy. This is a lack of strategy actually, right? Most people don’t have these withdrawal strategies like we talked about. So let’s say the sequence of return risk is one of the biggest risks that retirees face, and they don’t even know what it means. Sequence of return risk is that if the market drops, if you get into a bear market as soon as you start taking dollars out, right, you’re in jeopardy of running out of money a lot more than someone that starts in a bull market and ends in a bear, right? 19% loss. Given this example, this person has a 10-year shortfall if they had just maybe a standard rate of return or maybe had a little bit of a bull market in the beginning, then faced that bear later in life. Guess what, al. You’re exiting the building.
Al: Exiting the building.
Joe: They’re exiting the building.
Al: Ha ha ha! Yeah, and so one of the ways that you mitigate this is–and you’ve heard this before, right–when you’re growing your portfolio, you can afford to take more risks. It’s a higher rate of return. When you’re withdrawing money, it’s a different investment strategy. You want to have more safety. So if the market goes down, that’s OK. You can let that part of your portfolio go back up. You pull money out of the safe money, whether it’s bonds or cash or whatever it may be. Let the market do its thing, but do not be pulling money out of the market when it’s down because it’s very, very hard to recover.
Joe: You know, and that goes back to here is that, right? You’ve got to determine what you’re spending, ok? You select your strategy, right, location and order. Which one are you gonna be pulling from, right, taxable, tax-deferred, and then select the assets to sell, right? So and hopefully now this is coming full circle that it’s starting to make sense, that you have to have a strategy as you approach retirement to make sure that you can stretch those dollars out as much as you can. If you need help with this, you know where to go. Go to your moneyyourwealth.com. Click on that special offer. It’s our “Withdrawal Strategy Guide.” Avoid the trap doors, folks. Go to yourmoneyyourwealth.com. Click on that special offer. It’s free of charge to you today. We’ll be right back.
Joe: Hey. Welcome back to the show, folks. The show is called Your Money, Your Wealth®. Joe Anderson here, CERTIFIED FINANCIAL PLANNER™. Big Al of course. We’re talking about withdrawal strategies, avoiding those trap doors. Go to our website yourmoneyyourwealth.com. Click on that special offer this week. It’s our “withdrawal strategy guide.” that’s our gift to you this week absolutely free. All right. So there’s different strategies that we want to take a look at when we create retirement income. You know, there’s ordinary income that’s taxed, right, just like your paycheck, and then you have capital gains income, so it depends on what your tax bracket is is gonna determine how much capital gains is taxed on your investments, and a capital gain–just a refresher–is, let’s say I buy a stock for $10, and it grows to $15, and I sell that stock. I’m taxed on that gain from $10 to $15 or that $5.00 is gonna be taxed at a capital gains rate. The capital gains rates are zero depending on your tax bracket. Could be 15%, or it could be as high as 20%. Then there’s also a net investment income tax on top of that, but we don’t want to get too complicated here. So capital gains versus ordinary income. Which one would you choose, Big Al?
Al: Yeah. Well, of course, capital gains, Joe, and this is a good illustration. So let’s just say you got about 120,000 of income, 116,950 to be exact, and then you get your standard deduction. You get down to 89,000 of taxable income. That’s what you pay tax on, that, by the way, in 2023 is the top of the 12% bracket for a married couple. If it’s all ordinary income, you’re gonna be paying about 10,000 in tax plus state tax. If it’s all capital gain, meaning that you had securities or mutual funds or whatever that you sold at a gain and this is your taxable income, your tax is zero, at least on the federal level. You may have some taxes on state, but on a federal level, taxes are zero. A lot of people don’t realize if they can arrange their non-retirement accounts to be long-term capital gains, they’ll pay a lot less tax in retirement.
Joe: Tax loss harvesting. Bank losses or–
Al: Bank your losses.
Joe: Bank your losses. We’re having some troubles in the banks here over the last couple of months, so a good choice of words here, but you want to bank your losses. What does that mean, Big Al?
Al: Yeah, that just simply means, you know, sometimes when you have investments outside of retirement or even in retirement, they go down. So now I’m focusing on assets outside of retirement. So you buy it at $10 a share, it goes down to $8.00 a share. Maybe you bought a whole bunch of shares. So $20,000 is now worth $16,000, and here’s the strategy. You sell that stock or mutual fund, you’ve got a $4,000 loss. You can use that loss dollar for dollar against future capital gains, whether you have them this year or in future years. So when you have losses, it’s a good idea to bank those losses to utilize against other capital gains in the future. Sometimes, like right now with the market, you may have a lot of losses. Sell them–of course, don’t necessarily go into cash. Buy something similar so you’re still in the market, so when the market does go up, you’ll have that recovery. In the meantime, you’ve created a loss that you can use on your tax return for this year and in future years.
Joe: And another strategy to use for tax-free income is a Roth ira or a Roth conversion could make a lot of sense for you. So sometimes, it makes sense, sometimes, it doesn’t. So here’s some high-level thinking. If you’re thinking about putting money into a Roth ira, look at your tax bracket. Is it gonna be the same or higher in retirement? You might want to take advantage of today’s lower tax rates. Accounts are diversified by taxes. We talk tax diversification. Most of you have all of your assets in an ira, 401(k), or deferred account, right, so when you take all those dollars out in retirement, you’re going to be taxed at the highest of rates, which is ordinary income. It might make sense to be diversified from a tax perspective, have a little bit of money in tax-free versus taxable and of course tax-deferred. Estate taxes. So if you’re one of those one out of 100 million…
Al: Ha ha ha! That has estate taxes.
Joe: That has to, you know, if your estate is over $23 million, you know, you might want to convert your IRAs to a Roth, right, and then the kids or the kiddos or the grandkids will receive those tax-free, but a lot of times, too, if you want to give those IRAs to charity, well, there would be no tax there at all. You know, if you have irregular income streams, right? So let’s say you’re a boom-or-bust type of employee–or employer, I should say, or if I’m a contractor, all sorts of different jobs where you have very high income and then maybe very low income. In those low income years, you might want to get some ira dollars off the table and put it into a Roth. So just different ideas that people should be thinking about, especially in today’s, you know, volatile stock market and also today’s tax environment.
Al: Yeah, and something else to consider is sometimes when you retire you don’t have that salary, and hopefully you retire before required minimum distribution age, which is 73 this year. Maybe you got a few years where you don’t have to pull from your ira, but you don’t have salary. You got low income. Great years to do Roth conversions, get some of that money in tax-free forever in low tax brackets today.
Joe: All right. Let’s switch gears. Let’s go to ask the experts.
Al: this is from Kristen. Great question, Kristen. I’ll take a stab, and, Joe, you can clean it up. I don’t think you change anything in terms of market. Market’s good, market’s bad. The point of rebalancing is that if certain asset classes go down relative to others, you want to sell the ones that have done better than the ones that haven’t because you want to buy some–use some of this money to buy the investments low, right? You’re buying low so that you’ll get more recovery and your account itself will recover more quickly because you’re buying assets cheaper.
Joe: So it’s rebalancing, keeping that risk profile the same because if you don’t rebalance, sometimes your stock exposure is gonna get way too heavy. So if you have a bull market, right, you want to sell your winners and buy your losers. It sounds stupid, but that’s what you have to do because if you keep buying winners, sometimes those winners will lose, and then you’re heavily weighted on the winners, and when they do lose, the whole portfolio might crumble on you.
Al: Yeah. Let me just say one more thing before we wrap up, and that is if you’re buying individual stocks, it’s a little bit trickier because now you have company risk. This works best when you have mutual funds or index funds, where you have a lot of diversification.
Joe: What did we learn today? We’re talking about withdrawing your money and avoiding those trap doors. First thing that you have to do–determine what you’re spending. OK. You select your strategy, right? Location and order–which one are you gonna be pulling from, right, taxable, tax-deferred? And then select the assets to sell. What percentage can you take from your overall portfolio? We talk about 4%. You don’t want to roughly take out any more than 4% if you want to stay in that 90 percentile. Most people don’t have these withdrawal strategies like we talked about. A lot of advice for many, many years was always defer the tax. Defer, defer, defer, defer, right? Well, I think that advice is flawed because you’re probably not very tax-efficient. The sequence of return risk is one of the biggest risks that retirees face, and they don’t even know what it means. You’re in jeopardy of running out of money a lot more than someone that starts in a bull market and ends in a bear, and another strategy to use for tax-free income is a Roth ira or a Roth conversion could make a lot of sense for you. Go to yourmoneyyourwealth.com. Click on that special offer this week. It’s our “Withdrawal Strategy Guide.” If you’re transitioning into retirement and you need a strategy to figure out your withdrawals, go to our website, yourmoneyourwealth.com. Click on our “Withdrawal Strategy Guide.” that’s our gift to you this week absolutely free. All right. That’s it for us. For Big Al Clopine, I’m Joe Anderson. We will see you next time, folks.
IMPORTANT DISCLOSURES:
• Investment Advisory and Financial Planning Services are offered through Pure Financial Advisors, LLC. A Registered Investment Advisor.
• Pure Financial Advisors, LLC. does not offer tax or legal advice. Consult with a tax advisor or attorney regarding specific situations.
• Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
• Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.
• All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.
• Intended for educational purposes only and are not intended as individualized advice or a guarantee that you will achieve a desired result. Before implementing any strategies discussed you should consult your tax and financial advisors.
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