Where Should I Pull Funds From First in Retirement?

Our topic on this episode of the Ready for Retirement podcast is about understanding where you should pull funds from first in retirement.

How much of my retirement expenses are covered by fixed income sources and how much income do I need my portfolio to generate?

When it comes to pulling funds in retirement, identifying how to create the most income is important, but arguably less so than the tax implications of how those funds are withdrawn, and not just the for the first few years, but throughout the entirety of retirement.

Are you ready to start focusing on the things that truly matter when it comes to your financial future?

Key Points

• Where should you pull funds from first in retirement?
  • Fixed Income Sources / Non-Portfolio Income Sources
    • Ex: Social Security, Pension Income, Rental Income, Annuity Income. How much of my retirement expenses are covered by these fixed income sources? The difference between your total expenses and fixed income sources needs to be generated by portfolio income. 
      • The first step is to understand what expenses will look like in retirement.
        • How much income needs to come from my portfolio?
        • Example: Suppose you need $100,000/year in retirement to reach your goals. If this is the total income needed to generate, and if both you and your spouse collect $45,000 total from Social Security. The remaining $55,000 is what we need the portfolio to generate.
    • Taxation 
      • Let’s suppose you have a Roth IRA, Traditional IRA, and Taxable Account. 
        • Roth IRA – tax-free for the rest of your life.
          • This is an account best to reserve and not pull from in retirement until needed because of the tax-free growth.
        • IRA – tax-deferred, but taxed upon withdrawal.
          • More tax favorable than a taxable account, but you do owe taxes once you withdraw the funds.
        • Taxable account- not in qualified retirement and capital gains are fully taxable.
          • Best to withdraw early in retirement so you can maximize your growth in any other tax-free accounts.
    • What’s best for your situation?
      • Example: Let’s assume you have a Pension and Social Security as you enter retirement. 
        • Your Pension and Social Security cover a decent amount of the income, but we’ll assume $40,000 is still needed to cover the rest of the expenses.
          • Where do you go first?
            • Option 1: Pull funds from Taxable account first to allow other accounts to grow tax-free & tax-deferred
            • Option 2: Assume you have $60,000 of Taxable Income (Gross Income – Deductions). Once your Taxable Income exceeds $80,250, you jump from the 12% tax bracket to the 22% tax bracket at the Federal level.
              • This would allow for $20,000 in gains to be realized while staying in the 12% tax bracket.
              • Using funds that would have otherwise been taxed at higher tax brackets allows you to save more for retirement.
          • Staying with the same example, if you needed $40,000/year and had it all in savings, that may appear to be the best option when it comes to withdrawing funds because there wouldn’t be a tax consequence.
            • Let’s assume you have a 401(k) or IRA worth $2,000,000. When you reach age 72, you’re going to be required to take RMD (Required Minimum Distributions).
            • If you didn’t touch the funds and it grew from $2,000,000 to $3,500,000 all of a sudden you still have the Pension, Social Security, and you are forced to take a set RMD % (~3.8%). 
              • This comes out to a Required Minimum Distribution of $133,000/year and likely more than you would need – and fully taxable. 
      • Things To Be Mindful Of
        • Avoid massive Required Minimum Distributions (RMD) in the future.
        • Understand the taxation of Social Security.
          • Some states tax Social Security and others don’t, but at the Federal level, you will be including 0%, 50% or 85% of your Social Security benefit in your Taxable Income.
        • IRMAA (Income Related Monthly Adjustment Amounts)
          • The premium you are paying for Medicare Part B.
          • If your Married Filing Jointly(MFJ) and have an income under $174,000, you will not be paying additional taxes for Medicare Part B & D.
            • If your income exceeds $174,000 and your MFJ, you will be paying an additional premium for Medicare Part B & D.

Timestamps

2:30 – How Much Do You Need From Your Portfolio?

3:30 – Non-Portfolio Income Sources

5:30 – Taxation of Retirement Accounts

6:20 – Taxable Accounts vs. Roth IRA vs. Traditional IRA/401(k)s

9:16 – Ordinary Income Tax Treatment

11:30 – Required Minimum Distributions (RMD)

14:10 – Social Security Taxes

16:20 – Tax Implications of Withdrawals

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