Learn how to withdraw your assets in retirement
June 11, 2013
Rebecca Katz: Our next question is from Robert, and Robert says, "What is the hierarchy for spending sources for living expenses during retirement?" So basically, in what order should you take money out to use for retirement spending: cash first, then tax-exempt sources, then taxable accounts, then IRAs? Is there a one-size-fits-all solution to this?
Maria Bruno: Well, there's a general guideline on this, and it's a really good consideration because taxes are like a cost. Much like investment costs, taxes will, at the end of the day, eat into what the net income would be from these accounts. So tax-savvy withdrawal is really one great way to think about retirement withdrawals and to maximize the longevity of the portfolio.
That said, generally speaking, if you have different buckets, you'll want to spend from taxable accounts first and let the tax-advantaged accounts—the 401(k)s, the IRAs—grow tax-advantaged as long as possible. There are two reasons. One reason is to enjoy the tax deferral. The other thing is, in the current tax environment, distributions from taxable accounts are taxed at lower rates. Capital gains rates are lower than ordinary income tax rates. So if you do take withdrawals from the portfolios and taxable accounts, it's more tax-advantageous, generally speaking.
Then when you start drawing down from tax-advantaged accounts, it becomes, well, do I take from the Roth or the traditional? And that sometimes is really looking at tax expectations. So if you think you might be in a higher tax bracket later, then you may want to take from traditional assets first—the deferred assets—because again, they'll be taxed at ordinary income tax rates. So you're paying, presumably, at a lower rate today.
And if you have reverse expectations, then the order would be reversed. Most people don't necessarily know what the future tax rate will be or [what] their situation would be; so if you do have the different types of accounts, really take a look at what the tax situation is this year. Maybe there's a way to manage the brackets. For instance, if you're in a certain bracket, you might be able to take additional—or generate additional—income without increasing your tax bracket. Really look at it—maybe on an annual basis—look strategically: do I have a normal or abnormal tax return situation that might warrant changing that order?
Rebecca Katz: So it's important to think through this before you take action.
Maria Bruno: Oh absolutely, yes.
Joel Dickson: And I think, a couple of tips too around making sure you don't end up paying taxes on taxes. What I mean by that is there are going to be some tax situations that might occur naturally. So for example, when you're rebalancing, you might be rebalancing those investments that did better than other investments, right? So you might be realizing gains if you have a regular rebalancing plan, all else equal. Or, you do get distributions from funds and other investments occasionally, whether it's income distributions or dividends or even sometimes capital gains distributions. If you are reinvesting those distributions and then you sell the fund or the investment at some additional gain, there might have been a way to manage the cash flows in a more tax-efficient way.
For example, especially in retirement, where you might be spending income out of your portfolio, there are certain things that you might think about doing that might be a little bit different. So in an accumulation phase, if you're growing your portfolio and so forth, reinvesting distributions may make sense from that standpoint. But you might consider in retirement having the distributions go to a money market account or a bank account—your spending account—as a way either to rebalance your portfolio if you don't need it to spend, because you then aren't going to incur additional taxes through your rebalancing because you've already paid the taxes (because those are taxable distributions), or as actual spending, as income. Because again, there's nothing you can do about those distributions in terms of a tax standpoint. You're already going to be taxed on them.
Maria Bruno: In taxable accounts.
Joel Dickson: In taxable accounts.
Maria Bruno: Exactly. Joel's really talking about the taxable accounts.
Joel Dickson: That's right.
Rebecca Katz: Right; within tax-deferred accounts, it all gets taxed at the time it all comes out.
Maria Bruno: Exactly.
Joel Dickson: Right.
All investments are subject to risk, including the possible loss of the money you invest.
For more information about Vanguard funds, visit Funds, Stocks & ETFs or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
When taking withdrawals from an IRA before age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax.
We recommend that you consult a financial or tax advisor about your individual situation.
© 2013 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.
Vanguard experts discuss retirement drawdown strategies
If you want to be a tax-savvy investor, it's important to consider which accounts to tap for living expenses—and when. Maria Bruno and Joel Dickson from Vanguard's Investment Strategy Group describe the order you can use to minimize taxes when withdrawing funds for retirement.
Other excerpts from this webcast:
- All investments are subject to risk, including the possible loss of the money you invest.
- For more information about Vanguard funds, visit Funds, Stocks & ETFs or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
- When taking withdrawals from an IRA before age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax.
- We recommend that you consult a financial or tax advisor about your individual situation.