Planning the Withdrawal of Your Retirement Assets

You've worked long and hard to accumulate the assets that you are using to help finance your retirement. Now, it's time to start drawing down those assets. Exactly how you liquidate your assets will affect your tax and impact how long those assets last, so it pays to plan a withdrawal strategy that is efficient and maximizes the benefits of different types of investments.

The first step in planning your withdrawal strategy is to make a precise inventory of all the assets you have in your portfolio, paying particular attention to distinguish between taxable accounts, such as ordinary bank or brokerage accounts, and tax-deferred accounts such as 401(k), 403(b), and 457 plans, and IRAs. From this inventory, you can estimate how much cash you will receive from dividends, interest payments, redemptions, and distributions in the coming year. You can also assess how much you will need to hold in reserve in order to meet the associated federal and state tax obligations.

If your total net cash flow from the assets in your taxable accounts is strong enough to meet your budgeted cash needs for the year, you may consider yourself to be fortunate. You need not weigh the transaction costs of different asset sale strategies or consider the added income tax effects of withdrawing assets from employer-sponsored plans and IRAs. But if you do need to liquidate assets in order to meet your cash flow targets, then you should consider the pluses and minuses of each withdrawal strategy as outlined in the following savings withdrawal hierarchy.

As you consider these options, keep in mind that no single order can be right for every person and every situation. Among the additional issues you should consider when designing your withdrawal strategy are the management of portfolio risk, your tax bracket, and the cost basis of the investments. With that in mind, below is a high-level summary of guidelines for creating an appropriate strategy. Remember, this is a conceptual ranking. Your circumstances may require a different sequence, so be sure to obtain relevant financial advice before taking any action. Note, too, that estate tax considerations might have an impact on withdrawal priorities.

Required Minimum Distributions (RMDs)

For traditional IRAs and employer-sponsored retirement savings plans, individuals must begin taking required minimum distributions no later than April 1 following the year in which they turn 70½. RMDs from a 401(k) can be delayed until actual retirement if the plan participant continues to be employed by the plan sponsor and he or she does not own more than 5% of the company. The size of an RMD is determined by the account owner's age. An account owner with a spousal beneficiary who is more than 10 years younger can base required minimum distributions on their joint life expectancy.

Estimating the Required Minimum Distribution

This is the most broadly applicable required minimum distribution table -- the Uniform Lifetime Table for unmarried owners, married owners whose spouses are not more than 10 years younger, and married owners whose spouses are not the sole beneficiaries of their accounts. Other tables apply in other situations.

Age 70 75 80 85 90 95 100 105
Actuarially projected life expectancy (in years) 27.4 22.9 18.7 14.8 11.4 8.6 6.3 4.5
RMD (% of assets) 3.6% 4.4% 5.3% 6.8% 8.8% 11.6% 15.9% 22.2%
Source: The Internal Revenue Service

A Potential Tax Benefit for Company Stock Held in a Retirement Plan

For individuals who hold company stock in their 401(k) or other qualified retirement plan, the IRS offers certain tax advantages when withdrawing company stock from the plan. Rather than paying ordinary income tax on the entire amount of the withdrawal, you may elect to pay it on the original cost basis of the stock, assuming it was paid for in pre-tax dollars, then pay capital gains tax, usually at a lower rate, on the net unrealized appreciation when you eventually sell the shares.

Keep in mind that the IRS has exacting requirements for exploiting all of the tax management strategies discussed above and that tax laws are always subject to change. You should review your cash management plans with your tax and investment advisors before taking any specific action.