Your Retirement Portfolio: Best Ways to Liquidate It
There's no absence of advice on how to build your retirement savings account. But once you do shut that office door, and the first day of the rest of your life begins, how do you correctly deconstruct your portfolio? Liquidation takes just as much skill as creation.How Much to Withdraw?
How much you'll need to take out of your accounts for income, of course, is highly tailored to your specific financial situation. Professionals often use the benchmark of withdrawing 3% to 5% of your funds per year at the beginning of your retirement. Although that doesn't look like a very big range on paper, in real money terms, it's a huge variance! The investment company Vanguard has a handy calculator for estimating how different percentages translate into monthly sums.
With interest rates so low and not expected to dramatically rise any time soon, aiming for the lower end of the range might be better until you get further into retirement.
Also, don't forget the cost of living. As each year passes, even if you're lucky enough to have enough capital gains to keep your portfolio balance from drastically depleting, you need to add in the rate of inflation to your withdrawals each year in order to make up for the rising price of goods and services. If inflation is 1.5%, the amount you withdraw the first year should increase by 1.5% the second year. And you should continue to adjust for inflation each year thereafter.Maintain Appreciation
Conventional wisdom usually dictates that retiree portfolios should shift from capital appreciation (usually achieved through stocks) to income-producing (via bonds, annuities). That doesn't necessarily mean you should drop equities, though. Sure, they can be risky, and at this stage of life, you have to protect your income from short- and medium-term market slumps, but your portfolio still needs to maintain some growth.
So how much to keep in the market? The age-inverse rule still applies in retirement: Subtract your age from 100; the resulting amount is the percentage of your assets that should be in equities. Some experts wonder Is ‘100 Minus Your Age' Outdated? Your advisor may feel it's safer to subtract from 110 or even 120.A Taxing Dilemma
When it comes to qualified retirement plans (IRAs, 401(k)s, 403(b)s, etc.), the size and timing of your withdrawals isn't completely up to you. When you reach age 70½, you fall under the IRS' required minimum distribution (RMD) rules. This means that, aside from certain exceptions, you must start taking money out of these accounts; having let you fund the plans with pre-tax dollars, and let them grow tax-free, the IRS wants to ensure it will get its cut of that tax-deferred money. The amount of the annual RMD varies, depending on your age and the account balance; but there are plenty of private calculators; and that can help you get a bead on the sum, and how it will increase each year. The IRS provides worksheets, too. See also How Does a Pension Plan Work After Retirement?
If your RMD is substantial, it could kick you into a higher tax bracket, especially when joined to any other s of income that you have. If your account balance is large, you might want to start taking out funds before you reach the age when the RMD kicks in; you'll still pay tax on the money the year you withdraw it, but it could lessen the bite of the mandatory distributions later. If you're already into your RMD years, you could try to sell losing investments in your portfolio and then withdraw the funds; it won't change the amount of the RMD, but you can use a capital loss to lower your taxable income overall.Sell in the Proper Order
The order in which you liquidate your holdings is important, too. If you have bonds maturing in the next 12 months, receive fixed payments from a pension and are receiving Social Security benefits, any or all of these s may generate enough income to pay you what you need for the year. If that's the case, don't touch anything else. However, if you need more, sell long-term investments in taxable accounts before taking money from the tax-deferred accounts. Then, if you need still more, that's when you look to your traditional and then Roth IRAs, first selling the lowest-quality investments and working your way to the higher rated ones.The Bottom Line
Remember that commutative property rule from math, about how the order in which you add numbers doesn't affect the the answer you get – but the order in which you subtract numbers does? (Think: five minus three vs. three minus five.) It certainly affects your financial property. When liquidating a portfolio, the order of operations can make a big difference in how much income you receive, and the tax consequences – and not just income tax, but estate tax as well (but that's a whole other article: see Estate Planning Tips for 401(k)s and IRAs).
When figuring out how to draw down the balance of your accounts, don't hesitate to get some serious help, perhaps from a financial advisor who specializes in retirees. Only an expert can remember all these rules and regulations.