We often meet with prospective clients within five to ten years of retirement who have been diligent about maxing out retirement plan contributions and want to plan a retirement income strategy. While their conscientiousness should be applauded, they may inadvertently have set themselves up for a risk of depleting those assets too rapidly during their retirement years.
Many of us look at our retirement account balances and forget that as much as 30 percent or more of every dollar taken out of a pretax retirement plan is a taxable event—and those taxes during the distribution phase can greatly impact how long the retirement account lasts.
The following is a hypothetical example and is for illustrative purposes only. No specific investments or tax tables were used in this example. Actual results will vary.
Say you and your spouse have accumulated $2 million in retirement accounts and plan to draw down $100,000 a year. That would put you in the 22 percent Federal tax bracket under current tax law, which means you may need an additional $31,429 distribution for Uncle Sam. If you live in the downstate New York area, add another 8 percent--$11,429—for state and local taxes. Therefore, the 5 percent distribution rate (5 percent of $2 million is $100,000) you thought you would employ is actually 7 percent (the $142,858 gross amount, including taxes, divided by $2 million). Don’t forget, the higher your withdrawal rate—especially in downward markets—the more you risk depleting those assets sooner. At some point along the retirement road, you may wind up eating into principal (instead of profit) to pay those taxes.
This is why we advocate that most individuals should seek to have a balance of pre-tax and after-tax accounts. Even if there are long-term capital gains owed on the sale of some of your after-tax securities, those gains are currently taxed at 15 percent, half of the retirement account taxes.
Understanding the real value of your retirement portfolio is the key to a successful retirement plan. Consult with your accountant and financial planner to ensure you are properly accounting for taxes as part of your financial plan.