The countdown to retirement is often equal parts exciting and nerve-racking. Whether you’re 1, 5, or 10 years out, chances are you have questions about the best way to plan for and live comfortably in retirement. But the planning doesn’t stop once you retire. In fact, inflation, changing tax laws, and an ever-shifting stock market mean retirees would be wise to revisit and reevaluate their plan at least annually.
Here are some of the most common retirement questions and ideas for navigating each situation.
How can I make my retirement savings last?
No one wants to be 10 years into retirement and realize they have to return to work in order to pay the bills. Fidelity research finds that people should plan for their savings and pensions to replace about 45% of their pretax, preretirement income, with the rest coming from Social Security.1
You can potentially avoid running out of money by setting up 3 buckets for your savings: emergency, protection, and growth. Your protection bucket should have enough savings to fund your day-to-day life. Fidelity recommends keeping at least 3 to 6 months of essential expenses in your cash emergency fund.
The right amount of savings to have in your protection bucket depends on factors like your expected lifespan, retirement age, and your desired lifestyle. “It really all comes down to how much you want to spend and what's negotiable and what's nonnegotiable,” says Ryan Seward, a vice president and branch leader at Fidelity.
Nonnegotiable expenses include basics such as housing, food, and health care, and personal purchases that you don’t want to compromise on, such as traveling to visit your kids for holidays. “What are the things that you don't want to live without when you retire?” Seward says.
Your protection bucket should be invested in a way that generates steady and predictable cash flow, with one option being a deferred income annuity. This can provide you with fixed income payments—regardless of how the markets are performing—starting at a future date and lasting for a predetermined period of time or for the rest of your life. Purchasing a deferred income annuity shifts key retirement risks, such as market risk and longevity risk, from you to an insurer. Consider working with a financial advisor to determine how this may fit into your plan.
Your remaining savings should go in your growth bucket. It can be invested more aggressively than your protection bucket, since it’s not needed for immediate expenses. “If the market does well, that's where you'll do some of the more discretionary spending versus if the market doesn't do as well—maybe that year you just avoid doing some of those nicer things,” Seward says. For example, you might consider 2 international trips per year an essential expense, or nonnegotiable in retirement, but flying first class instead of economy is a bonus.
What’s the best tax strategy for taking withdrawals from retirement accounts?
If you have retirement savings spread across multiple types of accounts, it can be tricky to determine the order of operations when you’re ready to draw an income. Reducing the tax bite means you must be strategic.
The first step for retirees is assessing current income. People usually have more income in the first year of retirement than subsequent years since they worked for part of the year, Seward says. Will you collect Social Security, a pension, or deferred compensation this year? Is that enough to cover your expenses or will you need to draw from savings too? Consult a tax professional regarding your personal situation.
“Get a sense for where you are and how much room you have before you get to the next tax bracket,” Seward says. Then, consider working with a financial professional to do a cash flow analysis to estimate your annual income for the years ahead. Think about how much you’ll need to withdraw from your tax-deferred and taxable accounts and how much you’ll be collecting from other sources, such as Social Security.
One tax-savvy approach to reach that target income is withdrawing a proportional amount of savings annually from taxable accounts, tax-deferred accounts (traditional IRAs and 401(k)s), as well as deferred income annuities, and tax-exempt accounts such as Roth IRAs, 401(k)s, and other sources of tax-free income. This could help eliminate the risk of experiencing a “tax bump” in retirement where you have a small, or no, tax bill in the early and later years of retirement, and a hefty tax bill in the middle years. This strategy tends to perform best when you may have a moderate level of taxable income.
In years where you may have low taxable income, it may make sense to withdraw more from tax-deferred or taxable accounts. Distributions from tax-deferred accounts are typically fully taxable at ordinary income rates, so it’s best to make them when you are in a relatively low tax bracket. Withdrawals from taxable accounts can generate realized gains or losses on the securities that you sell to fund the distribution and are taxed as short- or long-term capital gains. If the security was held for one year or less, it is considered a short-term capital gain which is typically taxed at your federal income tax rate.
For securities held in taxable accounts longer than one year, total realized long-term capital gains are taxed at 0%, 15%, or 20%, depending on your taxable income and filing status. Assuming no other income, total capital gains would need to exceed $47,025 after deductions for a single person before taxes would be owed, or $94,050 for a married couple filing taxes jointly in 2024. If you can meet your income needs solely with withdrawals from a taxable account, you’ll give your tax-deferred accounts more time to grow but be mindful of required minimum distributions (RMDs).
In years where you may have high taxable income, it may make sense to withdraw more from tax-exempt accounts because those qualified distributions are tax-free and won’t affect your tax liability for the year.2
How can I keep my 401(k) growing in retirement?
You might wonder what happens to your 401(k) when you retire. You can’t keep contributing to your account, but you still have control over your investments—and now is the time for a checkup. “The number one thing is making sure that the asset allocation that you’re using still makes sense,” Seward says.
Consider how your 401(k) fits into your overall retirement income plan. Do the funds in your 401(k) belong in the protection bucket or growth bucket? If you need to generally preserve your balance to pay for everyday expenses, you may need to shift into a more conservative allocation than you used in the years leading up to retirement. Another option is to consider a 401(k) rollover to an IRA, where your money will maintain its tax-deferred status.
What are some strategies for lowering my tax bill when I have to take RMDs?
Required minimum distributions (RMDs) are a fact of life for retirees with tax-deferred accounts. After reaching age 73, the deadline for taking RMDs from accounts where you have contributed pretax money is December 31 each year. However, you have the option to delay your first RMD to April 1 of the year after you turn 73.
RMDs are considered ordinary income, which can lead to federal and state tax bills. But if you don’t need your RMD to cover your expenses, there are a few strategies you can use to lessen, or even eliminate, the tax burden.
- Donate your RMD to charity with a qualified charitable distribution (QCD). A QCD is a direct transfer of funds from your IRA to a 501(c)(3) charitable organization. It satisfies your distribution requirement and avoids triggering an income tax, since no money ends up in your pocket.
- Bunch charitable contributions to one year for a bigger itemized tax deduction. A donor-advised fund is a great way to group multiple smaller charitable donations into one year and claim an immediate tax deduction, which lowers taxable income. For example, instead of giving $15,000 over 5 years, you can donate $75,000 to a donor-advised fund, qualify for an immediate tax deduction for the full contribution, and recommend grants to eligible 501(c)(3) public charities. The following year, while you wouldn’t claim charitable deductions, you’d still qualify for the standard deduction, which could save you thousands of dollars in taxes over 2 tax years.
- Purchase a qualified longevity annuity contract (QLAC) to turn your RMDs into a future income stream . A QLAC can be purchased with up to $200,000 from a traditional IRA, 401(k), 403(b), or governmental 457(b). Essentially it removes that portion of your balance from RMD calculations, lowering the amount you are required to withdraw each year and setting you up with a future income stream that will start at the date of your choosing up to age 85.
Find out more about managing taxes in retirement in Viewpoints: Understanding the retirement income valley.
Retirement planning shouldn’t be managed alone. Working with financial and tax professionals as you approach retirement can help ensure you maximize every dollar and don’t miss any opportunities to save on taxes before it’s too late.