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Today I’m going to talk about Three Big Retirement Plan Withdrawal Mistakes. If you’re planning for retirement, you’re going to be looking at how you can make a transition from what we call the retirement accumulation phase, when you’ve been saving and investing money for your retirement, into the retirement withdrawal phase. You’re going to take some of that money that you saved, and you’re going to start distributing that money back to you, by starting to take some withdrawals. There’s three big mistakes that we see people make here.
Mistake number one is probably the most common one that we see, and it’s Waiting Too Long to Begin Taking Withdrawals. And this mistake can actually compound into a couple of other little mistakes that actually can cost you a lot of money. People will often begin taking their Social Security benefits as early as they can at age 62, and not only does this prevent them from getting a bigger Social Security check and kind of maximizing that, but it also means that they’re delaying taking their retirement plan withdrawals, and what that does is compound itself down the road, because as many of you probably know, at 70 1/2, the IRS is going to mandate that you’re going to start taking some withdrawals from those retirement accounts. It’s called the Required Minimum Distribution Rules. And what that might do is push you up into a higher tax bracket at that time, and on top of that, it can also affect your Medicare premiums as well, because your Medicare premiums are tied to the level of income that you make. So the more money you make, the more you pay for Medicare. One of the things that we look for, though, as a way to kind of get around this mistake is to really map out some of those cash flows. One of the things that we identified is that by taking some retirement plan withdrawals early on in retirement we can take advantage of what we call low tax years.
If you’re waiting to take Social Security, for example, or maybe your pension doesn’t kick in right away, you might have few years early on in your retirement where you’re in a very low tax bracket. By taking some of those retirement plan withdrawals early, you can take advantage of those low tax years and at the same time, help you get a bigger Social Security check down the road. It could also take some pressure off of some of those required minimum distributions. Maybe some of those won’t be so high and pushing you up into those higher tax brackets. We can also look at doing some Roth conversions too as a way to take advantage of some of those low tax years.
The second mistake is Taking Your Distributions At Too High Of A Rate. What I mean by this is that there are some schools of thought out there. Probably the most prominent of these is something called the four percent rule. This was created by financial planner, William Bengen back in the 90s, and he did a lot of math, studied some probability and statistics, and said that if you limit your retirement plan withdrawals to no more than four percent of your entire portfolio each year, you should have a pretty good chance that your money is going to last you throughout the rest of your lifetime. If we think about the four percent as kind of our withdrawal rate that we should be targeting, consider that if we go up to five or six percent, it may not seem like a big difference, but looking at the math, your probability of running out of money goes up pretty high once you start getting up to five, and especially once you get up to six percent or more.
The last mistake is Not Understanding Your Cash Flow Needs. One of the things that we want to understand are some of the variabilities that you might be experiencing with your income and your expenses in retirement. Here we talk about the sequencing of returns. That’s what William Bengen did when he did his research on the four percent rule. If we’re earning, let’s say, a six or seven percent average return over time, because of the sequencing of returns, we could end up with a bad string of years where we’re not earning that average or we have down markets, what is the impact of that on our long-term ability to sustain our retirement withdrawals? One of the ways we can get around this is to use a bucket strategy. What that means is we keep one to two years worth of liquid cash reserves in an account that’s very safe, very accessible, so that as you need money to supplement your retirement, we don’t have to take it out of some of the riskier investments that might be in the stock or the bond market.
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