Accumulation is a key facet of reaching your retirement goals. However, we tend to see far less about portfolio drawdown, or decumulation—the logistics of managing a portfolio from which you’re simultaneously extracting living expenses during retirement, which can be even more complicated.
Pitfall: One of the big mistakes of retirement distribution can be neglecting to consider tax consequences of some distributions. Distributions from traditional IRAs and 401(k)s are fully taxable at your ordinary income tax rate, so if you’re not paying taxes at the time you’re pulling money out, remember that the distribution is smaller than it looks because you’ll be paying taxes on it at a later time.
Workaround: It may be a good idea for retirees to pay quarterly estimated taxes to avoid a penalty from the Internal Revenue Service. Also, retirees should consider the tax effects associated with IRA and 401(k) distributions when assessing their portfolio’s long-term viability. Spreading assets among various account types can help lessen the tax shock, as can carefully sequencing withdrawals to lessen the drag of taxes and preserve the tax-saving features of IRAs and 401(k)s for as long as possible.
401(k) plans and IRAs are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. Funds in a traditional IRA grow tax-deferred and are taxed at ordinary income tax rates when withdrawn. This is for informational purposes only and should not be considered tax or financial planning advice. Please consult with a financial or tax professional for advice specific to your situation. This article contributed by Christine Benz, Director of Personal Finance with Morningstar.
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