Saving for retirement requires discipline throughout your entire career, but if you're not careful, you can ruin a lifetime of successful saving when it comes time to start withdrawing from your nest egg after you retire. Many retirees do a good job of saving and investing during their work years but then make serious mistakes with their retirement withdrawals that dramatically reduce the effectiveness of their long-term financial planning. By being aware of these mistakes, you can take steps to avoid them and achieve better results in retirement.
1. Waiting too long before tapping IRAs and 401(k)s
Continue Reading Below
No one likes to pay taxes, and many retirement savers make it their goal to avoid tapping into their tax-favored retirement accounts as long as possible. With the IRS requiring distributions from traditional IRAs and 401(k)s at age 70 1/2, many see that age as the earliest that they'll want to withdraw from those accounts.
What many people who use this strategy find is that by the time they turn 70 1/2, their IRA and 401(k) balances have gotten large enough that the required minimum distributions can push them into higher tax brackets. Given that you can withdraw from all retirement accounts starting at 59 1/2 without penalty -- and can take even earlier penalty-free withdrawals under special rules -- smart financial management can help you minimize your total lifetime tax liability from your retirement savings and prevent yourself from having to pay higher tax rates on your income.
2. Not having a plan for withdrawals that matches with spending needs
It's easier for many people to plan for how much they can save and what returns they can expect on their investments during their careers than it is to plan for how much they intend to spend once they retire. If you don't have a spending plan that accurately reflects your financial needs, there's a temptation simply to tap into retirement accounts whenever you need money. That can lead to a host of problems, including poor tax planning and disruption of your investing strategy if you have to sell investments to raise cash unexpectedly.
A smart plan for retirement withdrawals includes a solid budget of expected expenses and a cash cushion within your retirement savings to cover near-term financial needs without having to sell off investments. Dividends and interest can play a role in generating the income you need, but you shouldn't be afraid to use capital gains and even dip into principal as necessary to replenish your cash cushion over time. The key is to have a plan ready in advance that can cover contingencies like a downturn in the financial markets.
3. Ignoring the tax impact of taking withdrawals from different retirement accounts
It matters which order you take retirement withdrawals from various types of accounts. After taking any required minimum distributions, you typically can choose whether to take money from regular taxable accounts, traditional IRAs and 401(k)s, and Roth IRA and 401(k) accounts.
There's no single "right" order in which to take retirement withdrawals, because the best decisions are highly dependent on your individual tax situation. Taking money first from taxable accounts lets your tax-deferred assets grow longer within IRAs and 401(k)s, but as discussed above, taking more money from tax-favored retirement accounts early can help you reduce future taxes. Leaving Roth IRAs intact as much as possible can be extremely good for those who want to leave a tax-free legacy to loved ones, but tapping into Roth accounts earlier can reduce taxes on income from Social Security or help you avoid adverse consequences from having too high a taxable income.
The value of a strong financial planner really comes through when it comes to planning retirement withdrawals. By avoiding these common mistakes and using experience to tailor a custom-made solution to your personal financial situation, the right financial planning will ensure that after working so hard to save for retirement, you'll get the peace of mind that you deserve during your golden years.
The $16,122 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,122 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.