Postponing Retirement After 72 Law
The 4% withdrawal rule is a common framework for people who want to make sure their retirement savings last. The strategy involves withdrawing 4% of your savings in your first year of retirement, then adjusting that amount for inflation in subsequent years.
However, this rule could end up conflicting with required minimum distributions (RMDs) that the IRS requires people to start taking from traditional retirement accounts when they turn 73. Here’s what you need to know.
Potential tax risk
RMDs count as taxable income, and you must withdraw money equal to a percentage of your nest egg. Your RMD amount is based on your total account balance and the IRS’s life expectancy factor based on your age. Traditional retirement accounts (IRAs) and 401(k)s have RMDs, but Roth accounts do not.
Your RMDs can increase as you age, which can make it challenging to keep withdrawing 4% throughout your retirement. But again, larger RMDs often come with a larger tax bill.
When determining your retirement strategy, tax planning is important.
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Make strategies to minimize your RMD taxes
One way to deal with RMDs and their associated taxes is to start withdrawing from your traditional 401(k) and IRA plans before you turn 73. You can withdraw from these first instead of Roth accounts, since RMDs do not apply to Roth accounts.
Some people choose a Roth conversion, which involves moving money from a pre-tax retirement account to a Roth account that is not subject to RMDs. Any withdrawals from a Roth retirement plan are tax-free, and your money can grow over time.
You can also make qualified charitable distributions to give your money to charitable causes while lowering your taxes.
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Adjust your withdrawal strategy over time
The 4% rule won’t work for everyone, and the right strategy for you can change over time. Morningstar determined that 3.3% was the safest initial withdrawal rate in 2021 (“assuming a portfolio balance, constant real withdrawals over a 30-year retirement period, and a 90% chance of success”). The company increased that to 3.8% in 2022 and 4% in 2023, then lowered it to 3.7%. Their latest average is 3.9 percent of first-time withdrawals.
But Morningstar says there are potential benefits to more flexible strategies, such as not fully adjusting your withdrawal rate for inflation after an annual portfolio loss. “For example, a person following this strategy will not increase withdrawals after the 2022 bear market, despite the large increase in inflation occurring at the same time,” Morningstar researchers wrote.
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Another possible strategy is to take withdrawals in conjunction with RMDs.
“Retirees can use the same framework that supports RMDs from IRAs,” the researchers wrote. “Divide the portfolio value by life expectancy to calculate the optimal withdrawal amount.”
