Sooner or later, you’re going to start drawing IRA income.
Once you start that process, you’ll want to make sure you’re getting the most money you can. There are two basic principles you need to understand in order to achieve just that:
1. Tap into your taxable accounts first.
If you want to invest for income, this is your first rule. Doing so allows you to continue the tax deferral on your IRA investments longer. Remember, retirement accounts grow faster than non-retirement accounts. That’s because your regular IRAs grow tax-deferred as long as you keep the money in your account. And your Roth IRA grows tax-free forever.
Since your retirement snowball will grow faster (and fatter) than your non-retirement snowball, it will ultimately generate more retirement income. Keep that snowball growing as long as possible to continue that accelerated growth. The best way to do that is to tap into your taxable accounts first.
This is especially important if you are under 59 ½ years old. IRA restrictions state that any withdrawals from retirement accounts before that age will cost you. You’ll get slapped with income tax on those withdrawals (from non-Roth retirement accounts) and a 10% penalty to boot. Bottom line? Do whatever you can to keep that money growing with tax benefits for as long as possible.
Some people argue that you should take withdrawals from retirement accounts so long as those withdrawals don’t push you into a higher tax bracket. For example, if you are in the 15% marginal tax bracket and you can withdraw another $10,000 without getting pushed into the higher bracket, these people would argue that you should take out that IRA money.
This is hogwash (in most every case). Usually, you will be much better off by continuation of the tax deferral. This allows your retirement capital to grow faster. Remember, the greater your retirement assets, the greater your retirement income will be. Continue tax deferral by withdrawing retirement assets last. Let’s move on to the next important tactic to increase IRA income.
2. Think about investment performance.
Too many people agonize over their non-retirement investments and completely ignore how their 401k investments are doing.
Other people make an equally dangerous mistake. They buy bonds in retirement accounts and use growth outside of those retirement accounts. They do this because they want to be diversified (good) and save on income tax (better). They argue that since they want a certain percentage of their assets in bonds anyway, it’s better to do so in the retirement account. You’re going to have to pay income tax on the money in your retirement accounts as you pull the money out – regardless of how you invest it, they say. That being the case, these people suggest that you should have growth funds or ETFs outside your retirement account and bonds inside. That way, you’ll pay capital gains on growth and reduce your tax bracket.
Personally, I don’t like this approach and here’s why.
Your retirement assets are, by definition, your longest-term investments (see above). That being the case, you should be more aggressive with retirement money than with assets outside your retirement accounts. Remember, if you suddenly need a lump sum to pay for a roof repair or car replacement, you’ll want to go to your non-retirement accounts for that money. That being the case, you’re going to want your non-retirement assets to be invested more conservatively than your retirement assets.
Generally speaking, I am not a fan of predicating my investments based on current (fluid) tax law. Yes, it’s important to keep tax in mind, but you should not make investments based on taxes. For one reason, tax codes change. And when people focus on tax, they often forget about risk considerations. This can lead to terrible consequences.
So the second crucial tactic to help stretch your retirement assets is to invest long-term and (relatively speaking) more conservatively in taxable accounts. If you fail to do this, you just might need random access to your capital when the market is down. If that happens, you’ll have to lock in losses. Not a good tactic, friend.
What other ideas do you have to help us make our retirement accounts last longer?