Don’t suffer from withdrawal

Throughout your working life, retirement is all about “what if?” and “how much more do I need?”

Once you near retirement, though, the questions change. When should you start drawing on Social Security? Roll over or lump sum? How much should you withdraw, and from which accounts?

Here’s a look at some of those issues.

How should I withdraw money?

Roll over the lump sum? Turn it into a stream of income? The decision may boil down to whether you are comfortable withdrawing money as you need it or want the security of regular payments.

There’s no right choice. But there is a risky one. “The worst thing you can do is to take the whole thing in cash, pay the income taxes and spend it all,” says Chris Mahoney of Mercer Human Resource Consulting.

Taking the cash will greatly increase your chances of running out of money during retirement. That’s the chance companies present, however, when they offer employees a lump sum.

But employees choose a lump sum up to 90 percent of the time, says Hewitt Associates.

That strategy could make sense if you directly roll the money into an individual retirement account, or IRA, to allow it to continue growing tax-deferred, says Jonathan Guyton, a financial planner in Edina, Minn.

“Now you have complete flexibility, complete control” over the money and can set up your own withdrawal plan, he says. You could take periodic withdrawals or regular ones. You may also be able to have a set amount transferred automatically from the IRA to your bank account each month.

Rolling a lump sum into an IRA, investing it, then taking withdrawals on an “individual schedule offers the greatest potential for return vs. the most risk,” says Robert Fishbein of Prudential Financial. It also takes spending discipline.

If you need the security of a stream of income, here are some ways to get it:

“ Consider withdrawing money slowly from a 401(k).

A 2005 Hewitt study of 458 plans shows that while all offered lump-sum distributions, 43 percent also allowed partial distributions, and 20 percent offered annuities, which can turn a lump sum into a stream of income. Half of 401(k)s allow participants to take money out through little-known installment payments.

“ Withdraw a set percentage of your assets each year.

Research differs on how much you can safely withdraw each year without running out of money. Conservative projections start annual withdrawals at 3 percent to 4 percent, then adjust upward with inflation.

“ Buy an immediate annuity.

These are insurance products whose value lies in the guaranteed stream of income you get for the rest of your life. The amount you get is based on how much money you put in, your age and current interest rates.

If you’re reluctant to tie up all your money in an annuity because relatively low interest rates mean lower payouts, you could “ladder” your investments. This means investing some money now in variable annuities and some later, as interest rates rise, to get benefits similar to dollar-cost-averaging.

How much should I take out each year?

Everyone seems glad to tell you how much to save for retirement, but it’s harder to get advice on how much of your retirement portfolio you should withdraw every year.

At first glance, managing a retirement portfolio shouldn’t be that tough. If you earn 8 percent a year, you should be able to withdraw 7 percent a year and still have some left over to give your heirs. But there are some big problems with that equation.

Inflation will erode the buying power of your withdrawals. Suppose you withdraw $35,000 a year from your retirement account. If inflation averages 3 percent a year, your $35,000 will have the buying power of $30,985 after five years — an 11 percent drop.

To keep up with inflation, you’ll have to increase your withdrawals over time, and that means you increase the odds of running out of money before you die.

Also, you can’t guarantee earning 8 percent a year. The 10-year Treasury note yields about 4.6 percent now, which is the most you can earn with no risk for 10 years. If you want to earn more than that, you have to take some risks. And that means your returns will vary year by year.

Several fund companies offer excellent calculators:

“ Vanguard. Probably the most cautious of the lot, Vanguard’s simple calculator will tell you how much to withdraw, given the length of your expected retirement and your asset allocation. Don’t expect to spend a lot: A $500,000 portfolio will give you a monthly income of $1,771, assuming a moderate portfolio allocation. That’s 4.25 percent of your portfolio annually.

“ Fidelity. This far more sophisticated planner takes into account Social Security and pensions as well as your investment holdings. It also allows you to explore “what-if” scenarios. You have to register to use the planner, however.

“ T. Rowe Price. This planner, like Fidelity’s, looks at your portfolio allocation under hundreds of possible market scenarios and looks for the withdrawal rate with the greatest potential for success — which, in this case, means lasting longer than you do. T. Rowe’s calculator allows limited “what-if” modeling as well.

When should I start taking Social Security?

It’s a big decision and once you make it, you can’t revise it.

Start by looking at how your retirement age affects your Social Security payout. You can begin to take reduced Social Security benefits at age 62. The age at which you can get full Social Security benefits depends on when you were born. Those born in 1960 or later can’t collect full benefits until they reach 67. For those born earlier, full benefits kick in between 65 and 67.

You can get an even higher payout by delaying your retirement past your full benefits age. The government increases your payout every month you delay retirement, up to age 70.

Is it better to take lower benefits immediately or wait until you can get full benefits? It depends, in part, on how long you live.

Suppose you’re eligible for full benefits at 67, and reduced benefits at 62. If you retire at 62, you get $700 a month, or $8,400 a year. Full benefits at 70: $1,000 a month, or $12,000 a year.

If you take the reduced payment at 62, you’ll collect $8,400 a year for five years. That would give you a big head start over someone who starts taking payments at 67.

You have two other factors to consider before you lock into your Social Security payments:

“ Work. If you start taking benefits at age 62 and continue to work, your benefits will be reduced by $1 for every $2 you earn above $12,000 a year. That reduction ends when you reach your full retirement age. So if your job pays $30,000 a year, your Social Security benefits would be reduced by $9,000.

“ Taxes. At least part of your Social Security payout may be subject to taxes.

If you’re filing jointly and your combined income is $32,000 to $44,000, you’ll owe federal income taxes on half your Social Security payment.

If your combined income is more than $44,000, you could owe taxes on as much as 85 percent of your payout.

Which accounts should I tap first?

Prioritizing the order of withdrawals can help minimize your tax bite.

The general rule is to take money first from regular investment accounts and let tax-deferred assets accumulate. Tap tax-free Roth IRAs last, because they can be passed along to kids.

Ready for the caveat? Throw in your tax rate and early withdrawal and required distribution rules, and these guidelines could go out the door.

If your brokerage accounts hold only assets taxed at the long-term capital gains rate — currently at a maximum of 15 percent — consider withdrawing first from tax-deferred accounts, says Robert Carlson, author of “The New Rules of Retirement: Strategies for a Secure Future.”

Assets in IRAs and 401(k) plans accumulate tax-deferred and then are hit with ordinary-income rates, currently at a maximum of 35 percent, when they come out.

It could make sense to spend down this money first if you think income tax rates will rise in the future, says Dallas Salisbury, president of the Employee Benefit Research Institute.