26 January 2011
By: Greg Daugherty
Many of us have become pretty good at investing for retirement by now. But after we retire we'll face a new and different challenge for which we could be far less prepared: getting our money back out. Unfortunately, drawing down a retirement account is an art unto itself, and fouling it up can undermine decades of careful saving and investing. In fact, even if you've been a happy do-it-yourselfer all along, this might be an occasion to consult an accountant or financial planner. Whatever you do, here are five common mistakes to try to avoid.
Taking too much. Surveys tell us that running out of money in retirement is the greatest fear for many pre-retirees. (In a recent survey, it even beat out death.) A sure way to make that fear a reality is to tap your assets at too fast a pace. Since the 1990s, the conventional wisdom in financial-planning circles has been that retirees can safely spend about 4 percent of their wealth each year with little risk of exhausting it. More recently, some planners and academics have begun to challenge that wisdom, arguing that 4 percent might be too much, especially if your money is invested very conservatively, or not enough, making it likely you'll leave money on the table when all is said and done.
While the critics clearly have a point, I still think the 4 percent rule can be useful as a starting point. For example, if you tote up your expected sources of retirement income, including Social Security and any pensions, then add 4 percent of your invested assets, you'll at least have some idea of whether you're on track to retire on schedule or had better tough it out in the workforce awhile longer.
Taking too little. It's also possible to err on the side of caution and deny yourself some of the well-deserved pleasures of retirement, such as travel, dining out, and tickets to see your favorite bands before they themselves hang it up. Perhaps not surprisingly, it's often the very people who were most disciplined about saving money who have the greatest trouble parting with it. "Sometimes you have to tell them: 'Spend more money! Go buy a new car!'" Ray Mignone, a certified financial planner in Little Neck, N.Y., says about some of his clients. But, he hastens to add, "that's the minority."
Obsessing over income. "Some people have it in their head that they should never spend principal," notes Elaine E. Bedel, a certified financial planner in Indianapolis. "They think they can only spend their interest and dividends." That can be an admirable habit when you're in saving mode but counterproductive once you enter your retirement spending phase. For one thing, it might cause you to live more frugally than you really have to. For another, it can lead to some other dumb financial decisions.
From a tax perspective, for example, it could make more sense to spend principal in a nonretirement account while leaving the income and dividends in a tax-deferred IRA untouched, Bedel points out.
The quest for income could also mean taking undue risks in pursuit of better rates, especially at a time like this when even 3 or 4 percent seems like a bonanza. Mignone, for example, cautions against higher-yielding, longer-duration bond funds because of the battering they're likely to suffer when interest rates start back up again. Bedel urges investors to think twice before buying annuities for their promise of guaranteed income. Among other downsides, annuities often carry high expenses, plus whatever money you put into one is likely to belong to the issuer, rather than to your heirs, when you die.
Messing up required distributions. RMDs, or required minimum distributions, were waived for 2009 but are now back in all their glory. For anyone who forgot about them in the meantime, RMDs are the minimum amount you must generally take from your retirement accounts each year starting after age 7QVi. One reason to pay attention is that the tax penalty is a brutal 50 percent of whatever you failed to withdraw. Financial advisers and retirement-account custodians can provide you with personalized guidance here, or you can consult IRS Publication 590 at www.irs.gov, which includes a worksheet and life-expectancy tables to help you calculate your required minimum distributions.
Ignoring the tax angles. Besides knowing how much money you can or must withdraw each year, there's the question of where to take it from. Tax considerations will play a big part in that. As a general rule, you might want to tap non-retirement accounts first so that your IRAs can continue to grow tax-deferred. But there can be exceptions depending on your tax situation, Mignone points out. Suppose, for example, you retire at 66 and have a relatively modest retirement income but a sizable amount of money in IRAs that is going to be subject to RMDs after you reach 70'/2. In that case, it might make sense to start withdrawing some of the IRA money right away. Otherwise, your RMDs could not only push you into a higher tax bracket but also raise your Medicare premiums substantially. And that, as Mignone warns, "really makes retirees crazy." $
A former economics editor of Consumer Reports, Greg Dougherty is executive editor of our publications as well as our Retirement Gay. He is also a co-author of "The Consumer Reports Money Book"