An Effective Strategy Should be Tailored to Your Needs

Key Takeaways:
  • Your distribution strategy must match your personal retirement goals—don’t rely on a one-size-fits-all plan.
  • Factors like Required Minimum Distributions, tax implications and account types all play a role in avoiding unnecessary losses.
  • Revisit and adapt your plan regularly, because family changes, market shifts and evolving needs can quickly alter your financial picture.

 

When retirement is on the horizon, many people focus on saving enough to meet their income goals but fail to consider designing an effective retirement withdrawal strategy. Creating a retirement distribution strategy that works for you is an important part of preparing for retirement, and it must be customized to meet your specific needs and circumstances. Your neighbor may tell you his distribution strategy is the best, and it may indeed be the best – for him.

But your needs may be very different, and it’s important to work with a trusted advisor who can tailor a distribution strategy to your specific situation. For instance, you may be focused on a simple plan of utilizing your retirement savings to support your lifestyle over the next 20 to 30 years. Or you may want to leave a legacy to your children or to charity. The distribution strategies for these two goals would be very different.

Some things to consider when planning a withdrawal strategy are: Have you saved enough to meet your retirement income needs? What types of accounts do you own? There are three basic types of investment accounts: taxable, tax-deferred, and tax-free. How will distributions from these accounts affect your tax situation? How much risk do you need to take, or can you take, in retirement? What is the best portfolio allocation for you in retirement? What other sources of income do you have? What is your overall long-term goal for your assets? Do you plan to leave a legacy for your children or a charity?

There are many distribution strategies to choose from, and it is important to take some time considering which strategy or strategies may be best for you.

Planning Strategies for Qualified Accounts

Start with understanding your Required Minimum Distributions (RMDs). Owners of qualified retirement accounts such as 401(k), 403(b), and Traditional IRAs are required by the IRS to start taking RMDs when they turn 73. This will increase to age 75 starting in 2033. These types of accounts are tax-deferred and will be taxed at your ordinary income rate in the year you take withdrawals.

Often people choose to defer taking income from these types of accounts until RMD age to avoid paying taxes on the distributions. However, this may not be the best strategy. By not taking withdrawals, you are allowing the accounts to continue to grow tax deferred. This may cause you to have excess income and pay more in taxes down the road.

Retirees in a lower tax bracket may consider taking income from tax-deferred accounts first and allowing their taxable and tax-free accounts to grow. These account types may be more tax-efficient to take later in life, especially if you are planning to leave them to a future generation.

Making use of a Roth conversion is another strategy that may benefit you if you are looking to pay fewer taxes in the future or want to leave tax-free assets to the next generation. With a Roth conversion, you convert all or part of your qualified account to a Roth IRA where it can begin to grow tax-free. You will pay ordinary income tax on the amount converted. When considering a Roth conversion, it is important to have good tax planning and understand the rules for tax-free growth in a Roth IRA.

Another useful tool is a Qualified Charitable Distribution (QCD). A QCD allows individuals over the age of 70.5 to donate up to $108,000 in 2025 directly from their IRA to one or more charities. A one-time election of up to $54,000 can also be made to fund a Charitable Gift Annuity (CGA) or Charitable Remainder Trust (CRT). The advantage of doing so is you can exclude the QCD amount from your taxable income for the year, and the receiving charity will receive the funds tax-free.

The 4% Distribution Rule

The 4% Distribution Rule is a common strategy. It assumes, based on historical market returns, that a retiree can safely withdraw up to 4% annually from their portfolio for 30 years and not run out of money. Here’s how it works: you take the total value of your portfolio and withdraw 4% in the first year of retirement. The next year, you increase the amount to adjust for inflation. This strategy assumes you invest in a moderate allocation like 50% stocks and 50% bonds. It’s easy to understand and provides steady and predictable income for many years.

However, future market returns may not produce the same result as historical returns. You’ll want to make sure to reevaluate the strategy annually. Four percent may be too much, especially if your portfolio suffers large losses in the first few years of retirement or you have a very long-time horizon. As your income needs change, you will want to readjust the percentage you withdraw each year.

The Bucket Strategy

For retirees who want to encourage continued growth in their portfolios, the bucket strategy is an efficient way to divide retirement savings into segments that perform different functions.

  • The “short-term bucket” provides income over the next two to three years, so this bucket should be mostly invested in fixed income and cash instruments to ensure safety.
  • The “mid-term bucket” looks out to the three-to-ten-year period beyond the immediate future and can be invested a bit more aggressively to encourage growth.
  • The “long-term bucket” is intended to fund retirement 10 years from now and beyond. This bucket can tolerate far more risk, depending on your personal risk profile, and has the potential for significant gains.

The idea is to periodically move funds from the long-term bucket to the mid-term bucket, to the short-term bucket. This allows your short-term income needs to be invested in safer investments and provide liquidity. While all distribution strategies require at least an annual review, the bucket strategy is a more hands-on approach, requiring adjustments as your income needs and lifestyle change, so the annual review is a must. You can customize this strategy to your needs, creating fewer or more buckets if needed.

Rules to Remember

Certain factors affect all retirement distribution strategies and must be considered by retirees during their planning period:

  • Consider the role that RMDs will play in your distribution strategy, particularly if you retire at a relatively young age before RMDs kick in.
  • You don’t have to stick with one strategy – some strategies can be combined for maximum value and tax efficiency. Moreover, any good strategy is something you’ll have to develop rules for to guide you when it needs to be changed. If income needs change, you want to be able to effectively adjust for that.
  • Stay flexible. A distribution strategy that works during your first 10 years of retirement may not be the best for meeting your needs after that. Stay on course with the annual reviews to ensure your strategy continues providing the income you need.
  • Any changes in family configuration and estate plans should be considered during the annual review and may compel a change in strategy.
  • Many people want to receive monthly income in retirement because that is what they are accustomed to while working. However, talk to your advisor about whether it’s better to take small amounts monthly from your retirement accounts or one large distribution per year.
  • As part of your planning around a distribution strategy, consider doing some planning around your Social Security benefits and any pensions you may receive. Individuals and couples have many options as to when to draw Social Security and pension benefits, and the idea is to maximize long-term income and minimize taxes by doing effective planning.

Questions?

Creating an effective distribution strategy can help you maximize tax efficiency and make sure you don’t outlive your retirement savings. Planning for distributions should start before your retirement, but if you are already retired, it’s never too late.  If you would like to discuss a distribution strategy for your retirement savings, contact a private wealth advisor at Adams Brown Wealth Management.