Tax-Efficient Strategies for Summer Adventures and Beyond
Tax-Efficient Strategies for Summer Adventures and Beyond
For many retirees, the idea of retirement is synonymous with freedom. You can exercise that freedom by choosing to spend your days traveling, spending summers with the grandkids, or simply relaxing and taking it day by day without a harried schedule. However, the transition from a steady paycheck to a reliance on your own savings can be daunting. Without a clear strategy, the lifestyle you envisioned and saved for could be hard to maintain.
To help keep your summer plans and long-term financial health intact, it’s important to approach your retirement spending with tax efficiency in mind.
A Quick Look at the Standard Withdrawal Options
The standard advice can often look like this: spend your taxable brokerage accounts first, then your tax-deferred accounts (like traditional IRAs), and finally your tax-free Roth accounts. However, if you haven’t made any withdrawals from your traditional IRA by age 73, Required Minimum Distributions could unintentionally push you into a significantly higher tax bracket. This could also affect your Medicare costs or increase taxes on your Social Security. Another drawback is that if you’d like to move your money into a new vehicle earlier in your retirement (when you still have taxable accounts you’re pulling from), this could also add to your tax burden, so drawing from tax-free sources that year could help balance that income.
The other piece of standard advice is the 4% rule. This classic retirement rule of thumb is designed to help you determine how much you can withdraw from your portfolio each year without running out of money over a 30-year period.
The rule is straightforward in its execution*:
- Year One: You withdraw 4% of your total retirement nest egg. For example, if you have $1,000,000, you take out $40,000.
- Subsequent Years: You don’t take 4% of the remaining balance. Instead, you take the same dollar amount from the previous year and increase it by the rate of inflation, with the idea that the market will continue to make up for your withdrawals.
It’s important to be able to tailor your income to your specific needs from year to year, as you never know what the future holds, for the market or for you personally. And while these options are great starting points, they can lack flexibility and don’t account for years with larger spending (like when you want to go on that big European vacation!).
Strategies for Your Summer Travels and Beyond
When planning for seasonal spikes in spending, such as a summer vacation, an option that might appeal is a bucket strategy.** This involves dividing your assets into distinct buckets. An example of this looks like:
- The Immediate Bucket (Years 1-2): This bucket should hold enough cash in high-yield savings or money market accounts to cover your lifestyle needs, including that big summer trip.
- The Intermediate Bucket (Years 3-10): This consists of more stable investments like bonds or CDs that can replenish your cash bucket.
- The Long-Term Bucket (Years 11+): These funds remain in assets geared towards long-term growth, with the goal of allowing your future wealth to continue to compound.
This is just one of the many ways to start thinking about how to construct your own tailored bucket strategy. You can also utilize a dynamic withdrawal strategy within this framework that allows for larger withdrawals when the market is performing well and uses those better-performing years to fund lifestyle changes or vacations.
However, moving assets between buckets can trigger unintended tax consequences if not coordinated with your overall strategy, so it’s important to consult with your financial professional about your goals and plans.
Why Planning Ahead in Pre-Retirement Matters
Thinking about where your income will come from once you stop receiving paychecks is something to consider sooner rather than later. Building your income plan out as many as five or ten years ahead of retirement can help you make some potentially impactful moves, such as:
- Roth Conversions: Moving money from a traditional IRA to a Roth IRA during lower-income years can create a pool of tax-efficient wealth.
- Tax Diversification: Ensuring you have a mix of taxable, tax-deferred, and tax-free accounts so you can choose the most appropriate source of income each year for your specific goals.
- Avoiding the 59½ Trap: If you intend to retire early, making a liquidity plan can help you avoid the 10% early withdrawal penalty of most retirement accounts.
Your Summer, Simplified
We can help you focus on your retirement goals and navigate the complexities of tax planning. By coordinating your withdrawals, managing your tax brackets, and maintaining a cash buffer for your lifestyle goals, you can confidently enjoy your summer plans.
Successful retirees plan for both building and utilizing their savings, so if you haven’t yet mapped out your retirement income plan, now is the time to consult with a financial professional. Let us help you tailor your financial situation to both your short and long-term goals for a happy summer and beyond.