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The accumulation phase of your life – otherwise known as your professional career – is when you should maximize contributions to your retirement accounts.
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The more nest egg you can accumulate when you retire, the more options you will have when you reach your distribution phase. At this point, it’s generally safe to trade the bulk of your growth-oriented investments, such as stocks, for more stable, income-generating investments.
But, since so many variables are involved in this process, it pays to plan ahead and have a strategy to best achieve this. It’s also a good idea to sit down with a financial planner and discuss how to achieve your goals as you approach retirement.
See how you can convert your savings and investments into retirement income.
Estimate how much you have and how much you will need
As you approach retirement, it’s a great time to assess where you are and where you want to go. Knowing how much you have in all of your available retirement accounts, from 401(k) plans to IRAs and more, is an important first step, as it will be the basis for your calculations of how much income you can generate in retirement. The sooner you can do this before you retire, the easier it will be to fill any shortfalls.
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For example, imagine you want to generate $30,000 in annual income from your retirement accounts, but anticipate a nest egg of only $300,000. In this case, the math just won’t work, because you’ll need to generate 10% revenue per year to meet your goals.
But, if you anticipate this shortfall in advance, you may have enough time to increase the value of this account to $500,000, in which case a much more reasonable – although still high – return of 6%. would be required.
Keep in mind that you will likely have additional sources of income in retirement besides your 401(k) plan or IRA. Social Security, other pensions, or even a part-time job can help get you where you need to be. But strictly in terms of retirement accounts, the sooner you can plan, the more likely you are to reach your goal.
Plan your withdrawals from taxable and tax-free accounts
An important thing to remember when planning your retirement income is that some of your accounts may be taxable. Withdrawals from traditional IRAs and 401(k) plans, for example, are generally fully taxable as ordinary income. This not only reduces the amount of income you can earn from these types of accounts, but it may also be enough to push you into a higher tax bracket. This is why the taxation of your retirement accounts, both on contribution and on the end of distribution, can be so important.
With a Roth account, for example, qualifying retirement distributions are completely tax-free. Best of all, you don’t have to make mandatory withdrawals at age 72 from a Roth like you would with a 401(k) or traditional IRA. Balancing your distributions between these accounts can help manage both your tax burden and your overall net income.
Conversion of investments in your retirement accounts
There are two big decisions you will have to make with your investments as you approach retirement age: (1) how much to convert growth into income and (2) what investments, if any, to pay your distributions into. . Here are some of the ways you can use your savings to fund your retirement.
The common wisdom was that once you retire, you should immediately shift all your growth investments, like stocks, to income-generating investments, like bonds. But as longevity has increased, so has financial advice. These days, if you retire at age 60, for example, you may well have 30 or more years of retirement ahead of you. It can be difficult to finance your expenses for so long with income-generating investments alone, which is why most advisers now recommend that even retirees keep significant allocations in growth investments.
Another option to ensure you don’t outlive your retirement income is to use your withdrawals to fund a fixed rate annuity. This type of investment guarantees you the same payment each month, regardless of your lifespan. One of the disadvantages of a fixed annuity is that inflation will eat away at the value of the fixed payment over time. However, most insurers offer a rider that will increase your payment to match the rate of inflation – it will just cost you more.
Some investors have enough money in their retirement accounts to simply live on withdrawals. In this case, you can invest your money in ultra-safe investments like treasury bills and withdraw just enough for your needs. But be sure to account for changing circumstances, such as the effects of continued inflation and your desire for a more extravagant lifestyle in retirement, should they arise.
Buy Bond Ladder
A bond ladder is a way to earn income on your retirement investments without locking all of your money into current interest rates. A typical bond ladder distributes money in equal amounts among bonds of different maturities, such as one to 10 years. As each bond matures, it is reinvested at the rate then prevailing at the long end of the scale – or the 10-year maturity in this example. You can use the income generated from the bond ladder to fund your retirement.
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