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How Much to Withdraw in Retirement?

After growing and protecting your nest egg for years, it's time to begin making withdrawals. But first, you need to cook up a shrewd withdrawal strategy. Without one, you could end up with a scrambled mess – early-withdrawal penalties, tax hikes, insufficient money for your golden years and nothing to leave heirs.

A Recipe for Wise Withdrawals

The recipe for wise withdrawals is no secret: It's not about how big your egg is, but how you crack it. Here are a few special ingredients that can keep your financial statements sunny-side up:

An adjustable withdrawal rate. Consider your living expenses, age, life expectancy and rate of return (ROR) on your investments to set an appropriate withdrawal rate. For most retirees, this ends up being 3% to 4% annually to start – enough to live on without depleting principal, assuming a 6% ROR on your overall portfolio. If you retire early, you may need to reduce your withdrawal rate to make your money last longer.

Beyond the first year, adjust your rate annually to account for inflation. For example, if you have $300,000, you could withdraw about $12,000 the first year. Figure on withdrawing an additional $360 the next year to account for typical inflation of 3%. However, you may need to reduce your rate during a declining market. Stay as vigilant in spending as you were in saving.

Available taxable funds. Take advantage of tax-deferred compounding on retirement accounts as long as possible. Dip into taxable accounts – mutual funds, stocks and other nonretirement investment funds – and personal savings first. Also, tax-favored assets such as traditional individual retirement accounts (IRAs) and your 401(k) are taxed at ordinary income tax rates. These are generally higher than the capital gains rates that may apply to some of your nonretirement assets, so hold off going there if you can.

And remember age matters: You typically can't take money from tax-deferred accounts until age 59½ (or age 55 from an employer's plan if you leave the employer) without incurring a 10% early withdrawal penalty – another good reason to dip into taxable accounts first. But, if you are 70½ or older you must take a required minimum distribution (RMD) from a traditional IRA or employer-sponsored retirement plan or incur a 50% excise tax on the amount not taken.* There is no RMD for Roth IRAs, so if you don't need the dough, let it grow. Bonus: Your beneficiaries may be able to take money out of an inherited Roth IRA income-tax-free.**

Emergency fund options. A retirement emergency fund is different than your preretirement cash emergency fund for the unexpected – such as a flooded basement or temporary unemployment. A retirement emergency fund can help preserve your portfolio from dramatic market declines. Retirement emergency fund options may not deliver the highest returns, but they are stable and may keep you from having to sell stocks when the market is down. Federally insured savings accounts, CD ladders or money market accounts may be options to consider.

To learn more about how to adjust your withdrawal rate, which assets to tap first and what emergency funds may be right for you, contact an investment professional at PeoplesBank for a consultation.

* The Worker, Retiree and Employer Recovery Act allows those age 70½ and older to skip the required minimum distribution (RMD) from retirement plans for 2009, penalty-free.

** IRS minimum withdrawal rules for inherited IRAs apply.

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