Let's say everything goes fine, or as well as can be expected, and you enter retirement with a nice, plump nest egg.
Now that it’s time to start taking money out, where should you start if you have a variety of assets and accounts?
First, consider the basic asset types: stocks, bonds, cash and your home. As a general rule, you don’t want to rely on stocks or stock funds to pay for the week’s groceries. If you do, withdrawing a set amount every week could do a lot of damage when stock prices are down.
So the basic idea is to pay for ongoing expenses out of a cash account, such as a checking or money market account that is large enough for six to 12 months’ expenses. From time to time you can replenish the cash account, ideally from a relatively stable source like a bond or certificate of deposit that has matured, or from a bond fund.
Then, when conditions are right, you can draw from stocks or stock funds to top off the bond holdings, which ideally should be large enough to cover at least five years’ expenses. If stocks are down, you could postpone that move. If they are up, you can do it ahead of schedule. Using the bond and CD holdings as a buffer between cash and stocks can help you avoid having to sell stocks in a down market.
Deciding which type of account to draw from involves a look at tax issues. Most financial advisers recommend drawing from ordinary taxable accounts first. That allows tax-favored accounts like 401(k)s and IRAs to continue growing as long as possible.
Also, some of your holdings in taxable accounts may be subject to long-term capital gains rates, currently taxed no higher than 15%. Your 401(k) and traditional IRA holdings will be subject to income taxes, at rates as high as 35%. It pays to postpone those higher tax bills for as long as possible.