How to Plan Spending in Retirement

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Planning for your retirement often involves determining how you are going to save enough money to afford the lifestyle you want to maintain. But some forethought about when you'll withdraw money from your retirement accounts, and which accounts you'll tap first, can help you maximize your hard-earned savings.

Many Americans have more than one source of money in retirement -- income from Social Security retirement benefits, distributions from work-related accounts such as pension or a 401(k) and money saved in an individual retirement account. You may also have put a little extra aside in a high interest savings or taxable investment account.

After working for decades to save money in all these different pots, it can be a challenge to determine in what order you should take withdrawals.

One hint: Follow the taxes.

Withdrawals from each source of money are taxed differently. Distributions from your tax-deferred accounts -- such as your traditional IRA or 401(k) -- are taxed as regular income, up to a maximum of 35% in 2008. (Money withdrawn from a Roth IRA in retirement isn't subject to income taxes as long as you have held the account for at least five years.)

Meanwhile, income from your taxable investments -- dividends and long-term capital gains -- is taxed at 15%, which for most taxpayers is less than the tax you'll pay on regular income.

In general, the longer you wait to call on your retirement money, the more money you'll have in the end.

But there are limits: Traditional IRAs and workplace plans mandate that you begin taking required minimum distributions by age 70 1/2. Your taxable investment portfolio, with its 15% long-term capital gains, has no such distribution requirements. These funds can keep growing until you call on them -- or pass them along to your heirs. The same is true for a Roth IRA.

In retirement, you could dip into your taxable accounts first in order to allow your tax-deferred savings to grow as much as possible. This is a good idea if you believe that your income tax bracket will be lower later in retirement, or if you feel taxes may rise after the presidential election this fall.

Alternatively, you may think your tax rate will stay steady -- or even increase --throughout your retirement. In that case, you could let the money subject to the lowest tax rate (your Roth IRA and your taxable investments) keep growing while you take distributions from your tax-deferred accounts.

You also have choices with regard to your Social Security retirement benefits. The benefits you receive from Social Security count as regular income, but only 85%, at most, of your benefits is taxable. For every year you delay taking benefits after your full retirement age (66 years old for those born between 1943 and 1954), your monthly Social Security checks increase by 8%. The 8% increases stop at age 70.

But when you should take Social Security depends mostly on your health and expected longevity. The Social Security Administration can help you make this calculation by determining your break-even age. If you expect to live beyond the break-even age, it would likely be to your financial advantage to delay taking Social Security distributions.

Ultimately, the appropriate order of withdrawals depends on your specific financial situation. Your best bet is to sit down with a certified financial planner who can analyze your situation and determine what makes the most sense for you.

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