Retiring with an IRA: How Your Account Works in Retirement

Quick answer

• An IRA (Individual Retirement Arrangement) is a tax-advantaged savings account designed for retirement.
• You can withdraw funds from your IRA in retirement, but rules apply regarding taxes and potential penalties.
• Traditional IRAs involve paying taxes on withdrawals in retirement, while Roth IRAs offer tax-free withdrawals.
• Required Minimum Distributions (RMDs) typically begin at a certain age for Traditional IRAs.
• Understanding your IRA type and withdrawal rules is crucial for a smooth retirement income stream.

What to check first (before you invest)

Time Horizon

Before investing a single dollar, consider when you plan to retire. A longer time horizon allows for more aggressive investment strategies, as you have more time to recover from market downturns. A shorter horizon might call for more conservative approaches to protect your principal.

Risk Tolerance

How comfortable are you with the possibility of losing money in exchange for potentially higher returns? Your risk tolerance is a personal assessment. It’s influenced by your age, financial situation, and emotional response to market volatility. Understanding this helps you choose investments that align with your comfort level.

Emergency Fund

Before directing all your savings into retirement accounts, ensure you have a readily accessible emergency fund. This fund, typically covering 3-6 months of living expenses, acts as a buffer against unexpected costs like job loss or medical emergencies, preventing you from needing to tap into your retirement savings prematurely.

Fees and Tax Impact

Be aware of the fees associated with your IRA and its investments. Management fees, expense ratios, and trading costs can eat into your returns over time. Also, understand the tax implications of different IRA types (Traditional vs. Roth) and how withdrawals will be taxed in retirement.

Account Type (IRA, 401(k), Brokerage)

Know which type of retirement account you are using. A Traditional IRA and a Roth IRA have different tax treatments. Employer-sponsored plans like 401(k)s often have different contribution limits and withdrawal rules. A taxable brokerage account has no withdrawal restrictions but offers no tax advantages.

How an IRA Works When You Retire

Step 1: Determine your IRA type.

What to do: Identify whether your IRA is a Traditional IRA or a Roth IRA. This information is usually available from your account provider or on your statements.
What “good” looks like: You clearly know if you have a Traditional IRA (pre-tax contributions, taxed withdrawals) or a Roth IRA (after-tax contributions, tax-free qualified withdrawals).
A common mistake and how to avoid it: Assuming all IRAs are the same. Avoid this by checking your account statements or contacting your financial institution.

Step 2: Understand contribution limits and history.

What to do: Review your past contributions to understand your cost basis, especially for Traditional IRAs if you ever made non-deductible contributions.
What “good” looks like: You have a clear record of your contributions, which helps in calculating taxable income upon withdrawal.
A common mistake and how to avoid it: Forgetting about non-deductible contributions in a Traditional IRA. This can lead to overpaying taxes. Keep meticulous records.

Step 3: Check your age for penalty-free withdrawals.

What to do: Note that withdrawals from Traditional and Roth IRAs before age 59½ are generally subject to a 10% early withdrawal penalty, in addition to ordinary income taxes (for Traditional IRAs).
What “good” looks like: You are aware of the age threshold for penalty-free withdrawals and plan your retirement accordingly.
A common mistake and how to avoid it: Withdrawing funds before age 59½ without a qualified exception. This results in unnecessary penalties and taxes. Plan your cash flow to avoid early withdrawals.

Step 4: Plan for Required Minimum Distributions (RMDs).

What to do: For Traditional IRAs, be aware that you’ll likely need to start taking RMDs at a certain age (check the IRS for current age requirements). Roth IRAs do not have RMDs for the original owner.
What “good” looks like: You know when your RMDs will start and have a strategy for managing these required withdrawals to meet your income needs and tax obligations.
A common mistake and how to avoid it: Missing RMD deadlines or taking insufficient amounts. The IRS imposes significant penalties for this. Set up automatic reminders or consult your financial advisor.

Step 5: Decide how to take withdrawals.

What to do: Determine whether you want to take lump sums, regular income streams, or a combination.
What “good” looks like: You have a withdrawal strategy that aligns with your living expenses and tax situation.
A common mistake and how to avoid it: Taking large lump sums without considering the tax impact. This can push you into a higher tax bracket for that year. Consider spreading withdrawals over time.

Step 6: Understand the tax implications of withdrawals.

What to do: For Traditional IRAs, all withdrawals are taxed as ordinary income. For Roth IRAs, qualified withdrawals (after age 59½ and the account has been open for at least five years) are tax-free.
What “good” looks like: You accurately calculate the tax liability of your IRA withdrawals each year.
A common mistake and how to avoid it: Underestimating the tax burden from Traditional IRA withdrawals. This can lead to a surprise tax bill. Consult tax tables or a tax professional.

Step 7: Consider reinvesting or spending the funds.

What to do: Decide whether to spend your IRA withdrawals to cover living expenses or reinvest them in other accounts for further growth or income.
What “good” looks like: Your withdrawal strategy supports your retirement lifestyle and financial goals.
A common mistake and how to avoid it: Spending all retirement funds too quickly without a long-term plan. This can lead to outliving your savings. Create a sustainable withdrawal rate.

Step 8: Stay informed about IRS rules.

What to do: Keep up-to-date with any changes in IRS regulations regarding IRAs, contribution limits, RMD ages, and tax laws.
What “good” looks like: You are proactive in understanding and adhering to current IRS guidelines.
A common mistake and how to avoid it: Relying on outdated information. Tax laws and retirement account rules can change. Regularly check official IRS resources or consult a financial professional.

Risk and Diversification (plain language)

• Don’t put all your eggs in one basket: This is the core idea of diversification. Instead of investing all your money in one stock or one type of asset, spread it across many different investments.
• Different types of assets: Think about stocks (ownership in companies), bonds (loans to governments or corporations), and potentially real estate or other alternatives. Each behaves differently.
• Different industries and geographies: Even within stocks, diversify across various sectors (tech, healthcare, energy) and different countries. A problem in one industry might not affect another.
• Why it matters: If one investment performs poorly, others may perform well, cushioning the overall impact on your portfolio. For example, if tech stocks crash, your bond holdings might remain stable or even increase in value.
• Example: An investor might hold a mix of U.S. large-cap stocks, international stocks, and investment-grade bonds.
• Correlation: Investments are “correlated” if they tend to move in the same direction. Diversification works best when you combine assets with low or negative correlation.
• What to do during market drops: During market downturns, it’s natural to feel concerned. However, a well-diversified portfolio is designed to weather these storms. Avoid panic selling. Rebalancing your portfolio periodically (selling some assets that have grown significantly and buying more of those that have fallen) can help maintain your desired diversification.

Common mistakes (and what happens if you ignore them)

| Mistake | What it causes | Fix