An orchestra is merely a collection of instruments, each of which brings a unique sound.
It is only when a conductor leads them that they create the beautiful music imagined by the composer. The same can be said about your retirement strategy. The typical retirement strategy is a built on the pillars of a 401(k) plan, an IRA and taxable savings. When the instruments of your retirement planning work in concert, they have much greater potential to create the retirement you desire.
Hierarchy of Savings
Maximizing the effectiveness of your retirement strategy begins with understanding the hierarchy of savings. If you’re like most Americans, the amount you can save for retirement is limited. Consequently, you may want to make sure that your savings are directed to the highest-priority retirement funding options first. For many, that hierarchy begins with a 401(k), followed by an IRA, and after that, taxable savings.
You will then want to consider how to invest each of these savings pools. One strategy is to simply mirror your desired asset allocation in all retirement accounts.
Another approach is to implement the income-generating portion of the allocation (e.g., bonds) in the tax-deferred accounts, while investing in assets whose gains will be from capital appreciation (e.g., stocks) in the taxable accounts.
When it comes to living off your savings, you’ll want to coordinate your withdrawals. One school of thought recommends that you tap your taxable account savings first so that your tax-deferred savings will be afforded more time for potential growth. Another school of thought suggests taking distributions first from your poorer-performing retirement accounts since this money is not working as hard for you.
Finally, because many individuals have both traditional and Roth accounts, your expectations of future tax rates may affect what account you withdraw from first. If you think tax rates are going higher, then you might want to withdraw from the traditional before the Roth. If you’re uncertain, you may want to consider withdrawing from the traditional up to the lowest tax bracket, and then withdrawing from the Roth
In any case, each person’s circumstances are unique and any strategy should reflect your particular risk tolerance, time horizon and goals.
Actis Wealth Management