Financial Management in Retirement

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Building a nest egg takes you to the threshold of retirement. But once you've actually retired, how do you maximize your plans, to ensure a comfortable lifestyle? There are many variables:

Tax considerations
In retirement, it's important to generate the largest income stream possible. Therefore, minimizing taxes is critical. Income sources generally fall into these categories:

1. Fully taxable income. Withdrawals from tax-deferred retirement accounts, interest from taxable bonds and savings accounts, and dividends from equities and stock funds are, generally, taxed at your ordinary income tax rate.

2. Partially taxable income. The portion of your withdrawals from nondeductible IRAs and variable annuities attributable to your investment gains and earnings is taxable at your ordinary income tax rate-but the amount representing your after-tax investments will not be taxed a second time. Social Security benefits are also partially taxable according to your income level.

3. Long-term capital gain income. Only the appreciation on your investments is taxable, at a maximum rate of 15%.

4. Tax-free income. Most interest from tax-free municipal bonds and tax-free bond funds is exempt from federal and, possibly, state income tax as well. (But keep in mind that there may be alternative minimum tax considerations.) Also untaxed are proceeds from the sale of assets on which you have no gain, as are all withdrawals from Roth IRAs (once the account has been open five years, and the owner is age 59 ½).

Many advisors recommend accessing your savings and investments first, so the money in your retirement accounts will have more time to compound, tax-free. At the same time, taxes may be minimized by taking income from tax-free bonds and bond funds.

Estate planning considerations
If you're leaving substantial assets to your heirs, this may also mean that the general rule to use unsheltered accounts isn't appropriate for you. That's because:

* IRAs and retirement accounts pass to those you leave behind - along with certain distribution requirements and potential tax liabilities.
* Assets that have appreciated in value will pass to your heirs with a stepped-up basis (their fair market value at your death).

Therefore, if the assets are sold promptly, there will be little or no tax on the proceeds. Likewise, if you have a Roth IRA and don't need its tax-free income, then you can let it grow and compound throughout your lifetime, and provide a long-lasting source of tax-free income for your beneficiaries.

Investing in retirement
There's a natural tendency to gravitate to income-producing investments in retirement.

Yet longer life spans now mean that you could enjoy 20 or 30 years of retirement - which means over time, fixed-income investments may not be adequate, and using capital could become necessary. To help avoid this, here are a few tips:

* You may gradually increase allocations to lower-risk investments - but if you want growth as well as capital preservation, you'll need to retain a significant exposure to equities.
* As years go by, you can reduce your stock market participation.
* Be sure to keep one or two years' worth of living expenses in liquid accounts like savings, CDs, and money markets. That way you won't have to sell stocks when market conditions are unfavorable in order to meet emergency needs.