The Risks of Spending Your Retirement Savings

Don't ignore these pitfalls when drawing down your retirement investments.

Worried Senior Couple Looking At Bills Together
Getty ImagesSpending your nest egg appropriately can be just as challenging as was saving it.
By David Ning

After years of saving up for retirement, there will come a time when you need to start spending your nest egg. Drawing down your assets in an appropriate way can be just as crucial to your retirement security as saving and investing. Here are some risks to avoid when spending your retirement savings:

Losses in retirement are especially problematic. You annual returns start to be very important in the years leading up to and immediately after retirement. When you are saving up for retirement, it's certainly better to get a 15 percent return than a 5 percent return or a loss, but over a 30-year career the returns of a single year won't make or break your retirement. However, returns make a much bigger difference once you start taking withdrawals from your investments, especially if you experience a decline it the early part of your retirement.

A few big declines in the first few years of retirement on top of yearly withdrawals can deplete your nest egg so much that the remaining portfolio can never recover. For example, consider an investor with 100 percent of his assets invested in the S&P 500 index at the beginning of 2000. If no withdrawals are taken, the investor would have roughly 62 percent of his nest egg at the end of 2002 and fully recover sometime in 2007. However, the recovery is much worse for a retiree withdrawing $50,000 a year. By 2002, just 50 percent of the portfolio is left. And even by 2007 he would only be left with 63 percent of the original amount. And this calculation does not account for taxes. Add a bit of tax costs and the picture is even bleaker.

To avoid significant losses in retirement, many retirees shift their retirement money to more conservative investments that are less likely to lose value. While the growth might be slower, conservative investors are also less likely to suffer a financial setback they don't have time to recover from.

Debt is even more costly for retirees. It will be easier on your nest egg if you pay off debt aggressively before retirement, including your mortgage. Eliminating debt will allow you to significantly lower your retirement expenses and withdraw less from your savings each month, giving your money more time to grow. While mortgage rates do seem lower than the annualized returns of the market, it's not a sure bet you'll win financially after you account for the fact that money has to be taken out every month from a volatile market to pay for the principal plus interest owed on the loan. Taking additional money out of savings to cover debt payments each month in a volatile market can stress the portfolio too much.

Minimizing taxes is essential in retirement. Tax strategies may make an even bigger difference to your bottom line during retirement than they did while working. Retirees have many opportunities to save money on taxes because many of their income sources are no longer taxed at ordinary rates. Only part of your Social Security payments will be taxable, and the amount that is taxable depends on your income. When deciding when to claim Social Security, it's important to determine how taxes impact the calculations. Some retirees will come out ahead by holding off on starting Social Security checks until they convert pre-tax assets to a Roth IRA. While income tax is due on a Roth IRA conversion, if you make the conversion in a year when you don't have any other income you will typically pay a lower tax rate than if you convert while working or claiming Social Security benefits.

However, it's also useful to keep some money in taxable, pre- and post-tax accounts, and then each year in retirement you can determine the most tax-effective way to draw the income you need from these three types of accounts. You must pay income tax on withdrawals from pre-tax accounts, while Roth distributions in retirement are typically tax-free. It's important to weigh the tax consequences of each withdrawal to make sure you aren't paying more to Uncle Sam than you need to.

Take some time to consider the lasting effects of the retirement decisions you make. You have several opportunities in the decumulation stage to make your money last much longer. And if you don't end up spending it all, your heirs will thank you for the financial moves you make now.

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Nostradamus Dec 14,1503-Jul 1,1566

The man predicted the west would destroy China. Inspite of the proponents of unfair trade who allow this United States to push it's older citizens out of the manufacturing trades that sustained them, another Michel has already called the outcome!

July 13 2014 at 4:25 PM Report abuse -1 rate up rate down Reply

Job destruction caused by the unfair trade agreements set forth the rapid decline of the middle class. Over taxation and the willingness of politicians to force their own agendas over the voters accelerated the decline. No nation could be this stupid I once thought, but all I can do is shake my head in disgust.

July 13 2014 at 3:32 PM Report abuse +2 rate up rate down Reply

Oh my Miss Huffington is at it again and is blocking users from posting on AOL. This reminds me a lot of the IRS targeting people that do not praise and worship President Obama and the Democrats darlings.

July 13 2014 at 3:30 PM Report abuse +1 rate up rate down Reply
1 reply to mrs.perlosi's comment

It was worse before, people with no idea of freedom of speech or with personal bias would write you up like a degenerate punk from the big box store.

Changes were made that still haunt the boards today like the lost of colors, fonts, live links, and uploads of doc or photos.

Perhaps AOL did like merging their networks with competitors for instance when the chats rooms on AOL recieved a live paste from a chat room from MSN. :)

July 13 2014 at 4:49 PM Report abuse rate up rate down Reply

All you idiots who vote democratic are getting what you deserve.

July 13 2014 at 2:44 AM Report abuse -3 rate up rate down Reply

The stock market made it's money bleeding the boomers dry by outsourcing their jobs. The decline in the middle class is means less disposable dollars for consumption of services, medical care, and other expenses. The cry for a higher minimum wage comes because suddenly the trade deals that trashed American jobs doesn't leave much for spending. With Europe sinking hopes for exports grow dimmer. The global world order has become a joke and big investors have been the majority of winners.

July 12 2014 at 10:03 PM Report abuse +3 rate up rate down Reply

The last of the Baby boomers turn 50 throughout 2014. The later boomer can't retire at full ssi until age 67 so that's 17 years of disgruntled American boomers to go.

July 12 2014 at 9:52 PM Report abuse +3 rate up rate down Reply

Millions of babyboomers were outsourced more than a few times since the 1990's. There wasn't no quick roll over of funds from 401Ks, most were lucky to find another job. The crap economy is ensuring the boomers are forced out of the work force so the crap job creaters can wretch and wring out the highest productivity out of the next group of suckers and then dump them for some illegals.

July 12 2014 at 9:14 PM Report abuse +4 rate up rate down Reply
1 reply to Iselin007's comment

This maybe true, as Barack has intentions of giving 3.7 Billion to the new illegals coming over the border. America is already 17 trillion in debt, so what's a couple more billion on the backs of the American taxpayers ?

July 12 2014 at 9:22 PM Report abuse -1 rate up rate down Reply

What risk ? Just learn Spanish.

July 12 2014 at 8:45 PM Report abuse -1 rate up rate down Reply

If you start planning at the age of 20 for retirement you will have way over a million dollars at the age of 65 years . Most middle class have that set aside by then and all of the education for the kids and the home and cars all paid off no bills to worry about except the lights and the phone oh yes food

July 12 2014 at 8:44 PM Report abuse -2 rate up rate down Reply

What ever happened to the reverse mortgage scam ? Fred Thompson will help.

July 12 2014 at 7:46 PM Report abuse +4 rate up rate down Reply
1 reply to rrob.smythe's comment

Maybe they will have a a scam for a reverse foreclosure soon because another big bubble is waiting to pop.

July 12 2014 at 9:17 PM Report abuse +3 rate up rate down Reply
1 reply to Iselin007's comment

Think when the bubble busts this time anybody will turn a eye towards the Real Estate industry? " Why yes, that is a nice '74 Gremlin, you do need to get some new tires. Nice wife and those 4 kids are adorable, I see another is on the way. Part-time you say at Dominoes, let me do some figuring here? Yes I think you can afford this $600 thou house. Why yes I do get a decent commission but believe me this house is You" !

July 13 2014 at 10:46 AM Report abuse rate up rate down