Consider our step-by-step plan—with taxes in mind—to help make the transition.
If you’re like many people, you reach retirement with a mix of investments and accounts. After all, there were many tax-advantaged ways to tuck money away for retirement, such as a 401(k) or 403(b), a traditional or Roth IRA, or a deferred annuity. So how do you transition what you’ve saved into an income-generating retirement portfolio that has the potential to last as long as you do? Here are three steps to consider to help you do just that.
STEP ONE: Establish guaranteed lifetime income.
We believe most investors should strive to cover essential expenses with guaranteed income sources such as Social Security, pensions, and certain annuities. Since Social Security and pensions aren’t always enough, many people may want to purchase an annuity, which is one of the only other ways to generate lifetime income.
If you‘re looking to buy an annuity to generate additional lifetime income, here’s a way to consider which savings to tap first, with the potential to help minimize taxes and maximize your retirement savings:
Annuitize an existing tax-deferred annuity.
If you've saved for retirement in a tax-deferred annuity, now may be the time to annuitize it, turning it into a steady stream of guaranteed1 income payments. You aren’t taxed when you do this. Instead, each annuity payment will be taxed appropriately.
Tap tax-deferred accounts—401(k)s, 403(b)s, or traditional IRAs.
If you don’t own an annuity, you may want to consider rolling over the money from a traditional IRA, 401(k), or 403(b) to purchase one. You aren’t taxed on the amount you roll over. Instead each annuity payment will be considered taxable income and will be subject to ordinary income tax, assuming all contributions had been made pretax.
Use taxable accounts—brokerage or bank.
After utilizing tax-deferred balances, you may want to consider turning to taxable bank or brokerage accounts. If you need to sell an investment to do so, consider these suggestions, which have the potential to help minimize the tax impact:
Consider selling investments that have lost value, and which can generally be used to offset capital gains and up to $3,000 a year in ordinary income. First, realize short-term capital losses to offset short-term capital gains, which are taxed at ordinary income tax rates. Then, realize long-term capital losses to offset long-term gains, which are taxed at lower capital gains rates.
Use available cash.
Realize long-term capital gains, which are taxed at lower capital gains rates.
Realize short-term gains, which are taxed at higher ordinary income tax rates.
Consider working with a tax adviser before taking any of these steps.
Before investing, consider the investment objectives, risks, charges, and expenses of the fund or annuity and its investment options. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.
1. Guarantees are subject to the claims-paying ability of the issuing insurance company.
2. A distribution from a Roth IRA is tax free and penalty free provided that the five-year aging requirement has been satisfied and at least one of the following conditions is met: you reach age 59½, die, become disabled, or make a qualified first-time home purchase.
3. See How Long Different Portfolios May Have Lasted Chart: Short term portfolio represents 100% short term investments; aggressive growth portfolio represents 85% stocks and 15% bond investments; most aggressive portfolio represents 100% stock investments. Domestic stocks are represented by the S&P 500; bonds by U.S. Intermediate Term Government Bonds; and short-term assets are based on the 30-day U.S. Treasury bill. Foreign equities are represented by the Morgan Stanley Capital International Europe, Australasia, Far East Index for the period from 1970 to the last calendar year. Foreign equities prior to 1970 are represented by the S&P 500. Historical returns for the various asset classes are based on performance numbers provided by Ibbotson Associates in the Stocks, Bonds, Bills, and Inflation (SBBI) 2007 Yearbook (annual update work by Roger G. Ibbotson and Rex A. Sinquefield). This chart is for illustrative purposes only and is not intended to project or predict the present or future value of the actual holdings in an investor’s portfolio or the performance of a given model portfolio of securities. It is not possible to invest directly in an index.
Generally, among asset classes, stocks may present more short-term risk and volatility than bonds or short-term instruments but may provide greater potential return over the long term. Although bonds generally present less short-term risk and volatility than stocks, bonds contain interest rate risk (as interest rates rise bond prices usually fall); the risk of issuer default; and inflation risk. Finally, foreign investments, especially those in emerging markets, involve greater risk and may offer greater potential returns than U.S. investments.
Several hundred historical financial market return scenarios were run to determine how the asset mixes may have performed. The Average Market and Extended Down Market results are based on 50% and 90% confidence levels, respectively. The results for the Average Market highlight the number of years the hypothetical portfolio would have lasted in 50% of the scenarios. The results for the Extended Down Market highlight the number of years the portfolio would have lasted in at least 90% of the scenarios generated.
The purpose of the graphic is not to suggest that an investor use a 6% rate, but to illustrate the variations in the expected longevity of a portfolio under different target asset mixes. Different withdrawal rates will result in variations in the expected longevity of a portfolio under different asset allocation strategies.
4. Calculations based on a proprietary Fidelity investment analysis tool. The tool generates hypothetical income and asset projections based on real-time pricing of annuity products and certain market assumptions regarding invested assets. The tool uses hypothetical asset class performance estimates that are based on Monte Carlo simulations that run several hundred hypothetical financial market scenarios to project a range of potential outcomes for various retirement income portfolios. The tool does not run multiple hypothetical market scenarios; rather, it uses certain market performance assumptions derived from this analysis. There are a number of simplifying assumptions (such as the leveling of expenses and income streams, and estimating assets) and inherent natural mathematical imprecision (including the tools approach to confidence levels) that could cause variation over time. The tool uses certain assumptions and modeling to attempt to combine products that may provide income based on those assumptions.
Estimates of potential income and assets illustrated by the tool are in future dollars and are based on data entered, product attributes, and assumptions. Other investments not considered by may have characteristics that are similar or superior to those being analyzed. Numerous factors make the calculations uncertain, such as the use of assumptions that historical returns and inflation, as well as the data provided. Our analysis assumes a level of diversity within each asset class consistent with a market index benchmark that may differ from the diversity of your own portfolio. Results may vary with each use and over time. Fund fees and/or other expenses will generally reduce your actual investment returns and, other than the applicable annual annuity charges for the variable annuity, are not reflected in the hypothetical projections generated by this tool.
IMPORTANT: The projections or other information generated by the tool regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
The Wilsons' retirement income plan chart: Essential expenses are matched at an assumed 0% return level and total expenses (essential and discretionary together) at the 50% confidence level. The average market conditions (50% confidence level) are used to match the total income need.
Investment portfolio assumption: Illustrations of investment component are based on a balanced target asset mix. The balanced target asset mix is composed of 35% domestic and 15% foreign stocks, 40% bonds, and 10% short-term investments. See footnote 3 above for details on indexes used. Several hundred historical financial market return scenarios were run to determine how the asset mixes may have performed. The results are based on Average Market (50%) confidence level. The result for the Average Market highlight the number of years the hypothetical portfolio would have lasted in 50% of the scenarios generated.
Fixed-income annuity assumption: The fixed income annuity is assumed to be a lifetime annuity with a 10-year guarantee period, 3% cost of living adjustment, and a 100% survivor benefit at the death of either annuitant. In order to arrive at the estimate, the best quote available as of January 31, 2011, was used from among the fixed income annuities distributed by Fidelity Insurance Agency, Inc.; these annuities are issued by third-party insurance companies, which are not affiliated with any Fidelity Investments company. Rates may change daily.
Variable annuity assumption: The variable annuity is assumed to be a joint-life variable income annuity with a 10-year guarantee period, 3.5% benchmark rate of return, 0.60% annual annuity charge, and a 100% survivor benefit at the death of either annuitant. The illustration assumes an asset allocation that becomes increasingly conservative over time, consistent with the asset allocation schedule of the Fidelity VIP Freedom Lifetime Income Portfolios.
The variable income annuity values reflect the deduction of the annual annuity charge. The 0% rate of return is equivalent to a -0.60% return after this charge is reflected. Fund fees will also apply and are not reflected.
The amount of each payment from a variable income annuity is not guaranteed and may decrease based on the performance of the selected investment option.
Some insurance products are issued by third-party insurance carriers, that are not affiliated with any Fidelity Investments company.
5. Principal value and investment returns of a variable annuity will fluctuate and you may have a gain or loss when money is withdrawn.
The tax and estate planning information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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Investment and workplace savings plan products and services distributed through investment professionals provided by Fidelity Investments Institutional Services Company, Inc., 100 Salem Street, Smithfield, RI 02917.