The annuity solution
Here's a way to virtually ensure you'll always have money coming in, no matter how long you live.
NEW YORK (CNN/Money) - There is a simple way to take advantage of annuities without, on the one hand, paying too much for extra features or, on the other, giving up access to all your retirement assets.
That solution: Invest a portion of your retirement portfolio in one or more low-cost annuities with no expensive options, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from as needed.
Deciding the percentage that's right for you depends on a variety of factors: how much you've saved, how much income you want in retirement, how long you think you're likely to live, how concerned you are about running short and how much money you'll need on hand for unexpected expenses and such.
The greater your chances of living a long life and your concern that you might outlive your money, the more of your assets you would want to devote to annuities.
One approach is to cover as much as possible of your essential living expenses (food, clothing, housing, medical care and so on) with Social Security, company pensions and annuities, and then rely on withdrawals from the rest of your portfolio for discretionary spending and emergencies.
All in all, I think it would be reasonable for most people who decide they need the stability of a reliable life-time income to consider devoting 25 percent to 50 percent of their retirement assets to a combination of fixed- and variable-payout annuities.
To get the biggest retirement paycheck, you must do two things.
First, annuitize your money in chunks over a few years. Don't do it all at once. The payment you get from a fixed-payout annuity depends largely on current interest rates, so if you put all your money into an annuity when rates happen to be very low, you've relegated yourself to a lifetime of low payments.
Second, manage withdrawals from outside the annuity portion of your portfolio so that as little as possible gets siphoned off by the IRS and state tax authorities. Generally, you have the best chance of minimizing the tax bite and leaving more money for you by following these guidelines.
Draw from your taxable accounts first. If you hold investments such as mutual funds, stocks, bonds and CDs in taxable accounts, it's likely that they are regularly throwing off some sort of taxable gains in the form of dividends, interest payments and, in the case of mutual funds, capital-gains distributions. You're already paying tax on them, so you may as well spend them. And if you hold on to them, they'll continue to generate taxable gains.
Keep in mind that not all your assets in taxable accounts are equally vulnerable to taxes. Municipal bonds, for example, generate interest that is free from federal taxes and, in some cases, state taxes as well. Individual stocks and certain types of mutual funds (index funds and tax-managed funds, for example) can also be tax efficient, in that their returns come mostly in the the form of an increasing share price; your gains aren't taxed until you sell.
Those gains are also taxed at lower long-term capital-gains rates as long as you hold the stock or fund longer than a year. Dividends are tax efficient in the sense that they're now taxed at the same lower rate as long-term capital gains. But you have no control over when the dividends are paid out to you. Most companies pay them quarterly, which means you'll owe tax on those dividends every year.
So when drawing from your taxable accounts, look first to the investments that generate the biggest tax bills and then move on to more tax-efficient assets, such as muni bonds, as well as individual stocks and index and tax-managed mutual funds in which you've built up large long-term capital gains.
Move on to tax-deferred retirement accounts. It pays to avoid tapping tax-deferred accounts first, if possible. The reason: Those accounts can grow more quickly since the gains aren't being eroded by taxes. Keep in mind, though, that at some point the government requires that you start pulling money out of tax-deferred retirement accounts such as 401(k)s and IRAs (but not Roth IRAs). And if you don't withdraw the right amount, you can be hit with some staggering penalties.
Your withdrawals from these accounts will be taxed at ordinary income tax rates, with one exception: If you made nondeductible contributions to your IRA (or to a 401(k) that was then rolled into an IRA), only the gains on those contributions are taxable.
Save money in a Roth IRA for last. There are several reasons to hold off as long as possible on tapping assets in Roth accounts.
First, once you're over 59ª and the money has been in the account for at least five years, all withdrawals from your Roth accounts are tax-free.
Second, unlike traditional IRAs, Roths have no required withdrawals. You can let the money rack up tax-free gains in the account as long as you want.