How Can You Make the Most of Your IRA Nest Egg?

MARK RIEPE: I'm recording this episode in the summer of 2022, and a comedy series called Loot recently debuted.¹ It's about a woman who divorces her billionaire husband after a twenty-year marriage.

The premise of the show is that she has to figure out what to do with her $87 billion divorce settlement. She has a charitable foundation that she forgot about and decides it might be a good place to start.

It's hard to identify with the problems of the super wealthy, but the show illustrates a problem that we all have. Most of us spend a lifetime accumulating assets, but there comes a time when the accumulation phase is done, and the distribution phase begins. In other words, we build a nest egg and then we start depleting it.

In the case of the show Loot, much of those distributions will go to various charitable endeavors. For most people, though, the distribution of assets will go to fund our retirement and the goals we've set up for ourselves during those years.

The earnings from our portfolio will replace the paycheck we used to get from our employer. The common element, though, is the fact that instead of accumulating, you're spending, and that requires a different mindset.

I'm Mark Riepe, and this is Financial Decoder, an original podcast from Charles Schwab. It's a show about financial decision-making and the cognitive and emotional biases that can cloud our judgment.

Bill Gates is one example of an uber-capitalist who went from building up a legendary company to using that wealth to support charitable endeavors. He certainly isn't the only one, though.

And what's especially interesting to me is that so many of these people use the same principles and techniques in their giving as they did in their companies. They use their connections and know-how, and they like to invest their time as well.² They want to get more bang for their charitable buck and will partner with other groups and governments to make a bigger impact.

But the mindset is different. When done well, the end goal isn't just about growth and wealth—it's about achieving deeply personal goals or trying to solve especially intractable problems that affect many, many people.

Another example I like to use is the great athlete, someone like Larry Bird or Mike Ditka, who achieves success as a player but turns to coaching when their playing days are over. A lot of the skills and knowledge are the same, but the purpose and mindset are completely different.

Now, most of us aren't pro athletes or billionaire entrepreneurs who can give away a fortune and still live comfortably. Most of us will retire—if we haven't already—and we'll need to shift our mindset.

For decades, we socked money away in our 401(k)s and retirement accounts. We were savers first, then we became investors, and then one day we retire and everything changes. No more saving. It's time to spend, time to draw on that nest egg we've spent so much time building and turn that pool of savings and investments into something that can replace a paycheck.

This shift in mindset is challenging, and it's an issue we see with investors all the time, even though they've known it was coming and have even looked forward to it.

My guest today is going to help us think through some of the details when it comes to shifting your mindset from saving money for retirement to withdrawing and spending once you are retired.

A few of the things we discuss are:

• The failure of people who haven't yet retired to take advantage of higher contribution limits on tax-deferred accounts;
• The importance of coordinating accounts between spouses;
• How hard it can be to get an accurate assessment as to how much money you'll be spending;
• And many other topics.

Joining me now is Daniel Stein. Dan is a vice president and branch manager for Schwab in Bethesda, Maryland. He's a Certified Financial Planner, a Chartered Financial Analyst. Dan, thanks for being here today.

DANIEL STEIN: Mark, I'm a huge fan of the podcast, so it's my pleasure to be here.

MARK: Fantastic. So this episode is all about how to make the most out of your individual retirement accounts, or IRAs, or I-R-As, however you want to call it, after you've kind of built it up and spent your life of making contributions to it. But let me back up a bit from that and start by asking you, what suggestions do you have for people who are nearing retirement or thinking about retiring?

DANIEL: Well, Mark, we always say the earlier, the better, when it comes to taking advantage of saving through retirement accounts. But even contributions that are made in your late working years, they can still be really critical to a successful retirement. So starting out at that high level, contributions to traditional IRAs and retirement plans like 401(k)s, they grow tax-deferred, meaning you don't pay taxes on capital gains, interest payments, or dividends that are paid within that IRA. Now, you pay income when you take withdrawals from the IRA, but that tax-deferred growth could allow it to grow at a higher rate. So for Roth IRAs and Roth 401(k)s, you already paid income on your contributions, so those future withdrawals come out tax-free, making the tax-free growth that happens within the IRA even more beneficial.

MARK: Dan, in your experience, do you see it happen often where people, they have the ability to maximize their retirement contributions, but they aren't necessarily doing it? How often does that happen?

DANIEL: Yeah, we do see it, actually. And a key word that you mention there is ability to maximize retirement contributions. So just, for example, for 2022, the maximum employee contribution to a company-sponsored plan like a 401(k), a 403(b), or a TSP, it's $20,500. And the maximum that you can contribute to an IRA, either a traditional or a Roth, is 6,000 per year. Now if you're age 50 or older, though, you can contribute an additional $6,500 to the employer-sponsored plan, for a total of 27,000, and an additional $1,000 into your IRA, for a total of 7,000. So, Mark, taken together, if you're 50 or older, that's a total of $34,000 that you could contribute to these two types of plans alone.

MARK: Of course, given those numbers, not surprisingly, not everyone is able to max out on those contribution levels. If that's your situation, what's your advice for those people?

DANIEL: Yeah, absolutely. Not everybody is going to be able to have the financial flexibility to max those contributions, certainly. So if you don't, we recommend that you start out with your employer-sponsored plan first. You got to take advantage of any matching contributions that your employer offers, which are really very common.

MARK: And by employer sponsored, that's the 401(k), the 403(b), those types of plans, right?

DANIEL: Exactly. Exactly.

MARK: So what about the people, they have the financial flexibility to maximize the contributions, but they just aren't doing it? What's behind that? What are the reasons that you usually see for that kind of behavior?

DANIEL: Yeah, I'd say the most common one, it's just inertia of past behaviors. So many people set up their savings amounts for contributions to those employer-sponsored plans based on what they can afford at that time, but then they don't revisit those amounts. So throughout your working years, as your pay starts to increase, and then maybe you also have expenses like childcare that start to drop off, you might be able to increase your retirement savings, but you don't because you're just stuck in the way that you had set up initially. So when we help clients to create their wealth management and their retirement plans, we often find many opportunities for clients to actually go back in and increase those savings rates.

MARK: It's interesting that you mention that inertia, because in past episodes, one of the decision-making biases we've mentioned is the status quo bias, where people, they're just doing something just because that's the way they've always done it. It sounds like you see that a lot.

DANIEL: Oh, absolutely. And sometimes, Mark, the busier a person is, the harder it is to overcome that. So you might be somebody that has that "Well, if it isn't broke, don't fix it" mentality. And if you're someone that also has limited time in your schedule, well, you're probably going to be more likely to stick with the status quo. In practice, though, oftentimes small changes to your savings and investment plans, they can have big impacts on a successful retirement down the road. So if you're listening out there, and you haven't talked to a financial professional about your financial plan, make that important investment of your time.

Now, Mark, one last note on this, I often say that there are few people on this planet that haven't rethought their priorities over the last few years during the pandemic. And this really is a great time to make sure that those past behaviors of savings are still aligned with any of those new goals that you might have.

MARK: Dan, I know we need to move on, but for people in their 50s who haven't been saving, it's kind of a now-or-never moment, right? I mean, they're probably at their peak earning years, and let's face it, they could be out of the workforce in several years—I mean, that's a real looming reality. And with those catch-up contributions that you described earlier, the tax code has made it very attractive to makes some big contributions to those accounts.

DANIEL: Yeah. Well, Mark, even though I kind of kicked off by mentioning that the earlier you start, the better, getting a late start should never discourage someone from actually taking the initiative to make that change now. So if you're starting with a smaller amount of retirement savings and you're into your 50s, every year that you take advantage of contributing to your retirement plans, it's really critical. So if you're in this boat, don't get discouraged. Do go out now and make the commitments that will shape when and how comfortably you could retire by starting now.

MARK: A couple of episodes ago, we did a show about risk, and one of the topics we covered was the difficulties caused where one partner has a different risk tolerance than the other partner. My guess is you're working with couples a lot. Do you see couples coordinating their contributions to these types of retirement plans?

DANIEL: Yeah, it's a great question, because sometimes the focus can really be on coordinating the investments, as you mentioned. You had covered that on a recent podcast. But we do also help clients coordinate how they save. So let me give you a recent example. We met with a couple who were about five years away from retirement. Let's call them John and Sally. Now, Sally had a much higher income than John, and she was maximizing her 401(k) and her IRA contributions with plenty of savings left over after their living expenses. John was maximizing his IRA contributions, but his salary was lower. So he wasn't maximizing his 401 contributions, just on the thinking that it was too large of a portion of his salary. Well, in this case, we just helped by simply looked at the couple's income collectively. Now, we knew that Sally's income was funding all the living expenses and then some, so there was no reason not to increase John's 401(k) funding, getting that money into a tax-deferred account, rather than have it grow in a taxable one the way they had been. So this is one of the reasons why it's really important that all parties be engaged together in that financial planning process.

MARK: Dan, what do you see most often in your branch, couples who commingle everything, kind of like you were just describing, those who keep everything separate, or is a hybrid approach the most popular?

DANIEL: Yeah, probably the most common scenario is couples that are commingling everything. But even then, Mark, we often see that one spouse is more engaged in the finances than the other and try to fix that. We do, also, work with couples that prefer to keep their finances separate. Sometimes this could be the case of a second marriage, for example. And when we run into that, we like to learn more about why they prefer it that way. And sometimes as we talk through the reasoning for it, and then as we talk through their retirement goals and find that really they're truly joint, the benefits of looking at the assets holistically really starts to take shape. So as far as a hybrid approach, I'd say the best example I can think of is when clients are looking at the assets together for expenses during their lifetime, but then they have different beneficiary plans for the remaining assets. In these cases, it leads into an estate planning conversation that we can help with.

MARK: Dan, the foundation of this podcast, the overall podcast, is how emotions are a powerful force when we're making financial decisions. So what's the biggest emotional hurdle to overcome when people get to the point where they're going to start drawing down their financial assets for the first time?

DANIEL: Yeah, Mark, I think the biggest hurdle that we all see all the time is that fear of losing that consistent income from your salary. I mean, people spend their lives building their assets up, and the thought of spending them down, it could be uncomfortable. So the best advice that we can give is, it is OK to draw down your retirement assets. This is what you built them up for, to use them in retirement. But that idea of giving up the consistent income of a paycheck, it could be really hard for some people that do. So one caveat I'll throw out there, it's OK to spend down your accounts as long as you have a plan in place.

Now, one of the most impactful ways that we help clients, both pre-retirement and in retirement, is help them create that financial plan that accounts for their spending goals and their wishes, and then we determine how much could be withdrawn annually, how the assets should be allocated to reach those goals in a way that agrees with their tolerance for risk, and then what that spending plan looks like.

MARK: You know, that reluctance, it's interesting because there's a stereotype of Americans who don't save enough. Yhey spend recklessly. And it's interesting that you're encountering people who have retired and frankly, they're not spending enough, or at least they're overly thrifty given their resources. How common is that? What kind of percentage of clients are exhibiting that kind of behavior?

DANIEL: Yeah, that first issue of people overspending and under-saving for retirement, it's a big one, right? It's a primary focus of ours to help people minimize that risk of running out of funds in retirement, when without a plan, they might otherwise spend beyond their means. But on the flip side, Mark, it's actually pretty common for us to need to really help people maximize the enjoyment they can get from retirement. So we often see people that are working longer than they truly need to, or they're sacrificing parts of their ideal retirement that they saved for without really needing to, just because of that fear of drawing from their retirement funds.

I'll tell you one example. One interaction that I'll never forget was sitting in on a meeting with a newer client and a financial consultant. This client was about three years out from the age that she had chosen for retirement, but then she found her job eliminated. She ended up taking another role earning less and was really unhappy in that new role, so she decided to come in, wanted to get some guidance. Well, after we learned about her savings, her spending goals, her debt, really just her entire financial picture, we were able to illustrate to her that she was actually in a very strong position to successfully retire that day. And I'll never forget, Mark, her sitting back in her chair and repeating three times to the financial consultant, "I can retire. I can retire. I can retire." And then told the consultant, "You gave me a new life." And the reality is she had already done all the hard work of saving up to put herself in that position. She just needed someone to show her the path forward.

MARK: Yeah, that's a great story, Dan. Setting aside that kind of emotional hurdle, and let's focus on more, you know, kind of the … sort of the logical or the rational part of this process—what's a good starting point for how to start drawing down an IRA?

DANIEL: There's a common one out there when it comes to creating that spending plan. It's an old, popular rule of thumb. It's called the 4% rule. So this is relatively simple. You add up all of your investments, and you withdraw 4% of that total during your first year of retirement, and in subsequent years, you adjust that dollar amount you withdraw to account for inflation. Now, by following this formula, you should have a very high probability of not outliving your money during a 30-year retirement, according to the rule. So, for example, Mark, let's say, your portfolio at retirement totals $1 million. You would withdraw $40,000, so 4% of that in your first year of retirement. And if the cost of living rises 2% that year, you would give yourself a 2% raise the following year, withdrawing $40,800, and so on and so forth for the next 30 years.

MARK: Pretty straightforward, easy to understand, makes a lot of sense. Is that something that you're recommending to clients, that they follow something that formulaic?

DANIEL: You know, I bring it up because it's a common one, and the 4% rule can be a fine starting point. But these days, clients have access to far more personalized guidance, including the financial planning that we offer at Schwab.

Now, what we recommend is to personalize this approach by having a retirement planning conversation with a financial consultant. Here's where we can assist your unique situation, look at your assets, your risk tolerance for investing, other sources of income that you have, including Social Security, and then your unique spending goals.

MARK: Yeah, I think that personalization is pretty important. Too many people, I think, they … in fact, it's a known bias, they default to the default, and they don't bother to adjust it as their circumstances change. So give me some examples of the kinds of adjustments that people either should make or at least should consider making.

DANIEL: Yeah, I'll give you one big common one is planning for a large one-time expense in retirement. Very frequently, people have this goal in mind, maybe it's buying a boat or a vacation home. The 4% rule, it can't account for purchases like that, like a personalized financial plan can.

Now, when it comes to other income sources, too, like Social Security, well, the 4% rule, it's not going to address how and when you should start that income stream. Your Social Security decision's a very important one that you can actually be helped make by somebody running through a personalized financial plan with you.

MARK: Yeah, it sounds like, you know, a key part of this is really figuring out how much you're going to be spending in retirement and how much money you need to support that spending. So do you see cases where in retirement people will be needing either less than they're currently spending or maybe they need more, and, more generally, kind of what's driving those costs in retirement?

DANIEL: Yeah, you're spot on. It's a good question. I mean, we could help clients get a good estimate of their spending needs in retirement, and the closer to retirement you are, the more accurate we can generally be. But behaviors can and always will change, Mark. So this is one of the reasons why we recommend revisiting your retirement plan at least annually in the years that are leading up to your retirement, and then that initial few years of retirement, as well, when we can reassess and make any changes as necessary.

Now, it could be a pleasant surprise when you find yourself spending less than anticipated, but in practice, it's probably more likely that you're going to run into additional expenses that you hadn't anticipated. And, again, this is something that financial professionals will help you try to account for in advance.

MARK: It's another well-known decision-making bias that people have when planning. It's much easier to think about scenarios that are going to work out well than it is to think of all the different ways in which, you know, frankly, things may not work out so well. So, Dan, can you give me some real-world examples of the kinds of unexpected expenses that you see people have to deal with again and again?

DANIEL: Yeah, Mark, if you want me to be the bearer of bad news, I'm more than happy to give a couple of examples we see. So let me touch on five of the more common unexpected expenses that retirees might encounter.

Now, the first one is unexpected housing expenses. Now, some people might have paid off their mortgage, and they discount the costs that are actually associated with home ownership, things like repairs. And these might come in the form of a new AC unit or even a new roof that you need.

Second, unexpected healthcare costs, because while Medicare has many benefits, it still isn't going to cover all of your medical expenses and needs.

Then a third related one is long-term care. This is another need that isn't covered by Medicare. And one that estimates shows 70% of retirees 65 and older will need for an average of three years in retirement.

Fourth one, Mark, is unexpected family expenses. This can be in the form of a parent that might need aid or a child needing financial assistance.

And then, the fifth one is losing a spouse or a partner. And, particularly, for couples that might count on two streams of Social Security to fund their basic retirement needs, this one can be pretty tough.

MARK: Dan, you mentioned mortgages, and that's probably the biggest fixed cost in most people's budgets. So what advice do you have for people who are tempted to use retirement savings to pay off their mortgage just before retiring and kind of get that expense out of the way?

DANIEL: I love being asked this question because there's some differing opinions on the matter. And the reason for that is paying off a mortgage faster or in or before retirement, it's both a mathematical decision, but also an emotional one. So just as I mentioned, there's a lot of people that have a fear of losing their paycheck in retirement, many people feel more comfortable with the idea of being debt free in retirement, and they want to pay their mortgage off early.

Now, Mark, every situation is unique, and there certainly are some situations where paying off a mortgage early wouldn't have an adverse impact on a retirement plan. And if it makes for a happier retirement by providing that peace of mind of not having debt, well, it might very well be the right decision because of that emotional side of the equation.

MARK: Yeah, so I think probably for most people, they would err on the side of going ahead and making that … paying it off. But give me an example where not paying it off is worth considering.

DANIEL: Yeah, absolutely. One example is when there's a potential for better use of those funds. So recent example, we met with an individual, she was age 60, and she had gotten started late funding her retirement accounts, but now she was earning a higher income, and she had more funds to invest. She wanted to retire at 70, and she wanted to start her Social Security benefits at that age, as well. She was maxing out her IRA contributions at $7,000 a year, and then she was putting an additional $1,000 a month or 12,000 a year into her 401(k), and then on top of that, putting an additional $1,000 towards her mortgage payment monthly, an additional payment to pay down the principal faster on a loan she had of about 3.25%.

Now, in this case, by putting that extra $1,000 a month into the extra mortgage payment versus additional 401(k) contributions, she was actually foregoing the opportunity to have these funds grow tax-deferred for many years, she was foregoing the income tax reduction benefits of the 401(k) contributions, and she was doing this to pay down a relatively attractive low-rate loan.

MARK: Great example. What about a case where retirement has already been funded and the person has already retired?

DANIEL: Yeah, I'll give you an example along those lines. We recently met with a newly retired client that had accumulated a healthy amount of funds in his IRA and his 401(k) accounts, but he only had a small amount of non-retirement taxable accounts, so he was going to have to begin taking IRA distributions immediately. Now, this was OK based on his assets and his spending needs, but in discussing his retirement goals, he was adamant that he wanted to pay off the remainder of a $200,000 mortgage immediately. He had a low rate on the loan, and his monthly payments were less than 1,000 a month, meaning, to make these payments, he only needed to withdraw an additional $10,000 a year from his IRA beyond the $40,000 he planned on withdrawing for all of his other expenses. Now, remember, Mark, traditional IRA withdrawals are taxed as ordinary income, and the $50,000 in annual distributions that he would need to pay his annual expense of the mortgage, well, it would be taxed at a relatively low rate. But by taking out a single $200,000 payment right at that first year of retirement along with the extra $40,000 for other living expenses, well, now all of a sudden he has income of $240,000 in year one to pay taxes on at a substantially higher rate, foregoing also the opportunity to have those funds grow tax deferred in the IRA if he were to pay the mortgage down over time. In this case, we were just able to illustrate to him the tax savings alone, and that was enough to help make him change his mind.

MARK: Yeah, these are great examples given. At least as we're recording this, mortgage rates, you know, are changing all over the place because of the Fed's campaign to raise interest rates. So very timely.

Let's move on to a different topic here. Most people probably have more than one type of retirement account. It could be a 401(k), it could be other source of retirement income, such as a pension or Social Security. So how can they combine these types of incomes or these income streams in the best way to make sure they're getting that predictable income, that paycheck that you referenced earlier that people are so worried about losing that they had when they were working?

DANIEL: Yeah, going back again to overcoming that fear of losing the income stream of a salary, we like to call this replacing your paycheck in retirement. Now, having an illustration of where your income will come from in retirement, it can really help and put clients at ease, and it can actually be the thing that helps them commit to their hard-earned retirement. So as you mentioned earlier, it all starts out with how much you'll need to spend annually in retirement. A retirement plan will help you come up to those amounts, which can sometimes be phased with expenses dropping later in retirement, when goals like travel might become less frequent. And then after we find the income that's needed, adjusted annually for inflation, well, then we start to add up our known income streams. Now, you mentioned Social Security and pensions. We're going to take a look at those first alongside any other source of income—like rental properties, annuities. Then we look at portfolio income, like interest and dividends from stocks, bonds, and CDs that you hold. And once we take all these streams together and we account for income taxes, we can see what the shortfall is that could be generated from the portfolio.

Now, some people with high income streams and low spending goals, they might not have a shortfall at all, but the majority will. And here's where that reminder comes in again. It's OK to spend down your principal in retirement. You just want to make sure that you have a plan in advance on how you're going to do so.

MARK: So when you say pull money from the portfolio, what you're talking about is, you know, actually selling something to generate new funds. Is that right?

DANIEL: That's right.

MARK: So tell me a little bit about, then, that process. Maybe give me an example of one approach to doing that.

DANIEL: Yeah, of course. So this starts out first with having a proper asset allocation, or your mix of stocks, bonds, and cash that's appropriate for your situation. Now, while you'll generally want to reduce your risk when you're nearing and in retirement, stocks held in moderation, they still serve an important role as the growth portion of your portfolio. They're going to fund longer-term goals and help keep pace with inflation. But you never want to be in a position where you're forced to sell equities at an inopportune time. So for that reason, one of the strategies that we recommend is a bucket approach.

Now, to illustrate, once you identify the amount of money that you're going to need to take from your portfolio to supplement that recurring income, we recommend holding one year's worth in very short-term holdings, like high-yield checking accounts, or money market funds, or short-term CDs. Then you want a second bucket with an additional two to four years of funds to supplement other income sources. Now, that second bucket should still be low-risk, highly lucrative investments, like short-term bonds and CDs. And then you have a third bucket. Now, this is going to consist of some of that longer-term growth part of your portfolio. You'll have equities, bonds with longer maturities. And the idea here, Mark, is that in times of volatility or in down markets, you have that first bucket for 12 months, and then you have two to four years of relatively stable funds to draw down to avoid the need to sell riskier assets at inopportune times. Then as you deplete each bucket, you can rebalance and refill them with assets from the longer-term bucket above.

MARK: All right. I know we're supposed to be talking about retirement, but, Dan, I want to take a tangent here, and … because we get this question a lot. We've got people who, they've accumulated a lot of money in either a traditional or a Roth IRA, and they would like to withdraw some of the money before they retire. So what are the rules around that? Is that even possible?

DANIEL: Yeah. Well, while we always try to help people avoid tapping into their retirement accounts prior to retirement, sometimes the unexpected happens, and it just can't be avoided. So the good news here is that there are ways to withdraw funds pre-retirement.

Now, first off, once you reach age 59½, whether you're retired or not, you're able to withdraw funds from an IRA penalty-free. A traditional IRA, well, that withdrawal is going to be taxed as ordinary income. A Roth IRA, that withdrawal is going to come out tax-free. If you're in a position where you need to withdraw the funds prior to age 59½, though, you're still free to do so, but you might have to pay penalties to the IRS. Now, in a traditional IRA, the entire distribution is going to be taxed as ordinary income, and you could have an additional 10% penalty for the early withdrawal. In a Roth IRA, you can actually withdraw any contributions that you made tax- and penalty-free prior to age 59½, but you could be subject to a 10% penalty on the earnings, or the growth beyond your initial contributions to the Roth.

MARK: So let's talk a little bit about those penalties. I'm assuming, or, hopefully, there's some loopholes or ways to avoid that penalty. For example, if you want to buy a house, can that be used as a legitimate reason to avoid the penalty?

DANIEL: Yeah, there's actually several exceptions to the penalty. Some of them are more common than others, but a common one is what you bring up—it's called the first-time home purchase. Now … although that name's a little bit misleading … now, Mark, up to $10,000 of an early IRA distribution can avoid the 10% penalty if it's used to buy a primary residence for yourself, a parent, a grandparent, spouse, children, or grandchildren. But the first-time home buyer, it doesn't actually mean that it's the first time that buyer has ever owned a home. The buyer just can't have held an ownership interest in any home in the past two years.

MARK: Got it. OK. So I'm hesitating a little bit to ask this next question, because we really like to tell people to treat their retirement accounts as sacrosanct, but we both know that life has a way of getting in the way. So what if you've got some extreme financial hardships? Are there some ways around the penalties that you described earlier in those situations?

DANIEL: Yeah, absolutely. And several of the other exceptions, they really are related to hardships, as you mentioned. So, for one, if you're disabled, you can make withdrawals penalty free. Another one is if you have unreimbursed medical expenses in excess of 7½% of your adjusted gross income, you can use IRA distributions to pay those expenses and not be penalized. Third one, if you're unemployed for at least 12 weeks, you can use funds from your IRA to pay health insurance premiums for you, your spouse, and dependents without any penalty. And there's also a reservist distribution exception. That's for members of the National Guard and reservists that are called to active duty for at least 180 days. There are some restrictions. And, also, Mark, new parents can also withdraw to $5,000 to pay for birth or adoption expenses penalty free.

Now, the last one I'll hit, and this might be the most applicable to people that decide to retire prior to age 59½, is the periodic payment exception, or 72T payments. Now, this involves taking equal periodic payments from your IRA, based on one of three approved methods to calculate an ongoing withdrawal amount. Now, there is the additional stipulation that you have to stick to this schedule for a minimum of five years or until you reach age 59½, whichever event occurs later.

So to sum it up, it's definitely possible to tap into retirement funds early, but you should speak with a professional to see if you can avoid the costly penalties.

MARK: Dan, last question, the way retirement accounts are set up, you can't keep money in them indefinitely. Generally, you have to start taking them at least by age 72, thanks to the SECURE Act. But those required distributions, that can be really confusing, especially for married couples. What are some of the things people should keep in mind when it comes to taking these RMDs, or required minimum distributions?

DANIEL: Yeah. Well, while many people are in a position where they need to withdraw from their IRAs to fund their retirement, probably most people, others might be in a spot where they have other sources of income or after-tax accounts that could fully cover their living expenses. So, Mark, in those cases, people might wish to keep their funds in the IRAs indefinitely to continue to benefit from that tax-deferred growth, but this is where the required minimum distributions, or RMDs, come into effect. So the first advice that I'll give you on this, I tell people when you're required to take these distributions, take them.

MARK: Yeah, that's great advice because the penalties are pretty steep if you miss a payment, right, or miss a distribution, right?

DANIEL: Yeah, no doubt. There is a rather severe penalty of 50% of your RMD amount for failing to take it out of your IRA on time. So when you get those notices from the IRS or from your financial services firm, don't ignore them.

MARK: All right. What else do people need to know about RMDs to make sure they're doing things correctly?

DANIEL: Yeah. Well, as you said, RMDs from traditional IRAs, they now begin at age 72. Specifically, you must take your very first RMD by April 1st of the year after you turn 72, with all subsequent RMDs due by December 31st of each calendar year. Now, Roth IRAs, they don't have RMDs for the original owner. RMDs, they're based on an IRS schedule that takes into account your age and the balance of your IRA account as of the end of the day on December 31st of the previous calendar year. So based on your age and a set life expectancy table that the IRS uses, you're required to take a certain percentage of your IRA balance out every year. Now, Mark, this amount starts off relatively low, at about 3.65% at age 72. Then it starts to climb steadily through retirement. At age 85, it climbs up to 6.25%, and then at age 90, you're required to take 8.2% out of your IRA that year.

MARK: Dan, one of the confusing things about IRAs is that there are so many exceptions to some of the standard rules. So what are some of the common exceptions that you see that are applicable to RMDs?

DANIEL: Yeah, I'll touch on two special circumstances we probably see the most often. The first one applies to spouses where there's a 10-year or more age gap between the two. Now, when this is the case, and if the younger spouse is the sole primary beneficiary of the older spouse's IRA, you can actually use the younger spouse's RMD schedule. This results in lower required withdrawals. So if you're in a position where you prefer to keep the funds in the IRA as long as possible, well, this could be a real benefit.

Now, the second common scenario, this doesn't necessarily eliminate the need to take RMDs, but it could make them more palatable for investors that don't need the funds and they have charitable inclinations. So this situation is called a Qualified Charitable Distribution, or a QCD for short. A QCD, it's a donation that's made directly from an IRA to a qualified charity without the IRA owner taking possession of the funds first. This allows the IRA owner to deduct the entire amount of the distribution from their income, up to $100,000 annually.

MARK: Daniel Stein is vice president and branch manager for Schwab in Bethesda, Maryland. Thanks, Dan. Tons of great, practical information. I appreciate you taking the time today.

DAN: It was a pleasure being here today. Thanks so much for having me on, Mark.

MARK: Dan had great advice.

But one of the downsides of talking to a large group of people is that we're forced to generalize and, for the most part, the best advice is advice that's specific. In other words, most people want and need advice that is tailored to their lives.

To help bridge that gap, we've compiled many resources on how to manage your financial life while living in retirement into a single website.

The URL is schwab.com/learn/in-retirement. That's schwab.com/learn/in-retirement.

I want to go through just a few of the topics on that site to give you an idea of what I mean.

Dan mentioned the penalties for RMDs, or required minimum distributions. That's an important issue, but on our site we also have articles about taking RMDs if you're still working after retirement age.

We answer questions like, can you start contributing to your retirement accounts again if you get a new job at age 73?

Or maybe you are particularly concerned about how market volatility can affect RMDs. Rob Williams, who's been a guest on our show a few times, has an article on that subject.

At schwab.com/learn/in-retirement, we also walk you through the finer details of managing your Social Security and Medicare benefits, strategies for tax planning, and charitable giving.

There's a lot more there, so please take a look.

And also keep listening to our show. For our next episode, we're continuing with the retirement theme, and we'll dig into some strategies you can use if your retirement gets off track.

Thanks for listening. If you've enjoyed the show, we'd be really grateful if you left us a rating or review on Apple Podcasts.

Nothing can replace a podcast recommendation from someone you know. So if you know someone who might like Financial Decoder, please tell them about it and how they can follow us for free in their favorite podcasting app.

And if you want more of the kinds of insights we bring you on Financial Decoder about how to improve your financial decisions, you can also follow me on Twitter @MarkRiepe. M-A-R-K-R-I-E-P-E.

For important disclosures, see the show notes and Schwab.com/FinancialDecoder.

 

¹ Loot, tvapple.com, accessed July 21, 2022, https://tv.apple.com/us/show/loot/umc.cmc.5erbujil1mpazuerhr1udnk45

 

² Harvey, Charles, "Why Entrepreneurs Like Bill Gates Become Philanthropists," theguardian.com, May 22, 2014, https://www.theguardian.com/voluntary-sector-network/2013/may/09/bill-gates-warren-buffet-philanthropic