DanMoisand

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Editor’s note: Dan Moisand answers reader questions on all things retirement every Friday. If you have a question for Dan, please email him at RetireQA@marketwatch.com.

When we retire, we will likely have money in several different accounts. We must choose how much to take, when to take it, and from which account.

This week’s questions delve into the many possibilities for retirement income withdrawal strategies.

Q. What is the best retirement distribution strategy available today? — G.F.

A. Like beauty, best is in the eye of the beholder. What is best for each individual depends on their retirement goals and ability to handle investment risk. I think fellow RetireMentor Dr. Wade Pfau’s categorization of the two main schools of thought is a good starting point. He refers to them as probability-based or safety first strategies.

The safety first strategies try to guarantee an income that covers basic needs and if there are additional assets to cover discretionary expenses or to provide a legacy, riskier assets may be employed there. This is where you will hear of people annuitizing monies for the basic needs, heavily investing in various Treasury Inflation Protected securities, or using bond ladders matched to the expected spending over their lifetimes.

These strategies are popular with conservative families who place more importance on getting bills paid than having a lifestyle. Those that utilize immediate annuities do not mind giving up control or the ability to leave assets to others. The fact that they don’t have to manage those assets as they age or stomach market volatility can be very appealing.

Probability-based approaches put more importance on lifestyle and involve much more uncertainty. Such approaches may expect good odds of success but not a guarantee. The probabilities are assessed by using the historical record or employing forward looking estimates of market behavior.

In this camp you will find methods based on dynamic withdrawals such as withdrawing the percentage indicated on the IRS tables for Required Minimum Distributions from IRAs. Others take a guardrail approach, whereby you withdraw somewhere between 4% and 6% of your assets. Some alter the withdrawals based on how markets behave.

Another prominent distinction of this camp is enormous debate about the parameters used to calculate the odds. For instance, the so-called 4% rule may have always worked in the past but will it going forward.

Probability based approaches are popular with families that favor control over their assets, have experience with and tolerance for financial market behavior, place some importance on leaving assets to others, have the means and wherewithal to manage assets over their lifetime, and have some flexibility with their spending.

Both probability-based and safety first strategies face challenges. Our low interest rate environment means that returns on bonds that support probability-based methods are likely to be lower than in the past for some period of time. Therefore, the probabilities of success may be lower.

The same low-rate environment makes TIPS, bond ladders, and annuities employed with a safety-first approach pay less than in the past. This means that in order to achieve a specific income, more money is required.

To find the best approach, you have to focus on your goals and realize that sometimes your goals compete for the same dollars. The goal of higher spending conflicts with wanting low risk investments or leaving money to others. The best most of us can do is seek a balance that works with our particular circumstances and priorities. One size does not fit all.

Q. I am 62 and still hold the bulk of my retirement funds in my former company’s 401(k) plan, with a very aggressive stock-weighted mix. In addition, I have traditional IRAs, Roth IRAs and taxable funds.

This past year, I needed to supplement my income and began redirecting the dividend stream from the 401(k) plan to come to me. I have not started taking Social Security. Should I continue on this withdrawal plan or would it be wiser to withdraw funds from the taxable account? For the foreseeable future, I can easily live on the dividends from the 401(k). — I.C.D.

A. First, a suggestion about investments. Given yields, generally, your ability to easily live on the dividends suggests you have enough. One could argue that if that is the case, it is acceptable for you to be aggressive but one could also argue the opposite. Since you do not need to take on much risk, why do so?

Regardless of how aggressive you are, don’t fixate on investing for income. Put too much emphasis on interest and dividends and you could end up with a portfolio overloaded with long-term bonds, high-yield bonds, and dividend-paying stocks. Their higher income comes with higher risks. Long-term bonds will suffer with an increase in interest rates, high-yield bonds are called junk for a reason, and stocks are inherently volatile.

Instead of income, think cash flow. By doing this, you may seek alternative ways to generate cash flow and usually end up with a more broadly diversified portfolio. For instance, if you only consider high dividend paying stocks, you will eliminate an enormous number of stocks from your portfolio, including companies like Amazon, Google, and Warren Buffett’s Berkshire Hathaway.

Taxes are the biggest issue for you. You have a choice between paying taxes now by withdrawing from the 401(k) (or your traditional IRA) or deferring the taxes until later. The American Taxpayer Relief Act of 2012 (ATRA) made the tax tables “permanent.” It is now easier to estimate the taxes on withdrawals from retirement accounts in the near term.

However, determining what tax rates will apply farther into the future is still a bit of a guessing game. Your gross income will surely rise over time as you start Social Security and are forced to make withdrawals from your 401(k) and traditional IRA once you are age 70 1/2. How much higher depends on when you start Social Security and what those accounts are worth at age 70 1/2. Stay aggressive with your 401(k), and it could be worth a good deal more — or less — than it is today.

Nonetheless, if you are confident the tax rate you would pay later would be substantially higher, taking from the 401(k) now makes sense. The same would be true if your heirs are in higher tax brackets and preserving family money is important to you. You might also consider living off the taxable account and converting 401(k) and/or traditional IRA money to a Roth IRA.

If it looks as though you may not be in a higher tax bracket in the future, or your heirs won’t be, you might lean toward continued deferral. This is commonly the case when beneficiary designations are structured properly and the beneficiaries opt to spread their withdrawals over their lifetimes instead of taking a lump sum or when a qualified charity is beneficiary. Such charities don’t pay taxes.

Start with your goals and priorities, project your future spending needs, and overlay the taxes on that projection and the best choices for you may become clearer.

Dan Moisand’s comments are for informational purposes only and are not a substitute for personalized advice. Consult your advisor about what is best for you.