Cash planning is an integral part of all financial planning. Before retirement, you want to be sure you have enough cash savings for things like your home renovation, vacation or emergency funds. During retirement – cash planning is the most important aspect of your financial plan. This is because you no longer have income (besides Social Security and maybe a pension if you’re lucky), so you are now taping into your hard earned savings.

Cash planning is often referred to as your retirement withdrawal strategy. Ideally you should start planning for it 5 years before retirement. Why 5 years? I’m glad you asked.

5-Year Rule And Cash Planning

There’s no way to know when the market will crash, and how long it will take to recover. The largest market declines in our history have taken anywhere from 3 months to 10 years to recover. Most have recovered within 5 years. So when planning for upcoming expenses, a good rule of thumb is to always have cash available for your next five years of expenses. This way, if at any time the market declines, you will have liquid assets to use and give your investments a few years to recover. Therefore, you won’t need to sell investments at a loss during a bad market.

For example: You are spending $150k/year on living expenses and taxes, and bringing in $50k/year in Social Security. You need $100k from your savings each year – therefore, you should have $500k in cash or a cash equivalent.

This money should be saved in vehicles ranging from pure cash (short-term needs) to liquid and conservative investments (Bonds, CDs, balanced funds – longer-term needs).

Retirement Withdrawal Strategy

Now that you know how much cash you need – where and how do you take it out. In retirement, the strategy is all about minimizing taxes and maximizing growth. Below is the order that you take money from during retirement.

1st Source – Cash: This is the cash you have in savings, checking and taxable accounts.

2nd Source – Brokerage Accounts: The next account to use in retirement is your brokerage account because capital gains taxes are less than income taxes.

3rd Source – Traditional IRAs and 401ks: By age 73, you must take out Required Minimum Distributions (RMDs). For some this is more than enough, but others will need more than their RMDs for living expenses. Because the original contributions were tax deferred, you need to pay income taxes on these distributions.

4th Source – Roth IRAs and 401ks: If possible, the account to pull from last is your Roth accounts. This is because this money grows tax free (you paid taxes upfront!). This is a great tool for inheritance, as your heirs will inherit this money tax free.

Liz Frazier is a Certified Financial Planner (CFP), Forbes contributor, the author of Beyond Piggy Banks and Lemonade Stands: How to Teach Young Kids About Finance, and Director of Education at Copper Banking. Her goal is to simplify finance so anyone can live a financially healthy life. You can connect with her here for more information on financial planning or financial education.