“Creating a Retirement Paycheck”
For many, transitioning from work to retirement is learning to live without a steady paycheck. This can be challenging as expenses continue even after you stop working. Many of us would like to create a reliable income stream in retirement, but doing so requires focus, attention, and assistance from someone who has worked through it before. The right choices can help you create a sustainable income stream for the rest of your life, while the wrong ones can leave you short of cash.
During our working lives, we accumulate assets. We strive to receive dependable income from our employers or generate it from our businesses. We focus on how much we spend and save, and hopefully how we are investing the excess. The story changes in retirement. We stop receiving a steady paycheck. Social Security or a pension may provide a base of income, but most want or need more. The other place to turn for income is our investments. Securing consistent, dependable retirement income that meets all your needs as well as your wants can be more challenging.
If your goal is to create a consistent and reliable retirement paycheck then here are some factors to be aware of or ask your advisor about:
- Understanding & Maximizing Social Security benefits
- Tax efficiency of accounts
- Setting a sustainable withdrawal rate
- Required Minimum Distributions (RMDs)
SOCIAL SECURITY
Social Security often accounts for a significant percentage of a retirees’ income. You should try to maximize this benefit, and this starts with understanding how social security works. Based on some of my conversations with prospects, many people still believe full retirement age (FRA) is 65. It’s not. If you were born in 1960 or later, it is 67. For those born in 1954 and earlier, it is 66. As show in
this table, it increases each year for those born from 1955 through 1959. You can start collecting Social Security benefits as early as age 62, however starting to collect benefits earlier, results in smaller monthly payments in the future. In general, waiting until age 70 provides the largest monthly benefit available to an individual, but your own unique circumstance will determine the optimal time to begin drawing.
TAX EFFICIENCY OF ACCOUNTS
While we know taxes are an inevitable part of life, the goal is to make sure we are only paying the taxes we need to. Holding different account types from a tax perspective (Traditional IRA and Roth IRA as one example) is a great way to increase your tax diversification and create flexibility in your withdrawal strategy. As we focus on improving our tax efficiency in retirement, here are a number of items to consider:
- What portion of my assets/income are in accounts that will be taxed upon withdrawal? (401K, Traditional IRA, Social Security, Pension)
- What portion of my assets/income are in accounts that are tax free at withdrawal? (Roth IRA, HSA)
- What combination of taxable and tax free withdrawals are best suited for my income needs?
- What role do Roth IRA conversions play in my portfolio?
- What will my Required Minimum Distribution be from 401K/IRA accounts when I turn 72?
- What role does charitable giving play in my retirement?
SETTING A SUSTAINABLE WITHDRAWAL RATE
Conventional wisdom suggests using the 4% rule to determine how much to withdraw from your retirement accounts each year. In theory, this rule allows you to withdraw 4% of your total portfolio value each year without eating into the starting principal balance. Historically, this approach has posed a low risk of outliving your money especially if your overall portfolio returns are beating 4% on an annual basis.
Someone’s risk tolerance, monthly budgeting needs, and long-term estate plans will impact this standard 4% rule, but it can at least be a good starting point for many to consider. If nothing else, a sustainable withdrawal rate can provide the peace of mind for retirees to know they are taking care of their expenses and not seeing the total balance of their portfolio decreasing.
REQUIRED MINIMUM DISTRIBUTIONS (RMDs)
As we stated at the beginning of the article, taking a more strategic approach to withdrawals from traditional IRA, Roth, and taxable accounts can help you reduce your tax bill. What many retirees fail to appreciate is the taxable requirement coming their way in the form of required minimum distributions from their tax deferred retirement accounts. Accounts such as your 401K, 403B, or Traditional IRA will require you to begin withdrawing a certain percentage of assets from these accounts when you turn age 72. Failure to take these minimum distributions can be costly as you will pay a penalty of up to 50% on top of any income taxes due.
Understanding what your taxable income could/would look like when you reach age 72 can be an eye opening exercise. At that age you would have full social security income, requirement minimum distributions, and any pension benefits available to you. That could mean that your marginal tax bracket is much higher than when you first entered retirement. For these reasons, taking proactive steps to reduce your RMD’s prior to age 72 (with Roth IRA conversions as an example) can be a very valuable exercise.
FINAL THOUGHTS
Retirement should be a time when you can finally reap the rewards of all of the hard work you have put in during your working career. Yes, retirement looks different for everyone, but the one thing that is consistent is that retirees want peace of mind that their retirement paycheck will provide for the lifestyle they want. A steady stream of income can be just as reliable during retirement as it was before you retired. Connecting with a professional that can help craft this “retirement paycheck” with you can be a rewarding and valuable thing to do.
