One of the most unnerving parts of retirement planning is deciding how you will generate a steady stream of income from your accumulated resources. Many of you have likely spent decades receiving a steady paycheck from an employer, but are now tasked with building one for yourself. The two main goals are typically to maintain or enhance your lifestyle while also protecting the longevity of your wealth.
Of course, everyone will approach retirement with different resources, goals, and risk tolerance levels, but knowing where to lay the foundation helps to relieve some of the anxiety that accompanies the financial aspect of this major life transition.
1. Social Security
Although it is unlikely that social security will be your main source of income in retirement, it is a great place from which to gauge how much additional income you will need to meet your needs. Some retirees may use their social security benefits to bridge the gap between their early retirement years and the years when they must begin taking mandatory distributions from their tax-sheltered IRAs and 401(k)s. Others will choose to defer taking benefits (up to age 70) to earn the higher awarded amount social security pays for waiting.
2. Pension Plans
Even though defined benefit pension plans are largely becoming outmoded, there are still some retirees who will benefit from one. Much like a paycheck, pension plans provide a predictable source of income each month for the course of the beneficiary’s lifetime (and sometimes the life of the surviving spouse depending on elections made during employment). This income source can serve as a great base for covering living expenses.
3.Tax-Advantaged Retirement Accounts: Traditional IRAs and Roths
Traditional IRAs, 401(k)s and other employer plans, Roth IRAs, and employer Roths are all tax-advantaged retirement from which you will likely withdrawal income in retirement. Of course, where they differ is when the tax advantage is offered.
Traditional IRAs and 401(k)s are tax-deferred, which means distributions will be taxed in retirement. These accounts also have mandatory Required Minimum Distributions (RMDs), which require individuals to begin drawing on these assets (whether they need them yet or not) at age 70 ½.
Roths, on the other hand, offer tax-free withdrawals on earned income as contributions were made with post-tax dollars in the accumulation phase. Roth accounts also do not have RMDs, which makes them attractive from both the tax planning and estate planning perspectives.
It is typically best to begin drawing from your taxable assets before spending from tax-deferred as it (1) allows your tax-sheltered accounts to continue to grow and (2) decreases the amount of taxes paid—both wins for the longevity of your portfolio.
4. Non-Retirement (Taxable) Investment Portfolio
The investment portfolio will often serve multiple purposes for retirees from covering living expenses to building wealth to pass along to heirs. The specific objectives for your portfolio will determine your overall asset allocation and should always take into account your life expectancy, risk tolerance level, and other assets.
It is smart to hold tax-efficient investments in taxable accounts and tax-inefficient investments in tax-advantaged accounts to maximize your after tax returns. This strategy can drastically improve your retirement savings by lowering your taxable income.
5. Home Equity
The home is a sizeable asset for many individuals entering retirement, and a number of retirees will choose to downsize or relocate after they leave the workforce. In this case, the proceeds from the sale of the home may become a source of retirement income—and for the sale of a primary residence, this income is generated tax-free.
However, with real estate prices being what they are currently, downsizing or relocating may not yield enough profit to purchase a new primary residence and have a significant amount of cash in hand. Consult with your financial professional before selling your home. It may be best to leverage other forms of income and remain in your current residence until the housing market favors a more fortuitous outcome.
6. Additional Passive or Active Income
Many retirees opt for a gradual retirement where they either continue working part-time or pursue a new part-time job to remain engaged, interact socially, and earn a little extra cash. Working part-time also helps retirees maintain a predictable schedule and feel a sense of accomplishment that is oftentimes lost when the working years cease.
Still other retirees many have additional sources of passive income such as real estate, alimony, or deferred compensation. Make sure to factor in the tax implications of these passive income sources and plan ahead to determine if and when these income sources could dry up.
Piecing the Paycheck Together
The ways and means of crafting your retirement paycheck will be unique to you, your resources, and your needs. It is important to sit down with your financial professional and take a detailed and honest inventory of the resources from which you will pool your income to plan for the longevity of your wealth and the success of your retirement.
At Uncommon Cents investing, we specialize in helping individuals and families with all their retirement planning and wealth management needs. We invite you to take a look around our site and get to know us. If you like what you see, feel free to schedule a call on our calendar to get your questions answered or concerns addressed. Thanks for stopping by! We look forward to getting to know you.