Retirement income planning is similar to climbing a mountain. For mountaineers, the goal of mountain climbing is to make it to the top and get back down the mountain safely. In fact, more accidents occur during the descent than during the ascent. This is similar to retirement income planning and spending. Planning for retirement is not just about accumulating wealth and building a retirement balance. It's also about planning for how to use your income during retirement. Many people excel at the ascent — saving for retirement, less people are prepared for the descent — converting your saving to retirement income that will last.
The first step in designing retirement income is determining the difference between a pay check and “play check.” A pay check does what the name says, pays basic living expenses — housing, food, healthcare and other necessities. For many, the pay check will come from your 401(k) and Social Security. As Tom Hegna explains in the book, Paychecks and Playchecks — Retirement Solutions, this money is used to cover all of your fixed costs. If that amount is not sufficient to meet your lifestyle needs, you may want to consider a fixed income portion of savings or buying an annuity to increase the amount of the “pay check.”
Like a pay check, a play check does what its name says, it is used for items beyond your basic needs. After your pay check is covered, you can invest the remainder of your retirement savings balance for inflation protection and use as your “play check.” Take the retirement savings balance, typically in an IRA, and create a diversified investment program. Use your IRA investments (stocks, bonds and cash) to fund your “play check” to generate income above and beyond basic needs.
Social Security rewards patience and planning. If you wait to tap your Social Security you will be rewarded. Many individuals take Social Security when they become eligible at age 62. Social Security hedges against longevity risk — the longer you defer, the bigger your benefit. For more information read, “When to Start Your Benefits.”
Withdrawal and tax strategies are an important part of an effective retirement income plan. Unlike the taxes you pay while you work, you have more control over your tax rate during retirement. Pay attention to tax brackets and marginal tax brackets. Withdrawals from various types of savings accounts can be taxed at very different rates. You need to understand your different income sources — whether they are taxable, tax‐free or tax‐deferred, and how they will be treated. Withdrawing additional income that is taxed may push you into a higher tax bracket, knowing how sources are taxed can lower your tax consequences and save you more money.
A popular retirement income strategy is to begin withdrawing from your taxable savings account. The goal is to benefit from a reduced tax rate on long‐term capital gains versus the ordinary‐income tax rates you would typically pay on IRA withdrawals.
You can control taxes on some retirement income sources, and some you can't. Pensions and Social Security are generally set, while other sources may give you more control. Using this control can prevent you from increasing the amount you're taxed. If you want a higher retirement income than just your pension and Social Security payments, consider tapping a Roth account or brokerage account instead of your IRA.
When using this withdrawal strategy be careful of “burning off” too many taxable account assets that are subject to capital gains taxes. It's just as important for your tax strategy to allow income generation. Many experts and planning tools recommend using taxable money first as part of your retirement income withdrawal strategy. Consider using ordinary taxable income sources first up to the highest level of the lower marginal tax brackets, and then tapping more “tax friendly” accounts for additional income.
|Use a Tax Diversification Strategy While Saving
If possible, try employing a tax diversification strategy while you're still accumulating your savings. For example, if you are 50, you may qualify for moving your 401(k) retirement savings ($18,000 annually, or $24,000 with the catch-up contribution) into a Roth option. Many people chose a traditional 401k to get the immediate tax benefit of the deduction. Saving in a Roth can create tax‐free withdrawals and give you more options during retirement.
|Convert Savings to Roth
Another interesting tax diversification strategy is retiring at a certain point in a year to minimize taxable income. For example, if you retire early in the year, you can end up in a lower income tax bracket, and then convert a portion of pre‐tax savings in an IRA to a Roth account with lower tax consequences. This can be very beneficial in the long run.
At 70 ½ the government mandates you take minimum distributions from IRAs and retirement plans which will change the amount of income you need to take out.
Certified advisors understand the nuances of tax diversification strategies and can help you make decisions that maximize your retirement income and create beneficial tax outcomes. Learn more here about how advisors can help you create a retirement income financial plan.
This content has been produced for educational purposes only. It was prepared without regard to specific objectives, financial situation, or needs of any particular receiver and is not a recommendation to buy or sell any investment. Johnson Financial Group and its affiliates, Johnson Bank and Cleary Gull Advisors Inc., do not provide tax or legal advice. Please consult your own professional advisors. Investment products and services are not FDIC insured, not bank guaranteed, and may lose value.