Did you know that 50% of retirees worry about outliving their money? It’s a sobering thought as you approach retirement. Even if you’ve done some retirement planning, you may have underestimated how much it will cost to maintain your lifestyle. How do you know how much is enough? The good news is that you don’t have to worry
In our comprehensive retirement planning guide, we’ll walk you through the process of building a stable, tax-efficient retirement paycheck that will weather the market storms. Whether you’re a pre-retiree in your 50s, a recent retiree, or a financial advisor guiding high-net-worth individuals, our article offers the knowledge and strategies you need to create a reliable retirement income stream.
1. Three Phases Retirement Income
2. Four Pillars of a Secure Retirement
3. Common Pitfalls That Can Destroy Retirement Income
4. Action Plan: How to Build Your Retirement Paycheck
The Three Phases of Tax-efficient Retirement Income
Retirement is not a one-stop shop, and not everyone will have the same experience. It changes as you age, varying from the experiences of friends, colleagues, or even family members. You’ll face challenges and opportunities that are unique to your situation. Let’s look at the critical stages and how you can handle them.
Phase 1: Early Retirement (55-65)
These first years of retirement often bring new options and excitement, but you should include money management strategies as part of your retirement income plan. Market changes can affect your savings as you stop growing your money and start using it. That’s where the “sequence of returns risk” becomes part of your retirement income planning.
What Is the Sequence of Returns Risk?
The sequence of returns risk represents a threat to your retirement savings. It happens when your investments perform just as you start retirement. That critical timing coincides with when you start withdrawing money from your portfolio. So, poor returns during that initial period can have a long-lasting negative effect on your retirement funds.
To reduce the risk, here are a few effective strategies:
- Build a Cash Buffer: Set aside cash or short-term bonds to cover 1-2 years of expenses. The cash buffer helps you avoid the need to sell investments when the markets are down.
- Implement a Bucket Strategy: Split your portfolio into short-term, medium-term, and long-term buckets. This method can help you navigate the pitfalls and avoid the potential risks. Still, you’ll be gaining from long-term market growth.
- Use a Bond Tent: Boost your bond allocation before and after you retire. Then, reduce your allocation as time passes. This approach can shield you from early market drops.
Tax-efficient Withdrawal Strategies
Cutting your taxes in early retirement can help your savings last longer in your retirement income plan. Here’s what you can do:
- Roth Conversions: Change some of your traditional IRA to a Roth IRA if you’re in a lower tax bracket in retirement. You’ll potentially cut down on future Required Minimum Distributions (RMDs), which can give you tax-free income in the future.
- Tax-loss Harvesting: Unload investments at a loss when markets go down. This strategy can balance out your capital gains and help shrink your tax bill.
- Asset Location: Move your investments into tax-advantaged accounts. Then, put your tax-efficient investments into taxable accounts. You could lower your overall tax load.
Planning for Long-term Care
- Long-term Care Insurance: Think about whether long-term care insurance fits your needs. If you have health concerns, the long-term care insurance option might be even more of a necessity. Regardless of your current health and medical situation, your healthcare costs may be more than you realize.
- Medicaid Planning: Know the Medicaid eligibility rules and how they might change your estate. Your income must be below 138% of the Federal Poverty Level, but some programs might work if you’re “medically needy” with a higher income.
Estate Planning
- Develop/Update Your Will and Trusts: It’s great that you have a will, but if you haven’t looked at it or updated it in 15 or 20 years, it may not reflect your current situation and wishes. Take a look at your will, but also review other estate planning documents. Make sure they reflect what you want now.
- Review & Update Beneficiary Designations: Over the years, your various financial accounts can add up. Track down and determine which accounts require you to include beneficiary designations. Then, check and update regularly.
Phase 2: Mid-retirement (65-75)
During these mid-retirement years, you’ll face additional considerations for your retirement income plan based on your age and eligibility. One of the big choices during this time is when you should start getting Social Security benefits. Should you wait? Here are some factors:
Value of Waiting
If you wait to claim Social Security benefits after reaching full retirement age, your benefit increases by about 8% each year until you turn 70. So, if you claim your benefits at 62, the Social Security Administration (SSA) calculates your payments based on 60 months, which amounts to a 20% reduction for the first 36 months and an additional 10% for the remaining 24 months.
Spousal Benefits
If you’re married, think about ways to get the most benefits for both of you. When planning, think about health, age, and benefits. Even if you’re divorced, you can receive benefits from your ex-spouse’s record if you were married for 10 or more years.
Taxes
No more than 85% of your Social Security money is taxed. Social Security benefit taxes are based on your “combined income,” which is generally calculated as follows: Adjusted gross income (AGI) + any nontaxable interest you may have earned + 1/2 of your Social Security benefits = combined income.
Here’s a breakdown based on your filing status.
As an individual:
- Income up to $25,000: There’s no tax on Social Security benefits
- Income between $25,000 and $34,000: Up to 50% of benefits may be taxable
- Income over $34,000: Up to 85% of benefits may be taxable
As a married couple filing jointly:
- Income up to $32,000: No tax on Social Security benefits
- Income between $32,000 and $44,000: Up to 50% of benefits may be taxable
- Income over $44,000: Up to 85% of benefits may be taxable
Required Minimum Distributions (RMDs)
When you turn 75, you’ll start taking RMDs from most retirement accounts.
- Determine Your RMDs: Review IRS worksheets to see how much you can withdraw each year.
- Give to Charity with QCDs: Use Qualified Charitable Distributions (QCDs) to meet your RMD. The strategy allows you to help causes you care about without paying taxes.
Phase 3: Late Retirement (75+)
As the years go by, in late retirement, your retirement savings plan must take into account how or if you’re leaving a legacy. It’s never too late to plan how your money will impact the lives of your family, cherished causes, and even the community. So, how can you help ensure your money lasts?
Estate Planning
- Update Your Will and Trusts: If you haven’t reviewed your will in a few years, it might not align with your current needs and preferences. Take the time to go over it and other estate planning documents to make sure they still reflect your wishes.
- Beneficiary Designations: Over time, you may have accumulated multiple financial accounts, each with its own beneficiary designation requirements. Identify which accounts need these designations and make it a habit to review and update them periodically.
The Four Pillars of a Secure Retirement
Planning for a steady income in retirement requires you to think through your situation now and in the future. You can make smart choices and learn how to create a retirement paycheck by focusing on four main areas.
Social Security Optimization
Social Security often makes up the base of retirement income. However, you must understand how to get the most out of these benefits, as they can greatly affect your money security.
When Should You Start Taking Social Security?
The time you choose to claim Social Security can have a significant effect on your benefits:
- Taking benefits at 62: You can get your checks, but your monthly amount will be up to 30% less.
- Holding off until 67 (full retirement age for people born after 1960): You’ll get 100% of what you’ve earned.
- Pushing it to 70: Your check grows by 8% each year, giving you 132% of your full amount.
Making Social Security More Tax-friendly
Since your SS benefits could be taxed at up to 85%, depending on your income, your retirement income plan must track how your income and withdrawals will be affected.
Here’s how you can keep more of your cash.
- Keep an eye on your total income: Track your AGI interest, which isn’t taxed, and half of what you get from Social Security.
- Move money to Roth accounts: Shifting funds from traditional IRAs to Roth IRAs before you start claiming Social Security can help lower your taxable income when you retire.
- Plan your withdrawals: Be smart about which accounts you take money from to manage how much tax you pay. It takes some forethought, but it’s one of the essential retirement withdrawal strategies.
Spouse and Survivor Benefits
If you’re married, divorced, or have lost your spouse, you might be able to get more benefits:
- Spousal benefits: You can claim up to 50% of your spouse’s full retirement benefit if it’s higher than yours.
- Survivor benefits: As a widow or widower, you can receive up to 100% of your spouse’s benefit after they’ve passed.
Investment-based Income Strategies
A diverse investment portfolio can give you a steady income stream throughout your retirement years.
Dividend-paying Stocks vs. Bonds vs. Annuities
Each investment type has strengths and weaknesses:
- Dividend-paying stocks: These stocks have the potential to grow and produce income, but they carry market risk.
- Bonds: These bonds represent steady income and less volatility. Unfortunately, they might not keep up with inflation.
- Annuities: These annuities are guaranteed income. The negative side is that they charge high fees and offer less flexibility.
Combining these investments can bring both stability and room for growth. Alternative assets, such as real estate investment trusts (REITs) or commodities, can help you diversify beyond regular stocks and bonds. These alternatives can yield higher and more reliable returns while protecting you against inflation.
Portfolio Withdrawal Strategies
Here are two popular methods:
- The 4% Rule: A safe withdrawal rate is around 4% of your portfolio in your first retirement year. You can adjust it for inflation each year after that.
- Dynamic Withdrawals: Decide how much money you take out in withdrawals based on how the market is performing. A dynamic withdrawal approach is more flexible. You’ll likely alter your withdrawals based on what’s going on in your life.
The 4% rule is a good starting point for your retirement income planning. Then, introduce a more flexible approach as the market changes and your needs alter.
Bucket Strategy vs. Income Ladders
Here are two more ways to approach your retirement withdrawal strategies.
- Bucket Strategy: Split your portfolio into short-term, medium-term, and long-term buckets depending on when you’ll need the money.
- Income Ladders: Space out investments like bonds or CDs to come due at different times. It’s a great way to help to ensure you have a more regular income when you need it the most.
You can combine these strategies to create a well-rounded plan for retirement income.
Tax-efficient Withdrawal Strategies
Smart tax management in retirement can help your nest egg last longer and give you more cash to spend in your later years.
The “Withdrawal Hierarchy”
As you plan for and implement retirement withdrawal strategies, here’s the order for which accounts to use first.
- Required Minimum Distributions (RMDs) from traditional IRAs and 401(k)s
- Taxable accounts
- Tax-deferred accounts (traditional IRAs, 401(k)s)
- Tax-free accounts (Roth IRAs)
Your specific situation and tax bracket can radically alter this hierarchy. As you can see, though, each account has its tax implications.
- Roth IRA: You can withdraw money tax-free in retirement if you’ve met the requirements for qualified distributions(see IRS guidance).
- Traditional IRA: Your money grows tax-deferred, but withdrawals are taxed as ordinary income.
- Taxable Brokerage: You pay taxes on capital gains and dividends.
Roth conversions are an important option when your income is lower. With these conversions, you can reduce future RMDs and taxes.
How to Avoid the Social Security Tax Torpedo
The “tax torpedo” happens when your Social Security benefits become taxable, which might push you into a higher tax bracket. To steer clear, keep an eye on your overall taxable income. As you plan for your Social Security taxes, be vigilant. It could be the right time to push back when you take your benefits.
Tax-loss Harvesting & Capital Gains Minimization
Tax-loss harvesting means selling investments at a loss to balance out capital gains. This approach may help you cut down your tax bill and balance your portfolio. It can also boost your long-term returns. You can knock off as much as $3,000 in net capital losses from regular income every 12 months. *Reminder: Keep track of your losses because losses can carry over until fully used.
Inflation and Longevity Risk Planning
Inflation is a silent retirement killer. It might not seem threatening, but it can impact your financial well-being as you plan for your retirement. But how can you protect it?
Essentially, inflation causes your hard-earned savings to lose value. So, your money buys less and less. If you start with a million dollars and face an average inflation of 2% over 20 years, your purchasing power decreases. It’s like losing more than $300,000 without spending a cent.
To combat inflation, some retirement income sources may offer cost-of-living adjustments (COLAs) to help you maintain your income’s value.
- Social Security: The Social Security Administration provides annual COLAs based on the Consumer Price Index.
- Pensions: Some pension plans include COLAs, but you can’t count on it.
- Annuities: Annuity products sometimes offer inflation protection features, but a cost might be involved.
It’s not just that your money loses value, though. Inflation also affects your investment strategy. To plan for retirement, you’ll probably want to diversify your portfolio.
You can invest in Treasury Inflation-Protected Securities (TIPS), which adjust with inflation. These government bonds help to protect you from the effects of rising prices. I-Bonds from the U.S. Treasury are another option to protect your retirement savings from inflation.
As you plan for your future, use FINRA’s Retirement Calculator to see how inflation could affect your retirement. As you work through the numbers, consider the tried and true methods to protect your future retirement.
With a cash buffer, a growth-oriented investment mindset, working longer before retirement, and the adjustment approach (review and make changes as needed), you can tailor your strategies to your unique situation.
Common Pitfalls That Can Destroy Retirement Income
Getting ready to retire is tricky, and even little slip-ups can complicate things. Let’s look at four major mistakes that can derail your retirement plans. We’ll also discuss how to avoid them.
Relying too much on Social Security
You might think that Social Security will cover all your retirement expenses. However, Social Security aims to cover 40% of what you made before retirement.
Solution: Diversify your investments, put money into a 401(k), or start an IRA to boost your financial safety net.
Ignoring taxes on withdrawals
Retirement funds are not necessarily free from taxes. Even if you don’t have to pay them right now, you’ll pay them later. Ignoring those taxes on distributions can throw your budget out of whack.
Solution: Make sure you understand the tax implications of your retirement accounts. Then, use the withdrawal hierarchy to tap into those accounts that will have a minimal tax impact.
Not stress-testing a portfolio for market crashes
How will a drop in the market affect your retirement savings? It could cause your nest egg to shrink faster than you thought.
Solution: Stress test your savings and asset allocation to determine how your retirement savings will be affected. It’s a great way to see how the best investments for retirement income can keep you safer from crashes.
Overlooking healthcare and long-term care costs
Fidelity’s 2021 report indicates that you should have $300,000 after taxes to pay for your healthcare bills. Even if you included these costs in your retirement income planning, you may have overlooked the full scope of what will come due.
Solution: Remember to include medical costs in your retirement planning. Use Fidelity’s Healthcare Planning Tool to determine how much you may need to cover healthcare costs when you retire.
Mini-Case Study: “How a Small Change Allowed a Business Owner to Save More For Retirement”
A 45-year-old small business owner has a tech company with 10 employees. Despite her success, she faces a common entrepreneurial challenge: saving effectively for retirement while managing the day-to-day demands of business.
The business owner learned about the 401(k) plan, which is a great way to increase retirement savings. She was thrilled with how it seemed tailor-made for small business owners like her.
Key Benefits of the 401(k):
- Higher Contribution Limits: 401(k)s offer contributions of up to $23,500 of compensation, which is significantly higher than the $7,000 limit for traditional IRAs.
- Tax-Deductible Contributions: 401(k) contributions can be used to reduce her personal income and also as the business in the form of matches. The personal income contributions are made pre-tax, and the employer contributions are tax-deductible, so a business owner can reduce their taxable income for the year.
- Tax-Deferred Growth: Tax-deferred funds grow until withdrawal, allowing them the potential for greater compound growth over time.
The business owner worked with her financial advisor and accountant to set up the 401(k). It was a simple process:
- Choose a financial institution to administer the plan.
- Complete the necessary paperwork.
- Inform employees about the new retirement benefits.
- Set up automatic contributions.
The decision to implement a 401(k) benefitted the owner and positively impacted her employees. As 401(k) rules require, the company now contributes to employee retirement accounts. The owner enhanced her own financial security and boosted company morale.
The case study shows that it’s never too late to adjust to improve your savings potential dramatically. A plan like this can greatly benefit your business and employees.
Action Plan: How to Build Your Retirement Paycheck
As you build your action plan for retirement, it doesn’t have to be overwhelming. Here’s a 5-step plan to help you confidently build your retirement paycheck.
Step 1: Assess Your Income Sources
Start by taking stock of all your potential retirement income sources. Be sure to include:
- Social Security benefits
- Pension plans
- 401(k)s and IRAs
- Taxable investment accounts
- Annuities
- Rental income or other passive income streams
Use the Retirement Calculator to estimate the amount needed for retirement, how much you can withdraw, and how long your money will last. Then, use the Investment Calculator, 401(k) Calculator, and Roth IRA Calculator.
Step 2: Identify Tax Inefficiencies
You should know how taxes affect your income sources. A clear understanding is key as you work to boost your retirement paycheck.
- Traditional vs. Roth accounts
- Required Minimum Distributions (RMDs)
- Capital gains taxes
- Social Security taxation
Review the IRS’s Tax Guide for Seniors for detailed information on retirement-related tax issues.
Step 3: Choose an Investment Withdrawal Strategy
Selecting safe withdrawal rate strategies can help your savings last longer and minimize your tax burden. Popular strategies include:
- The 4% rule
- Bucket Strategy
- Dynamic Spending
The Retirement Calculator can help you visualize and plan for various withdrawal scenarios.
Step 4: Stress-Test Your Plan for Risks
To help ensure your retirement income plan can withstand potential challenges:
- Market volatility
- Inflation
- Healthcare costs
- Longevity risk
Use the Retirement Shortfall Calculator to run various scenarios and assess your plan’s resilience.
Step 5: Work with a Financial Expert to Fine-Tune Your Strategy
A professional can help you optimize your retirement income plan by:
- Identifying tax-saving opportunities
- Addressing estate planning concerns
- Providing ongoing guidance as your needs change
Retirement planning is too important to leave to guesswork. Schedule an Intro Call to optimize your income strategy for maximum security and tax efficiency.
