Creating Your Retirement Paycheck

The most common question we are asked when helping a client transition from working to whatever comes next is, “How do I replace my paycheck?” Your advisor can help you determine how to maximize your lifetime resources when creating your retirement paycheck, but the source of funding for that income will likely vary by age. Since right-sizing that retirement paycheck to be sustainable over your lifetime is just as important as the funding source of the paycheck, we also review safe withdrawal rate rules of thumb for your consideration.

Creating Your Retirement Paycheck

Paycheck Under Age 59½

If you can afford to retire before the age of 59½, you likely have investments outside of your 401(k), IRA, or other retirement accounts. At this age, withdrawing from retirement accounts is rarely a wise option, given the 10% penalty on non-qualified distributions. The first place we suggest spending from when retiring under the age of 59½ is the income already taxable to you. Rather than reinvesting dividends and then creating income by selling from your portfolio (potentially generating capital gains and additional tax), use the interest and dividends to fund your lifestyle. Income from business interests, rental properties, required minimum distributions (RMDs) from inherited IRAs, REIT dividends, and/or portfolio income such as interest or dividends are all examples of currently taxable income.

If your current income does not cover your spending, your advisor can help determine what to sell considering your overall asset allocation, assets that might be sold at a loss, and then assets to sell with gain taxed at preferential capital gains tax rates. If you need to take distributions from retirement accounts under the age of 59½, talk to your advisor about ways to potentially avoid the penalty. Either if you qualify to take distributions penalty-free from an employer-sponsored plan, given you separated from service at age 55 or later, or by taking calculated substantially equal periodic payments (SEPP). Taking SEPPs requires you to calculate a distribution amount based on one of three methods and take distributions for a minimum of five years or until the age of 59½, whichever is later. Extra tip: if you plan on taking from retirement accounts and separating from service at age 55 or later, consider moving IRAs into your employer-sponsored 401(k) before separation (if allowed). Then, you can pull from the larger pool before age 59½ with no penalty. The age 55 exception does not apply to IRAs, Simple IRAs, or SEP IRAs.

Paycheck Between Age 60 – 67 (or your Social Security Full Retirement Age)

Retiring after the age of 60 affords you the option of taking distributions from 401(k)s, IRAs, or other retirement accounts without a 10% penalty. However, the first place we suggest spending from is the income already taxable to you. Rather than reinvesting interest and dividends and then creating income by selling from your portfolio (potentially generating capital gains and additional tax), use the interest and dividends to fund your lifestyle. Income from business interests, rental properties, required minimum distributions (RMDs) from inherited IRAs, REIT dividends, and/or portfolio income such as interest or dividends are all examples of income currently taxable. Know that income accumulation in your portfolio can vary from quarter to quarter, so it may be necessary at times to sell assets to meet your needs.

If you have large retirement account balances in relation to your overall net worth, it might make sense to take distributions annually from these accounts to pay income tax at potentially lower rates rather than at income tax rates applicable to the higher income that comes from taking both Social Security and RMDs from retirement accounts. Taking withdrawals from retirement accounts annually may reduce the value of your retirement accounts and, in turn, reduce the amounts otherwise taxed in higher-income years.

While you might take benefits from a pension at this relatively young age, Social Security survivor benefits as early as age 60, or Social Security retirement or spousal benefits as early as age 62, it may not make sense to do so. Taking Social Security benefits before your full retirement age permanently reduces your benefits, and any survivor benefits based upon your record. Please let us know if you would like us to run a Social Security analysis to help determine your optimal Social Security claiming strategy.

Paycheck Between Age 67 and 73

If you have a pension in this age range, it might be possible to begin receiving payments without a penalty for starting payments too soon. While you can start taking distributions from Social Security at your Full Retirement Age (between ages 66 and 67, depending on birth year) without a reduction in benefits, it may be wise to delay benefits to age 70 to increase your benefits by 8% annually and increase survivor benefits payable to your spouse. Please let us know if you would like us to run a Social Security analysis to help determine your optimal Social Security claiming strategy.

Beyond any pension or Social Security income, the first place we suggest spending from is the income already taxable to you. Rather than reinvesting interest and dividends and then creating income by selling from your portfolio (potentially generating capital gains and additional tax), use the interest and dividends to fund your lifestyle. Income from business interests, rental properties, required minimum distributions (RMDs) from inherited IRAs, REIT dividends, and/or portfolio income such as interest or dividends are all examples of income currently taxable. Know that income accumulation in your portfolio can vary from quarter to quarter, so it may be necessary at times to sell assets to meet your needs.

If you have large retirement account balances in relation to your overall net worth, it might make sense to take distributions annually from these accounts to pay income tax at potentially lower rates rather than at income tax rates applicable to the higher income years when required to take RMDs from retirement accounts. Taking withdrawals from retirement accounts annually may reduce the value of your retirement accounts and, in turn, reduce the amounts otherwise taxed in higher-income years.

Paycheck After Age 73

To create your retirement paycheck after age 73, we first consider Social Security benefits and any pension income you receive coupled with any required minimum distributions you must take from retirement accounts if you are no longer working. The required beginning date for IRA owners and most plan participants is April 1 of the year following the year in which you reach age 73 unless you are still working. If you are age 73 and still working, the required beginning date for plan participants (i.e., 401(k), profit-sharing, 403(b), or other defined contribution plans) is April 1 of the year following retirement from that employer.

If you need additional income, the next place we suggest spending from is the income already taxable to you. Rather than reinvesting interest and dividends and then creating income by selling from your portfolio (potentially generating capital gains and additional tax), use the interest and dividends to fund your lifestyle. Income from business interests, rental properties, required minimum distributions (RMDs), REIT dividends, and/or portfolio income such as interest or dividends are all examples of income currently taxable. Know that income accumulation in your portfolio can vary from quarter to quarter, so it may be necessary at times to sell assets to meet your needs.

If you need more income, you and your advisor could consider the pros and cons of pulling from Roth IRAs, pulling more from your IRA, or from non-retirement accounts.

A Few Words On “Safe” Withdrawal Rates

Likely, the most important part of retirement planning is doing what you can to increase the likelihood that your portfolio will last throughout your lifetime. While this may be determined with your advisor through financial planning, it is also wise to be cognizant of your withdrawal rate. Your withdrawal rate is the amount distributed from your portfolio annually divided by the total portfolio balance. The 4% “safe” withdrawal rate rule of thumb was created by looking at the safe initial withdrawal rates of portfolios over the last 100 years, but this rate was based on the assets only needing to last 30 years, and it does not build in a cushion in case of extreme market volatility, emergencies, or legacy goals. If you need the portfolio to last longer due to increasing longevity, the safe withdrawal rate could decrease.

Keep in mind that the amount you withdraw to cover expenses needs to increase over time to keep up with inflation. The cost of goods and services increases over time, so the amount withdrawn initially will need to increase to maintain a similar lifestyle. When we analyze all of these factors, including conservative returns, inflation, life expectancy, and tax assumptions, we suggest limiting withdrawals from your total portfolio to about 2-2.5% if you begin in your 40s, 3% if you begin in your 50s, 3.5-4% if you begin in your 60s, and 4-5% if you begin in your 70s. Keeping withdrawal rates in check can provide a buffer against down markets, unexpected expenses, and a longer life to increase the likelihood of your portfolio lasting throughout your lifetime.

 

Important Disclosure: This material is intended for general informational purposes only. Beacon Pointe Advisors does not offer legal or tax advice. Please consult with the appropriate tax or legal professional regarding your circumstances. This information is not intended and should not be relied upon as individualized tax, legal, fiduciary, or investment advice. Only a tax or legal professional may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement any design discussed herein. Nothing herein should be relied upon as personalized investment advice, nor should it be considered an individualized recommendation, offer or solicitation for the purchase or sale of any security or to adopt a specific investment strategy. An investor should consult with their financial professional before making any investment decisions. Beacon Pointe is not responsible for errors or omissions in the material on third-party websites and does not necessarily approve or endorse the information provided.

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