Managing your income is always important, but it becomes even more critical during retirement, when your income comes from your savings rather than from wages and earnings. Because your source of income – which you saved so carefully during your working years – is limited during retirement, you need to ensure that it lasts through the rest of your life. This means determining your income needs in the years leading up to your retirement and, once you retire, efficiently managing your retirement assets. In this article, we look at some issues you need to consider when doing these things.
Planning in Pre-Retirement Years
As the time for your retirement nears, there is always a chance that the amount you thought would be sufficient to finance your retirement years isn't. Reasons may include cost-of-living increases and lower-than-projected returns on investments. To help increase your chances of having a financially secure retirement, you should make frequent reassessments of your retirement income needs and sources during the 10 years before your projected retirement date.
“We believe it is extremely valuable to reassess your retirement income needs annually during the 10 years before retirement,” says Patrick A. Strubbe, founder and owner of Preservation Specialists, LLC, in Columbia, S.C., and author of Save Your Retirement! “This is because of a number of factors. First, your financial situation and nest egg are ever changing. Second, your dreams and desires may change or fluctuate (maybe you decided you don't want to wait 10 years to retire anymore!). Finally, it’s good to make adjustments based on what is going on around you – taking into account inflation, interest rates and the general economic environment, among other things.”
The performance of the stock market in the 10 years between 1999 and 2009 is a good illustration of how potential retirees had to re-plan their retirement. For many, the market boon of the early '90s gave hope of a financially secure retirement. However, the subsequent market downturn resulted in a significant reduction of retirement assets, which forced many individuals near retirement to postpone their originally anticipated retirement date.
What to Do If You Don't Have Enough
If your reassessment of your retirement portfolio and current expenses reveals a shortfall in your savings, you may need to continue working beyond your anticipated retirement date. (For more on how to assess how much you will need for retirement and how much you have, see Saving for Retirement: The Quest for Success.) However, should you decide to work, be cognizant of how your income could affect the amount you receive from Social Security if you are under the full retirement age determined by the Social Security Administration.
Also, if you find you cannot retire as soon as you planned and must keep working, you can try to decrease your extended pre-retirement period by re-strategizing. Basically, you need to increase the amount you save so that you shorten the time until you reach your goal. Here are some ways to increase your savings:
- Consider debt consolidation or refinancing to reduce monthly payments for credit cards and other loans, including your mortgage. You can redirect the reduction in interest payments to your retirement nest egg.
- Make changes that reduce or eliminate spending on luxury items or other things you don't need. It may be easier than you think! Consider using a less expensive car, buying better priced items and even moving into a smaller or less expensive house or apartment. While it may be challenging to make these changes, you can take comfort in the fact that they will help increase your standard of living during retirement, when you may not be able to work or get high-paying jobs.
Controlling Your Assets During Your Retirement
Assessing Your Asset Allocation
Making your money work for you is a recommendation often made by savvy financial planners. This recommendation also applies to your retirement years. Making your money work for you means investing your assets to produce a return on investments.
That said, it's important to keep your assets safe during your retirement years. So you may need to shift from low-risk investments to those that produce a guaranteed rate of return. However, your reallocation depends on the number of years you plan to stay in retirement. A longer life expectancy may require more aggressive investing even during your retirement years. (For more information on asset allocation, see Achieving Optimal Asset Allocation and 6 Asset Allocation Strategies That Work.)
“The longevity of your retirement portfolio is very sensitive to returns in the first few years of withdrawals,” says Kevin Michels, CFP®, financial planner with Medicus Wealth Planning in Draper, Utah. “Negative returns early on can greatly reduce the life of your portfolio. That is why it is important to have an appropriate asset allocation from day one in retirement.”
When reallocating your investments, also consider the resulting level of liquidity and how it will affect your ability to make withdrawals when you need them. For instance, non publicly traded or closely held securities can take from a few weeks to over a year to be liquidated. Reallocating your assets without attention to liquidity may leave you without cash, which becomes a problem especially when you need to withdraw your required minimum distribution (RMD) amounts by the applicable deadline. There have been numerous cases of individuals not meeting their RMD deadlines because assets could not be liquidated in time.
Managing Your Income Stream
Your income stream during your retirement years usually depends on your annual expenses, the amount you have saved and the amount of years you project you will stay in retirement. To balance your income with your expenses, consider doing the following:
- Make a list of your monthly expenses, such as utilities – including electricity, telephone, gas and water – groceries, rent or property taxes and transportation. Also consider medical and leisure expenses. These amounts may change each year because of cost-of-living increases, which means that you must do an assessment at the beginning of each year. In general, inflation increases about 3% per year, but could be higher for certain expenses such as medical and health.
- Take stock of the amount you have saved for retirement. This includes your regular savings and your retirement account balance.
- Consider the amount of years you plan to stay in retirement.
Of course, the last two factors together determine how much monthly income you can have while making your savings last. Look at how much you have saved versus the number of years you plan to stay in retirement. Assume you plan to stay in retirement for 20 years and you have $500,000 saved. Your monthly allocation would be approximately $2,100. Add this amount to the amount you will receive from Social Security, and this is what you have as income to cover your monthly expenses. (To estimate your income from Social Security, use the benefit calculators at the SSA's website.)
Taking a look at your expenses every year will help you determine if you need to make adjustments to your spending, ensuring you don't compromise your income in future years. (Note: When assessing your retirement-income needs, be sure to include any income from your spouse as well as your spouse's expenses.)
Your Income from Your Retirement-Savings Vehicles
The amount of income you will need from your retirement-savings vehicles generally depends on the amount you have available or will receive from other sources, such as your regular savings and Social Security. When possible, consider withdrawing no more from your retirement account than you are required to each year by IRS regulations. This will allow the remaining amount to continue growing tax-deferred, or tax-free in the case of Roth IRAs. This will also help to reduce the amount you must include in your income, thereby reducing the amount of taxes you will owe for the year.
Once you have determined how much you should/will need to distribute from your retirement account for the year, contact your retirement plan administrator or financial services provider to establish scheduled distributions from your retirement account. To do this, you request that distributions are paid to you on a future date and continue at a particular frequency, such as monthly, quarterly or annually.
When establishing scheduled distributions, ensure that the amount you request is enough to satisfy any RMD. If the amount you withdraw from your retirement account for the year is less than your RMD amount, you will owe the IRS a penalty of 50% of the shortfall, referred to as an excess-accumulation penalty [see Avoiding Mistakes in Required Minimum Distributions (RMDs)]. Establishing scheduled distributions helps ensure not only that your RMD is distributed on a timely basis, but also that you receive your payments without having to contact your financial institution each month.
Income from Retirement Vehicles May Affect Income Taxes
When determining your annual expenses and income streams, bear in mind that you may need to pay income taxes on amounts you withdraw from tax-deferred retirement accounts. These amounts will be treated as ordinary income for tax purposes.
If Withdrawals Occur Before Age 59½
If you withdraw assets from your retirement account before you reach age 59½, the amounts will be subject to a 10% excise tax, unless you meet one of the exceptions as set out by IRS regulation (see 9 Penalty-Free IRA Withdrawals). This excise tax is charged in addition to any income taxes you owe on the amount. If you must distribute amounts from your retirement account before age 59½, talk to your financial planner about strategies to avoid or minimize the excise tax.
The Bottom Line
Like other aspects of financial planning, managing the income you will receive during your retirement years requires careful planning. It is critical that you do not wait until you retire to start making your financial plans. Instead, reassess your financial status during your pre-retirement years so that you can determine whether you need to defer retiring. Most importantly, talk to your financial planner, who will be able to determine your specific needs. (Keep in mind that the topics covered in this article are discussed from a general perspective.)