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—can often be limited during retirement, you need to ensure that it lasts for 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.
- Managing income is essential and can become even more important in retirement.
- Retirement planning often involves assessing your income needs in the ten years leading up to your planned retirement date.
- Important factors to consider are monthly expenses, such as utilities, transportation, groceries, and taxes.
- If your retirement savings, along with Social Security payments, are not enough to cover expenses, you might need to defer retirement.
- Talking to a financial planner can help determine the best mix of investments and an ideal retirement date for your specific situation.
Planning in Pre-Retirement Years
As the time to your retirement nears, there is always a chance that the amount you thought would be sufficient to finance your retirement years isn't enough. Reasons for this may include cost-of-living increases and lower-than-projected returns on investments. To improve your chance of having a financially secure retirement, make frequent reassessments to 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!" Strubbe adds:
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 boom of the 1990s 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 If You Don't Have Enough
If the 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. Should you decide to keep working or get a job after you file for Social Security benefits, be cognizant of how your income could affect the amount you receive if you are less than the full retirement age for your birth date, as designated by the Social Security Administration.
Also, if you find you cannot retire when you planned and must keep working, you can try to decrease your extended pre-retirement period by re-planning. Basically, you need to increase the amount you save to shorten the time it will take to 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. Consider using a less expensive car, buying better-priced items, and even moving into a smaller or less expensive house or apartment.
Controlling Your Assets
While it may be challenging to make substantial lifestyle changes during retirement, you can take comfort in the fact that they will help increase your standard of living. The next questions pertain to your investments.
Assessing Your Asset Allocation
The recommendation to make your money work for you also applies to your retirement years. Accomplishing this means investing your assets to produce a return on investments.
That said, it's important to keep your assets safe during your retirement years when you have less time to recover from market downturns. This means you may need to shift from higher-risk investments to those producing a guaranteed rate of return. However, your reallocation depends on how old you are when you retire and the state of your health. Retiring early, especially if you have a longer life expectancy, may require more aggressive investing even during your retirement years.
“The longevity of your retirement portfolio is very sensitive to returns in the first few years of withdrawals,” says Kevin Michels, CFP®, a 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 from IRAs and qualified retirement plans by the applicable deadline. (This starts at age 72, following the December 2019 passage of the Setting Every Community Up For Retirement Enhancement (SECURE) Act. Previously, RMDs began at age 70½.) There have been numerous cases of individuals not meeting their RMD deadlines because assets could not be liquidated in time.
As a result of the recent passing of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which aims to provide financial relief for people amid the COVID-19 pandemic, all RMDs have been waived for 2020.
Managing Your Income Stream
Your income stream during your retirement years usually depends on your annual expenses, the amount you have saved, and the number of years you project you will need to cover. 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, taxes, and transportation. Also, consider medical and leisure expenses. These amounts may change each year because of cost-of-living increases, which means you must do an assessment at the beginning of each year. In general, inflation increases by 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 your life expectancy and add extra to be sure your income will last.
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 expect you will need it.
For example, say you think the number will be 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 any pension benefits, if you have them). 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.)
When assessing your retirement-income needs, be sure to include any income from your spouse as well as your spouse's expenses.
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.
Income From Retirement Savings
The amount of income you will need to withdraw from your retirement-savings vehicles generally depends on how much 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 taxes you will owe for the year. Your income also determines what you have to pay for Medicare Part B.
Once you have determined how much you will likely 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, request that distributions be paid to you on a future date and continue at a particular frequency, such as monthly, quarterly, or annually.
When establishing scheduled distributions, ensure 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.
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 set out by IRS regulation. 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.
As a result of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) of 2020, meant to provide economic relief amid the COVID-19 pandemic, certain temporary changes have been put into place for the tax year regarding retirement plan withdrawals and tax liability.
The following changes apply to eligible participants. An eligible participant is a person who has been diagnosed with COVID-19, has a spouse or dependent diagnosed with COVID-19, or has experienced a layoff, furlough, reduction in hours, or inability to work due to COVID-19, or lack of childcare because of COVID-19.
Recent guidance from the IRS adds people who had a job start delayed or a job offer rescinded due to COVID-19 to the eligible list. Also, a spouse of someone who has been affected, even if still employed, can now take a withdrawal from their retirement account.
The law states that eligible participants can take an early withdrawal of up to $100,000 from 401(k)s, 403(b)s, 457s, and traditional IRAs without paying a 10% penalty. The act also puts on hold the mandatory 20% tax withholding that normally accompanies early distributions from workplace retirement plans, including 401(k)s. IRAs don't have an early withdrawal mandatory tax withholding requirement.
An individual has up to three years to pay the taxes on the early withdrawal or to redeposit the money back into their retirement account. Usually, money borrowed from an account must be paid back within 60 days.
Retirement plans are not required by law to accept this modification of early withdrawal rules, but most plans are expected to follow suit.
The law covers withdrawals made between January 1, 2020, and December 30, 2020.
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 not to wait until retirement to start making your financial plans. Instead, reassess your financial status during your pre-retirement years so you can, for starters, determine whether you need to defer retiring.
Most importantly, talk to your financial planner, who will be able to determine your specific needs.