If you are like us, you plan and hope for a retirement unhindered by financial worries. Plan as we might, we all will at some point encounter the unpredictable during our retirement. Strong income planning and a buttoned-up strategy for cash flow going into retirement will help give you flexibility when the inevitable surprise pops up, allowing you to weather incoming storms and enjoy a successful retirement.
The Age-old Question: Do I Have Enough?
Making the change from saver to spender is a financial and mental hurdle that must be addressed to be in tune with your financial life. There is no magic switch to flip to make this transition easy. However, creating a spend-down plan and paycheck replacement strategy will help you map out your path.
The spend-down plan is a piece of your overall financial plan designed to help you spend your assets in retirement and leave a legacy as tax efficiently as possible. As for paycheck replacement, we must be at peace with substituting our previous earned income with retirement cash flows like Social Security payments and portfolio distributions.
The first question to answer before officially jumping into retirement is whether you have enough. What does your retirement lifestyle cost? What are your sources of income? If your probability of success is below your comfort level, you can reduce planned spending in retirement, delay your planned retirement date, or pursue part-time work.
If, on the other hand, your probability of a successful retirement is high enough, you could look to increase spending, add additional goals, retire earlier, or take less risk in your portfolio.
Paycheck Replacement Strategy: Cash Flow Planning
While you may no longer receive a paycheck every two weeks, you still have sources of income that fund your cost of living. Of course these income sources are still taxable, like capital gain distributions, IRA withdrawals, and Social Security income just to name a few. Social Security, required minimum distributions (RMD’s), and pensions (if you are lucky enough to have one) are forced income. If you need additional dollars after those income streams, look to take distributions out of a taxable account and weigh that against taking additional dollars from IRA’s.
Often, the first few years of retirement come with increased spending on travel and leisure. There may also be a big purchase or two, like a second home or a family vacation. Later in retirement, spending usually increases again, this time because of medical expenses. Given that spending is not consistent each year, having a plan for cash flow is important. For higher-spending years when your retirement income does not cover your expenses, the following income planning items may help you maximize the odds of good outcomes.
Tax Efficient Income Planning
RMD’s are forced distributions out of retirement accounts starting at age 72. Review your taxable accounts for assets with the lowest appreciation and that are long term in place of additional retirement account withdrawals. If you retire before age 72, looking to withdraw money from your traditional IRA’s when income is low can reduce future RMD’s and help you avoid a potentially higher tax bracket later in life.
Look to utilize lower tax brackets in years where income is down. For example, if your income will decrease enough to take you below your normal tax bracket, consider taking out as much money as you can at that lower tax bracket without actually going over it. This could also be a great time for Roth conversions or taking additional IRA distributions.
Holding debt isn’t necessarily a bad thing. That being said, we need to understand how to address high interest rate debt in our financial lives. Each dollar used to pay off debt is a guaranteed return at the rate of the interest. For example, if you have a mortgage with an interest rate of 5%, every additional dollar that pays down the balance earns a 5% return.
Creating a plan to donate money to charity in a tax-efficient manner helps reduce taxes without penalizing the receiving organization. There are many charitable giving options and strategies other than traditional cash contributions. At 72, you can use a qualified charitable deduction (QCD) to gift directly from an IRA to charities, reducing your taxable income and providing funding to the cause of your choice.
In summary, running the numbers and looking at more than just the present are the keys to success when planning a cash flow and tax minimization strategy for retirement. Doing so will help ensure the highest probability of reaching your future goals.
Of course, if we can help with any questions you have regarding your own retirement income, don’t hesitate to contact us.