“Don’t let money run your life, let money help you run your life better.”
– John Rampton
“How does it work?”
That’s the big question I’m always asked.
By the time you are ready to put in your final notice, you’ve got money squirreled away in a million different places; 401(k)s, IRAs, Roth IRAs, brokerage accounts, savings accounts…the list goes on. And all you really want to know is, “How do I actually take the money out?”
You love the idea of creating a monthly paycheck from the pile of investments you’ve built up over many years. That was kind of the whole point, after all.
What you can’t wrap your head around is how to do it. The task seems daunting and the questions are endless.
Which account do I tap first? When am I allowed to pull from an IRA? Should I convert all my investments into income streams? What about taxes?
I hear you. Here are 5 helpful tips to create retirement income without creating retirement headaches.
1. Don’t make things too complicated
The great big retirement nest egg that’s been growing and growing ever since you started working is finally yours to crack!
But if you have more than one type of account to pull from, where do you pull from first?
Make sure you understand how to avoid 10% penalties when you tap your retirement assets. You are allowed to withdraw 401(k) dollars penalty free at age 55, and your IRA money is available without penalty at age 59 ½.
In many cases, it pays not to overthink it. If you are past the penalty phase, simply take a proportionate amount of income from each type of account you own, and that will get the job done.
For example, let’s say 60% of your portfolio is in IRA accounts and 40% is in regular (non-IRA) accounts.
Depending on your situation, you may find splitting the income 60/40 between those account types works well.
No spreadsheets, tax rate variables, expense variables…no overkill.
Now I know what some of you are thinking. “Wait, I have to pay taxes when I take income from an IRA. If I have money in a brokerage account, shouldn’t I use that first to avoid the taxes as long as possible?”
And the answer is yes, you do have to pay taxes on income from an IRA.
But later on I’ll explain why pulling from your IRAs early in retirement could put you in a more secure position than if you wait.
2. Don’t make things too simple
The allure of guaranteed income entices many retirees to cash in all of their investments and convert the balance to a monthly income stream, via financial products called ‘annuities’.
Talk about putting all your eggs in one basket!
This approach has too many pitfalls to fully cover here. But suffice it to say that alarms go off in my head when I hear retirees commit 100% to this strategy for one big reason; flexibility.
The idea behind annuities is that you are giving a firm—usually an insurance company—a big chunk of cash, that they then invest and send you an agreed upon monthly income. They keep the profits from your investments, and although your income probably won’t go down, it probably won’t go up either.
It’s also much more difficult to withdraw the principle from an annuity than it is from a normal investment account. So if you or your partner have a health emergency, for example, and all of your assets are tied up in an annuity, guess what?
You just limited your options in favor of guaranteed monthly income.
Keep things simple, but make sure your income strategy can handle multiple scenarios. You’ll be glad you did.
3. Don’t draw down all your non-IRA accounts first
Some CPA’s might balk at this, because they love to lower your taxes now.
So…if you’re between 59 ½ and 70 ½ they might suggest avoiding retirement account distributions, which are taxed at ordinary income rates. Just like we talked about back in Tip #1.
Here’s the thing. A successful retirement income strategy is about control and flexibility. I’ve seen too many retirees later in life who only had IRAs remaining to draw on…right about the time they needed to replace their roof.
…and the market began to tank.
…and tax rates started going up.
See where I’m going with this?
You might have avoided income taxes in the beginning, but now you’re paying them all at once, right when you can’t afford to lose money.
So don’t just think about dollar amount that will show up in your checking account every month. Make sure that when the big expenses come around 5, 10, or 20 years into retirement, you’re ready to deal with them without putting yourself into a higher tax bracket.
This will become doubly important when you hit 70 ½ and the IRS requires you to take money out your IRAs whether you like it or not.
4. Plan for Required Minimum Distributions (RMDs)
A Required Minimum Distribution is just what it sounds like; the minimum amount you are required to distribute from your IRAs.
Basically, the IRS has never collected any tax revenue from your IRA accounts…and they’re tired of waiting! So when you hit 70 ½, they will force you to start drawing down your IRA so they can collect income tax on the distribution.
The amount required is based on how much is in the IRA and how old you are. The larger the account balance, and the older you get, the more you have to distribute.
I once saw someone who did not plan for this and they ended up having $600,000 a year in RMD…when they only need $200,000 in income!
But if you pull income proportionately from each of your account types—as discussed in Tip #1—then by the time you reach 70 ½ your IRA account balance should be lower, and so is your RMD.
5. Plan for your ultimate beneficiaries
There’s a good chance you’ll have money left at the end of your life…and that’s going to go somewhere. In many cases family, such as children and grandchildren, will receive the bulk of what’s left.
Here’s the thing. Some types of accounts are better than others when it comes to leaving money behind. And if you plan to leave a sizable gift to future generations, don’t wait until you’re spent down your accounts to make a gifting plan.
For non-IRA accounts, there isn’t much that needs to be done. You’ve already paid tax on those assets, and assuming you haven’t crossed the estate tax threshold, your heirs won’t need to pay anything for the transfer.
IRAs, on the other hand, often are subject to full taxation…at whatever tax bracket beneficiaries are in at the time they receive the funds. And that includes taxes on the state level, depending on where you live.
However, Roth IRAs may be able to pass to family tax-free. So if you have money in a Roth IRA, and you plan to leave a gift for your beneficiaries, you should consider saving that account for last.
Planning your retirement income isn’t always about the money you will need today—sometimes it’s about the money you want to leave behind.
“Money, like emotions, is something you must control to keep your life on the right track.”
– Natasha Munson
Bottom line? Good planning can not only help produce a solid and sustainable stream of income, but can also help you prepare for the big expenses life is bound to through your way.
Not to mention the benefits for those who will receive your wealth after you pass.
It’s not that hard, once you know how it works!
CLICK HERE to become an Insider! Join my Email Insider Group to receive weekly tips and tricks on finance, education, home buying, insurance, Social Security and everything in between. Byron W. Ellis, CFP®, CLU®, ChFC®, CRPC®, is a CERTIFIED FINANCIAL PLANNER™ professional and Managing Director United Capital Financial Advisers, LLC, a Financial Life Management firm. The information contained in this article is intended for information only is not a recommendation, and should not be considered investment advice. Please contact your financial advisor with questions about your specific needs and circumstances.
© Byron Ellis