Congratulations! You feel you are in a position to retire. But then you feel a chill and the hair on the back of your neck rises up as the reality of producing a monthly “paycheck” from your various investment accounts starts to scare you. How in the world can you make this happen?
Most of us will retire with various accounts…retirement accounts like 401(k)s and IRAs, non-qualified accounts (which are accounts that are simply owned in your name or you and a partner). If retiring, your goal is, in its simplest form, to create a recurring deposit into your checking account from your pile of investments. This seems like a daunting task and in reality it is not easy. Which account do you tap first? Should you convert all of your investments into an income stream? What about tax considerations? All of these questions are important.
Allow me to share the five most common retirement income mistakes that I have seen.
- Making things too complicated. If you are an engineer this one may hurt a little. Spreadsheets with multiple tabs, year by year analysis and projections, tax rate variables, expense variables, Presidential cycle assumptions, and more can be overkill. As a financial professional, we actually do an in depth analysis of our client’s retirement period for many good reasons. However, setting up an income stream usually boils down to a very simple strategy. Noting that every situation is different, in many cases simply taking a proportionate amount of income from each type of account that you own is a good way to create income. For example, let’s say that 60% of your wealth is in IRAs and 40% is in an individual/joint account. If you are old enough to not have to worry about premature distribution penalties, consider simply setting up a distribution that is about 60/40 that satisfies your monthly income need. Yes, it could be that simple.
- Making things too simple. Many people have the urge to cash in all of their investments and convert the balance to a monthly income stream. You may also call this the “annuity” strategy. Once again, every situation is different, however, in most cases there are valid reasons to not follow this approach. I won’t get into the reasons that I don’t like this strategy today, just understand that this is most likely not the path that you need to take.
- Create your income by tapping only your non-IRA assets (also called non-qualified). If you ask your CPA, they will most likely advise you to create all of your retirement income by taking money out of your non-qualified assets. Why? This will most likely produce the lowest tax bill thus allowing you to keep more of your assets intact. Sounds good, right? To start it will be. I have two issues with this strategy. First, it may put you in a position down the road, when you have reduced the balance of your non IRA assets, where are forced to turn to your IRA for any expense need that you may have. Once you use up all of your non-qualified assets you may limit your tax options by forcing all distributions to come out of the IRA. Second, it could set you up for a bad tax surprise at age 70 ½ (see mistake number 4).
- Forget to plan for your Required Minimum Distributions. The IRS likes for you to pay taxes and in that light they have a rule that most call Required Minimum Distributions or RMD for short. In summary, when one turns 70 ½ the IRS will require you to pull out a set amount of money from your IRA each year. The amount is calculated using the account value, your age, assumed growth rate and your life expectancy. Basically, they want you to withdraw all of the money over your projected lifetime and of course pay the tax on those distributions. Let’s say you follow your gut and spend years taking money out of your non IRA assets (like mistake number 3) while your IRA balance just keeps getting bigger and bigger. A larger IRA balance can mean a larger required distribution when you hit 70 ½. I once saw someone who did not plan for this that ended up having to withdraw about $600,000 per year when they only needed about $200,000 to live on. In my book they ended up having to pay income taxes on $400,000 of income that they did not need. Poor tax planning indeed.
- Failing to think about your ultimate beneficiaries. I am talking about your kids or grand kids that will eventually get the remainder of your wealth. Most of you reading this will still have money at the end of your life. Where do you want this to go? Yes, your family. Why not think about which assets will pass with the least tax consequence to those deserving…or undeserving…kids? Some assets, like a Roth IRA, may be able to pass to your children or grandchildren with no tax consequence. In other words, they get 100% of the money. Other assets, like your IRA, most likely will be treated as taxable income when your family withdraws the money at whatever tax bracket they may be in at the time of withdrawal. They may not get all of the money that you so kindly gifted to them.
The bottom line is that income planning may actually be a little complicated but with careful planning and some thoughtful foresight about what may happen 15 to 20 years down the road, you can not only set up a good income stream for you but also think about those that you benefit from the legacy that you leave.
FINANCIAL ADVISOR WARNING! Are you being ripped off? Call 281-907-5136 to hear the 5 Costly Misconceptions about Financial Planning. Byron W. Ellis, CFP®, CLU®, ChFC®, CRPC®, is a CERTIFIED FINANCIAL PLANNER™ professional and Managing Director of United Capital Financial Advisors, 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. The opinions expressed herein are those of Byron Ellis and not necessarily those of United Capital Financial Advisors, LLC.