Retirement is just around the corner, but how do you make the leap from working life to retirement?
In previous generations, if you worked for a company for most of your life, the company would take care of you when you were finally ready to retire. They continued to give you a paycheck in the form of a pension and, combined with Social Security that was, in many cases, enough to live comfortably. For many Americans this has changed and the responsibility to provide for one’s retirement has shifted from their employer to themselves. Some employers still help in the form of a company match in a 401k, but pensions are hard to find. Because of this many people save in retirement accounts and have been doing so for years. However, in today’s age of having to save for yourself, how do you make that leap from working life into retirement? What do the mechanics of providing a paycheck for yourself look like?
One of the first things you may want to ask yourself is:
- How much money is enough to retire? If you use one of those online calculators they may give you a goal for retirement that looks unattainable, possibly in the millions of dollars. These numbers are generated by how much you would have to save in order to live off of only the interest. If you take that strategy a step further and earn a moderate return on investments, but withdraw less than what was earned, this can help keep up with inflation in retirement.
After you have discovered your magic number, you should consider the different strategies for how to take income during retirement. Below are two to consider:
- Maximize tax benefits: One retirement plan is to maximize the tax benefits retirement accounts offer. These benefits include tax deferral and, if investing in a Roth account, tax free withdrawals*. If tax rates are very high for a particular year during your retirement, you can consider taking more Roth dollars that year, or if rates are low you can take more traditional 401k or IRA dollars. Eventually the IRS makes you take money out of traditional 401k’s and IRAs when you reach 70 ½, so it is possible that you may have to take out more than you want to as you age. This is called an RMD or Required Minimum Distribution and can also deplete savings faster than anticipated. Ultimately the idea is to have a strategy to continue to utilize these tax benefits into retirement.
- Split retirement dollars: Unfortunately, many people don’t save enough so they can live off only the interest and avoid digging into your principle. One strategy for those who have not saved the ideal amount is to split retirement dollars in half between two accounts with different strategies. The first, which we will call the “income” account, is the one you live off of and is invested conservatively with the expectation that it will be depleted in 10 years. The second, or “growth” account, is invested more aggressively and the goal is to earn a higher return in the same 10 year period. Once the income account is gone, half of the growth account is carved off into a new income account that you would live off of for another 10 years. With this strategy there is more risk of outliving one’s income than living off of interest, but it is a way people can still retire.
There are many strategies for how to take income during retirement, but these are two concepts to be aware of and to consider. If you continue to take advantage of tax benefits and have a plan for your transition, the leap from the working life to retirement ma begin to look attainable.
*To qualify for the tax free penalty free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 591/2 or due to death, disability, or a first time home purchase (up to $10,000 lifetime maximum). Before taking any specific action, be sure to consult with your tax professional.
Plan distributions may be subject to tax and 10% penalty if withdrawn before age 59 ½.
There are no guarantees that any managed portfolio will meet its intended objective. Investing involves risk, including the loss of principal.