Retirement can be a wonderful period in your life, but only if you’ve planned for it appropriately. This means managing your investments well and keeping your expenses in check. With just your pensions (if you’re lucky enough to have them) and Social Security coming into your household each month, you’ll need to follow a new set of rules for managing your retirement income, expenses, and investments to ensure you can live comfortably. But to do this, and do it well, you’ll need to know the basics.

Where Will Your Income Come From?

Going from collecting a monthly paycheck and saving money to writing monthly checks and distributing money is a big psychological change. You’ll start to withdraw money and whittle down the balances from the investment accounts and savings you earned throughout your career. The means pulling down money from employer-sponsored plans like 401(k)s and 403(b)s, individual retirement accounts, taxable investment accounts, and bank accounts. Each of these accounts come with their own set of strings surrounding taxes, penalties, and withdrawals. It’s crucial to understand how these work so that you can maximize your retirement income.

For example, in this office we generally design retirement income plans to withdraw from taxable accounts first. This allows your tax-advantaged accounts (IRAs, Roths, 401(k)s, etc) more time to grow and compound in a way that is not impacted by taxes. Additionally, money pulled from taxable accounts are subject to capital gains rates, which could be as low as 0% depending on your income level. This also makes other planning strategies like Roth conversions more attractive.

Pulling from taxable accounts doesn’t just put you under more favorable capital gains rates, it can also help keep your total taxable income lower since these accounts have basis. Your basis is the principal that you contributed as well as the reinvested dividends and interest that you’ve already paid tax on, and when you withdraw those amounts they aren’t taxed a second time. A lower taxable income can also help to qualify you for certain tax deductions and credits as well as potential subsidies under the Affordable Care Act if you retired before reaching Medicare age.

More dependable income sources

Beyond your investments, you’ll also have fixed income streams to rely on. These income streams come from Social Security, pensions, private annuities you may have purchased, and rental real estate. (Caveat on the real estate – it’s only as reliable as your current tenant). It’s crucial to understand how much money you’ll receive, when you’ll receive it, and what happens to it after you’re gone. Social Security, pensions, and annuities all use a mortality assumption. This means that in most cases, the longer you wait to take income from these the more they will pay! In the specific case of Social Security, waiting to claim to at least your full retirement age ensures you get the full amount while also ensuring nothing is withheld in the event you’re still working.

Waiting can also have benefits for your spouse. Your pension, annuities, and Social Security all have a survivorship feature. This ensures that some amount of money continues to your spouse after you’ve passed on, and you select the option dictating just how much your survivor will receive before you start taking income (Social Security is the exception). Make sure you choose this thoughtfully in light of your full financial situation, assets, and objectives!

How Will You Budget?

Spending wisely is the key to a long retirement. You can use your working days as a guideline for estimating how much you’ll spend on your day-to-day living expenses. This includes food, housing, utilities, entertainment, dining out, insurance, personal care, and all the other things you purchase on a routine basis. But you’ll also need to consider new and evolving expenses, such housing if you plan to move, new hobbies, more travel, and critically healthcare!

You may still have a mortgage or car loans, or you may still want to pay for your children or grandchildren’s education. These expenses must be considered when estimating your spending. Here’s our two cents for how to do it: calculate out your day to day living expenses and then gross it up by 10%. Something always comes up and it will never feel like enough no matter how well you’ve saved, so give yourself some room to breathe and build in a margin of error. Then calculate your maximum annual spending in retirement and subtract your day-to-day expenses from it to determine the total amount of slack you have in your spending. (Note – this is an involved calculation that factors in your age, income streams, a rate of return assumption, and total assets saved. We suggest you connect with a planner for help calculating this correctly). This slack is what you have available for the bigger stuff, such as occasional car purchases, big trips, and gift to family members and charity.

The Bottom Line

Understanding earning and spending in retirement are the first steps to financial literacy, empowering you to take control of your future. To further gain insight into your finances in retirement, sign up for a complimentary review with us.