The idea that there will be no regular paycheck can be one of the most unsettling aspects of retirement. As you retire, you shift from a single income source that (hopefully) covers all your expenses to relying upon multiple sources of income. A whole host of questions typically come along with this shift, including when to draw Social Security, what accounts to draw from, how to handle taxes, how often to pay yourself and whether there is anything you can do to reduce taxes. Working through these questions systematically can help you create your retirement paycheck
Question 1 – How much do you need?
The best method to determine how much you’ll spend in retirement is to start with your current budget and determine what is likely to change once you retire. Saving for retirement will obviously stop, and you may find that there are life insurance or disability policies that are no longer needed. If you currently have a long commute, expenses for gas and car maintenance will likely go down. One expenses that often goes up – at least early in retirement – is travel expense. Lastly, don’t forget to take healthcare costs in retirement into account when forecasting your spending.
Question 2 – When should you draw Social Security?
Social Security is a key element in many retirement plans, so making the optimal decision about when to begin drawing is critical. Calculation of your benefit revolves around your full retirement age. If you are eligible for Social Security, you can begin drawing as early as 62, but you’ll see a noticeable reduction in benefits. Conversely, if you delay drawing benefits past full retirement age, your benefit will increase — potentially substantially so. When you should begin drawing depends on your specific plan – how long you plan on working, what other assets and income you have and how likely it is you’ll live a long life.
Question 3 – What retirement accounts should you use to fund needs?
Withdrawals from different types of accounts are taxed differently, and even within taxable accounts for which withdrawals aren’t taxed, decisions have tax consequences. Choosing which account to use for withdrawals and potentially employing more complex techniques like Roth conversions in low income years can substantially reduce the total taxes you’ll pay over the course of retirement. For more on tax planning in retirement, see this post.
Question 4 – How do you withhold enough in taxes?
The transition to retirement will likely mean a change in what you owe in taxes. For most people, taxes decrease because taxable income decreases. Withdrawals from traditional IRAs and 401ks are treated as taxable income, and depending on how much income you earn, Social Security benefits are taxable as well. Still, for most people, taxable income is lower in retirement so taxes will be lower. This is particularly true for retirees in Georgia, as the state excludes a certain types of income from tax if you are 62 years or older.
The best way to ensure you withhold enough income is by running a tax estimate in the year you retire. Once you’ve done that, you can set up withholding on Social Security payments, traditional IRA withdrawals or pay quarterly estimated taxes. It’s a bit of work, but you’ll avoid having to write a big check to the government at tax time or having to pay an underpayment penalty.
Question 5 – How often should you pay yourself?
How often you pay yourself depends on personal preference. Social Security payments are made monthly, but if you’re taking withdrawals from your portfolio, you can choose to receive those withdrawals in any number of ways. Most of our clients prefer to receive monthly transfers, but some choose to take ad hoc withdrawals or withdrawals one a year.
It can take some time to work through the questions above. Still, by doing so you’ll have created your own retirement paycheck and developed a solid understanding of how you shift from working income to retirement income.