Wealth and Investments: Juggling Retirement Income Streams
In simpler times, a retiree’s main worry in receiving retirement income and coordinating their wealth and investments might have been making sure he or she remembered to deposit the Social Security or private pension check in the bank after it arrived in the mail. Those days are long gone.
One thing we've come to learn in our 48 years of assisting families is that in today’s world, you often must strategically schedule the receipt of income from a variety of different sources at different times to optimize your retirement success. It’s important to understand your various retirement income streams and what each will be providing. Failure to do so could result in you receiving less than what’s available to you – or worse, cost you heavily in taxes, penalties and fees.
Let’s look at some of the most common retirement income streams and how to optimize the effectiveness of each.
Back in the day, Social Security checks all arrived at the same time – the third of each month. They still do if you filed for retirement benefits prior to May 1, 1997. But if not, today, your Social Security check arrives on a day determined by your birthday. People born on the 1st to the 10th of the month receive checks on the second Wednesday of the month; those born on the 11th to the 20th of the month are paid on the third Wednesday; and those born after the 20th are paid on the fourth Wednesday. When your check will arrive is important to know as you plan your bills and establish a budget.
Something else to consider when it comes to Social Security is your benefits are not taxed unless your provisional income exceeds $25,000 ($32,000 for married couples filing jointly). Provisional income is your modified adjusted gross income plus any tax-exempt interest and 50 percent of your Social Security benefits. From that point on, from 50 percent to 85 percent of your Social Security benefits are taxed on your U.S. federal income tax return.
One of the most important planning issues for Social Security is to make the right decision regarding when to commence your benefits. If you begin before your Full Retirement Age, your payments will be discounted for life. If you wait later than your Full Retirement Age to begin, payments can be enhanced. There is no one-size-fits-all in answering the question of when to begin. Careful number crunching that blends this decision with other relevant financial factors applicable to your family is important.
401(k)s and IRAs
Private pension plans have increasingly been phased out in favor of retirement savings plans such as 401(k)s or Individual Retirement Accounts (IRAs). What does this mean for you? In a nutshell, it means that it is your responsibility to understand how much of an income stream your retirement savings balance can realistically provide. You will have significant control over the decisions of when you need to withdraw from these funds, and how they will be taxed is in your hands – as well as much or all of the investment decision-making responsibility for continuing to invest the balance during retirement.
You can start drawing from your 401(k) funds when you retire if allowed by your company's plan. These withdrawals are free of penalty taxes if you have reached age 59-½. Withdrawals are taxed at your ordinary rate. In addition, you must start drawing from your 401(k) account when you reach 70-½. This is when you need to start Required Minimum Distributions (RMDs). Failure to do so can result in a penalty of 50 percent of any shortage in what you should have withdrawn. (RMDs depend on your life expectancy and the balance in your accounts.) If working with a financial advisor, ask him or her to calculate your RMDs.
If you have a traditional IRA, the rules are similar to those of a 401(k). You can withdraw from your traditional IRA accounts without penalty beginning at 59-½, and you must withdraw from them or face the same 50 percent penalty at 70-½.
For any given year, the RMD is your account balance divided by the Internal Revenue Service’s Uniform Lifetime Table. Withdrawals are taxed at the ordinary rate.
If you have a Roth IRA, no RMD is required. You can withdraw at 59-½ as long as you’ve had the money in a Roth IRA at least five years. At the other extreme, you can keep money in the account for your heirs until you die without any tax penalty. Withdrawals from Roth IRAs are generally not subject to income tax.
If you’re eligible for a pension, the rules on withdrawal may be determined by the company. Contact your employer to find out the age at which you can start receiving a check, options for receipt and whether there are any rules about when you must begin receipt.
Most pensions are taxed at an ordinary rate.
Your company's pension plan may provide you the option of taking a "Lump Sum Distribution" of your pension benefit in lieu of an annuity payment for your lifetime. This option raises a number of somewhat complicated tax and financial issues. You should seek qualified help in evaluating your options if considering a Lump Sum Distribution.
Stocks, Bonds and Savings
Stocks and bond investments not in a retirement account can be converted to cash and withdrawn at any point in time. So can any savings in money market accounts or matured Certificates of Deposit (CDs) in non-retirement accounts.
Interest income from personal investments like these is taxed at an ordinary rate. Stock and bond investments sold to fund withdrawals are subject to capital gains taxes.
Discussing your retirement wealth and investments with a financial advisor can help you best situate yourself to get the most out of your accounts. Ask about the optimum amount to withdraw per year to ensure that your money lasts and any tax implications of your withdrawals.
Almost 19 percent of people 65 and older were employed either full-time or part-time in 2016 – a rise of almost 50 percent from the nearly 13 percent of senior citizens employed in 2000.
If you are employed, it’s important to know the same things you did before you retired: When does your check arrive and how much will the amount be? Ask your employer the former when you first start, and gauge the latter by your wages and tax position.
Other Income Streams
Although Social Security, 401(k)s and IRAs are the most common forms of income in retirement, the number of potential income streams in retirement is broad. Here is a list of other potential income streams.
- Other retirement plans – To effectively manage receipt from other potential retirement plans, be sure to check on your participation throughout your career. For example, did you ever contribute to 403(b)s, 457(b)s, Keogh plans, Thrift Savings Plans, profit-sharing plans and/or Roth 401(k)s.
- Annuities – The rules for annuity payments, RMDs and taxes vary widely, depending on what type of annuity you have (immediate or deferred, fixed or variable), the payment (lump sum or periodic) and how your premiums have been invested.
- Rents and royalties – If you have income-producing properties or receive royalties, plan for those monthly streams. Income tax rules for these is complicated, so you may need help from a qualified tax professional to optimize the integration of these sources into your planning.
- Inheritances – Have you inherited assets? The distribution of money and the tax picture will vary according to type of asset and amounts.
Juggling money from potentially many different sources is one of the challenges that can make retirement planning so important. Staying proactive to ensure you don’t leave money on the table or reduce your spendable cash flow by taxes or penalties is important. It’s a good idea to have a discussion of your income streams with a financial advisor. Talk about your wealth and investments and what they can mean to you and your family in retirement. Imagine the peace of mind that can come from a well-coordinated financial plan.