Last week in Retirement Planning 101, I discussed the different types of investments used in retirement plans. If you do a good job saving during your working career, the most difficult phase of retirement planning in my opinion is the distribution phase. Since most people who think they are ready to financially retire worry about running out of money, figuring out the right way to take income from your investments is crucial during retirement. I think about retirement asset distribution much like the water faucet you have at home. You need to know which spicket to turn on in order to minimize taxation while you take home the most net income possible.
Remember that the first couple of years of retirement will generally result in a slightly larger amount of income needed before you settle into your regular expense mode for retirement income. We have found over the years that clients will spend more in the beginning of retirement filling up the some 2000 hours of newly freed up time.
The age that you begin the distribution phase will also have a large impact on which faucet you turn on to get your retirement income. Here are the three key areas and considerations for getting your income from the different faucets of income.
- Fixed Income – Fixed income can be received from different sources. The first may come from a pension that you get from your employer. Pension plans need to be studied closely because the amount you receive from your employer may vary greatly if you take the benefit at the age of 55 versus the age of 65. In addition you need to make sure you understand if your pension has a cost of living adjustment. If your pension does not have a cost of living adjustment, then in essence you have a decreasing benefit each and every year. You will also strongly need to consider when you take a life only or a joint with rights of survivor benefit with the pension plan if you are married. This may affect immediate income to be slightly higher or slightly lower benefit based upon your decision with the pension plan. Serious analysis of the pension decision should be done before making a final choice on which route to go with the pension plan.
Social Security will be the other portion of your potential fixed income. For most people, the decision on what age to take social security is a very complex decision. One of the very critical items to review is whether or not you will be earning income from work if you decide to take social security early. Since there is a social security offset program in place, those still earning considerable waged income when they turn on this income stream can actually be detrimental to overall net income from this source. In today’s environment, it is probably a good idea to plan for the cost of living adjustments on this income source to be less than the normal inflation rate.
- Qualified Retirement Money – This part of the water faucet consists of your IRA’s, 401(k)’s, and generally other money that you have been growing tax deferred for a long period of time. Most people are under the impression that you can only start accessing this money at the age of 59 ½, but by following the right procedures you could actually access this money earlier without an IRS penalty of 10% (consult a good financial advisor or CPA before doing this). Since most of these assets have never been taxes before, you need to really plan on what your ‘net’ number will be based upon current income tax brackets and your overall taxable income. Distributing qualified retirement money can often be very tough for retirees on handling managing the investment strategy within these accounts to generate the income while simultaneously keeping an eye on net income after taxes. Keep a reminder that at the magical age of 70 ½ you will begin to have to take a forced distribution called a required minimum distribution.
- Non-Qualified Assets – The final faucet is made up of other assets such as bank accounts, CD’s, brokerage accounts, real estate, and other liquid assets. I like the idea of having a year or two in cash when you are ready to make work optional since it allows you to not have an immediate worry about what investments you would have to use to generate income or which investments to liquidate. With non-qualified assets, you should consider what assets may trigger capital gains should you have to begin selling assets. Generally, selling your lowest performing least taxed assets will likely be the best strategy if you have to liquidate these assets. Depending on the size of your estate, using different types of trusts may help you escape some of this taxation. Comparing how much net income (net of tax) from these assets versus using non qualified assets is an important analysis for your financial advisor to do at the point you begin to generate retirement income.
Distribution is the most complex stage of retirement planning and should not be taken lightly. Since fixed income, qualified assets, and non qualified assets work in concert during the distribution phase, you should do plenty of analysis so you can maximize the use of your assets. This planning will help relieve some of the fear of running out of money, and will ultimately allow you to figure out the income level you can truly sustain during retirement. If you don’t know what to do, go to our website at www.oxygenfinancial.net to schedule a FREE visit today.
Ted Jenkin, CFP®, AAMS®, AWMA®, CRPC®, CMFC®, CRPS®
Co-CEO and Founder oXYGen Financial, Inc.
oXYGen Financial, Inc. co-CEO Ted Jenkin is one of the foremost knowledgeable professionals in giving financial advice and Smart Money Moves to the X and Y Generation.
Phone 1.800.355.9318or 770.777.0427
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