For most of your working life, retirement planning is about accumulation. You contribute to a 401(k), IRA, or other retirement account, invest the money, and hopefully watch those balances grow.
Then retirement arrives, and the question changes.
It is no longer simply: “How much have I saved?”
Now it becomes: “How do I turn what I have saved into income I can rely on?”
That transition from accumulating money to distributing it can be one of the biggest financial adjustments in retirement.
Consider a couple approaching retirement with Social Security, two 401(k)s, an IRA, a taxable investment account, and cash in the bank. On paper, they may have enough assets to retire comfortably. But that still leaves some important questions:
Which account should provide income first? Should one spouse delay Social Security?
How much should remain readily available?
What happens if the stock market drops shortly after they retire?
Could Roth conversions make sense before Required Minimum Distributions begin?
Having enough money and having a plan for using that money are not necessarily the same thing.
Building the Retirement Paycheck
Most retirees will not receive their income from just one place. A retirement paycheck might be assembled from Social Security, a pension, IRA or 401(k) withdrawals, taxable investments, cash reserves, annuity income, or perhaps some part-time work.
The important question is how those resources work together.
For our hypothetical couple, Social Security might cover part of their monthly expenses while their investments provide the rest. But deciding which investments to use, and when, can have consequences that extend beyond simply generating cash.
Which Account Should You Use First?
There is no withdrawal order that is right for everyone. Money withdrawn from a traditional IRA or 401(k) generally creates taxable income. Selling investments in a taxable account may create capital gains. Qualified Roth IRA withdrawals generally do not add to taxable income.
That creates planning opportunities. There may be years when taking additional taxable income makes sense and other years when controlling taxable income becomes more important. Higher income can also affect Medicare premiums through the Income-Related Monthly Adjustment Amount, or IRMAA. Medicare generally uses modified adjusted gross income from two years earlier when determining whether IRMAA applies.
So the question is not simply, “Which account has money available?” It is also, “Which source of income makes the most sense this year?”
Social Security Is Part of the Strategy
Social Security is another piece of the retirement paycheck. Starting earlier provides income sooner. Waiting can increase the monthly benefit. But the decision should rarely be made in isolation.
Could investment accounts provide income while one spouse delays Social Security? Does the higher earner’s benefit have additional importance because it may eventually become a survivor benefit? Would starting earlier allow the couple to preserve other assets?
There is no single claiming age that works for everyone. Social Security should be coordinated with the rest of the income plan.
What Happens When the Market Falls?
A market decline while you are working can be uncomfortable. A significant decline shortly after retirement can create an additional problem because you may also be withdrawing money while investments are down.
This is commonly referred to as sequence-of-returns risk. Poor market returns early in retirement can be particularly damaging when withdrawals are occurring at the same time. One way to help manage that risk is a bucket, or time-segmentation, approach.
For our hypothetical couple, money expected to be needed during the next few years might be kept more conservative and readily available. Assets that may be needed several years from now can be invested with an intermediate-term focus, while money intended for much later in retirement may remain positioned for longer-term growth.
This does not eliminate investment risk. Instead, it creates a structure designed to reduce the need to sell longer-term investments simply because the market happens to be down when a paycheck is needed.
Your Spending Won’t Be the Same Every Year
Another challenge is that retirement spending rarely follows a straight line. The early years of retirement may include more travel, hobbies, home improvements, or larger purchases. Later years may involve less discretionary spending but potentially higher healthcare expenses.
Our couple, for example, might plan for a larger travel budget in their first few years of retirement, knowing that spending may look different later.
There can also be occasional big expenses:
· A new vehicle
· A roof or major home repair
· A major trip
· Helping children or grandchildren
· A wedding
· Long-term care expenses
A retirement-income plan therefore needs to do more than replace a monthly paycheck. It should provide some flexibility for the years when spending is higher, or simply different, than expected.
Taxes Become Part of the Paycheck
Once withdrawals begin, retirement-income planning and tax planning become closely connected. A retiree might own traditional IRAs, Roth IRAs, taxable investments, cash accounts, and employer retirement plans, each with different tax characteristics.
That creates questions such as:
· Should we take additional IRA withdrawals this year?
· Is there an opportunity for a Roth conversion?
· Should charitable gifts be made through Qualified Charitable Distributions when eligible, generally beginning at age 70½?
· Should gains be realized from a taxable account?
· How could today’s decisions affect taxes later in retirement?
For our couple, the years between retirement and the start of Required Minimum Distributions might be lower-income years, which could create room to consider Roth conversions.
This is why focusing only on minimizing this year’s tax bill can miss the larger picture. Sometimes the better question is what tax strategy makes sense over many years of retirement.
From Retirement Savings to a Retirement Paycheck
One of the concerns we frequently hear from people approaching retirement is:
“I have saved money, but I don’t know where my monthly income is actually going to come from.”
A retirement-income plan should make that answer easier to understand. For our hypothetical couple, that might mean knowing where the next several years of spending will come from, which assets are intended for later, how Social Security fits in, and what adjustments might be considered when markets, taxes, or spending change.
The plan will not predict everything that happens during a 20- or 30-year retirement. It doesn’t need to. It needs to provide a structure for making decisions as circumstances change.
Eventually, those 401(k)s, IRAs, investment accounts, Social Security benefits, pensions, and cash reserves have to become the money that pays the mortgage or property taxes, buys groceries, funds vacations, and supports the life you worked to create.
That transition deserves its own strategy. If you are approaching retirement and have never mapped out where your income will actually come from, a useful first step may be to put all of the pieces in one place and ask a deceptively simple question:
“Where will my next paycheck come from after my employer stops sending one?”
The answer can reveal a lot about how prepared you are for retirement—and where additional planning may be helpful.
If you’d like help putting those pieces together, I’d be glad to walk through it with you. Sometimes just seeing everything in one place makes the path forward much clearer.
Next week: Do you really need a financial planner if retirement is still decades away? We’ll look at why planning can matter long before retirement begins.
FAQ
How do I create a retirement paycheck from my savings?
A retirement paycheck usually comes from several sources, such as Social Security, pensions, IRAs, 401(k)s, taxable investments, cash reserves, or annuity income. The key is coordinating those sources so they work together.
Which retirement account should I withdraw from first?
There is no single withdrawal order that works for everyone. Taxes, Social Security timing, Medicare premiums, Required Minimum Distributions, and the types of accounts you own can all affect the decision.
What is sequence-of-returns risk?
Sequence-of-returns risk is the danger that poor market performance early in retirement can have an outsized impact when you are also withdrawing money from your portfolio.
What is a bucket or time-segmentation strategy?
A bucket strategy organizes money based on when it may be needed. Funds for near-term spending may be kept more conservative, while money intended for later years can remain invested for longer-term growth.
How does Social Security fit into a retirement-income plan?
Social Security should be coordinated with other income sources. The timing of benefits can affect monthly income, survivor benefits, taxes, and how much you need to withdraw from investments.
Can retirement withdrawals affect Medicare premiums?
Yes. Higher income can trigger IRMAA, which may increase Medicare Part B and Part D premiums. Medicare generally looks back two years when determining IRMAA.
Should I consider Roth conversions before RMDs begin?
Possibly. The years between retirement and Required Minimum Distributions can sometimes create lower-income opportunities for Roth conversions, but the strategy should be evaluated in the context of taxes, Medicare premiums, and long-term planning.
How much cash should I keep in retirement?
The right amount varies. Many retirees benefit from keeping enough readily available to cover near-term spending and unexpected expenses, while allowing longer-term assets to remain invested.
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