Managing Retirement Income. Complete Guide

How to plan Retirement Income?

Keeping track of your finances is essential, whether you’re already fully retired or have recently started this new phase of your life.

When you retire, you should figure out your expenses. Then, create a financial plan based on your goals, expected spending, and how long you need your money to last.

Analyze the sources of retirement income you can anticipate, how much you can expect these sources to provide, and the changes – if any – you should consider making in the way you’re investing and managing your money.

As you transition from work to retirement, you may want to rethink your approach to asset allocation or the percentages of your investment portfolio you assign to different asset classes. For example, since your taxable and tax-deferred investments are held in separate accounts, you may have been allocating them separately, as many people do, rather than as components of a single portfolio. That may work fine. But rather than owning several asset classes in each type of account to help manage risk, you may want to concentrate certain types of investments in your taxable accounts and other types in your tax-deferred or tax-free Roth accounts.

So, for example, instead of owning equity, debt, and some alternative investments in both retirement and nonretirement accounts, you may want to emphasize equities in one and bonds and cash in another. Among the factors, you’ll want to consider in making these choices are how any earnings will be taxed, whether withdrawals are required, and the rates at which assets have the potential to grow.

Create an Emergency Account. You’re probably familiar with the value of having savings that could cover six months or so of expenses in an emergency. But the role of an emergency fund takes on a different dimension in retirement.

When you tapped your emergency fund while working, you expected to be well enough to return to your job or have a minimal delay in finding a new one. But when much of your retirement income depends on investment returns, as it does if it comes from a 401(k) or similar account and personal investments, a repeat of the 2008 freefall in the financial markets could mean a significant shortfall.

To provide the protection you need, a retirement emergency fund should hold two years’ worth of living expenses, and perhaps more, in a combination of liquid accounts that are essentially free of market risk, such as certificates of deposit (CDs) and Treasury bills and short-term notes.

In addition, if you want to be more prepared to have a wealthy retirement, consider buying insurance as part of an overall retirement plan to protect assets from the high costs and burdens of comprehensive healthcare. 

Moreover, consider where you can save money if you want to be on the safe side. For example, it would be a good idea to put retirement savings as a line item in your budget to set aside those funds every month.

What sources can be used for retirement income?

US workers count on six major sources of retirement income: Social Security, an employer-sponsored retirement savings plan, continued employment, individual retirement accounts (IRAs), other personal savings, and traditional pension plans. 

Social Security

It’s possible to take reduced benefits at 62 or retire first and receive your full benefits, depending on the year in which you were born. If you delay collecting, your monthly benefits will be increased. Social Security benefits are periodically adjusted for inflation. Social Security benefits are considered one of the most stable sources of income, but it’s unlikely that it will be enough to cover all your expenses.

An employer-sponsored retirement savings plan

The best-known defined contribution plans are 401(k)s, 403(b)s, and 457s. 

401(k) plans offer a variety of investments from which to choose. A 401(k) is an employer-sponsored retirement account that allows employees to dedicate a percentage of their pre-tax salary to a retirement account. You immediately lower your annual taxable income and start paying less when you contribute a percentage of your pay to a 401(k) plan. What you receive depends on how much was invested, how long it was, and how the investments performed.

Individual retirement accounts (IRAs) 

The IRA is a profitable investing tool for individuals to earmark their retirement savings. One of the benefits of the traditional IRA is that contributions are generally tax-deductible. You can move the money from your retirement account to an IRA in two ways:

• You can get a check for the money in a lump sum payout and deposit the total amount in the IRA within 60 days
• You can have the funds transferred directly to the custodian of your new or existing IRA

Traditional pension plans

When you retire from an organization that provides a traditional pension, you generally have two income choices: a pension annuity or a lump-sum distribution. With an annuity, you receive income each month for the rest of your life and the life of another person, usually but not necessarily your spouse. If you choose a lump sum, your employer calculates the amount you’ll receive and transfers the money to your designated account.

How to invest for retirement?

The more popular investment options are stock and bonds. 

When you put money into a bond fund, you buy shares in the fund, just as you do when you put money into a stock fund. The fund manager invests that money by buying bonds issued by corporations, governments, or government agencies. When issuers sell bonds, they’re borrowing money from investors willing to lend for a specific period, called the bond’s term. In exchange, the investors receive interest on the loan and the promise that the principal, or loan amount, will be returned by a specific date (the maturity date). 

Stock fund returns reflect the performance of the stocks in publicly traded companies that are the underlying investments of these funds. As you invest, stocks and stock funds may still dominate your portfolio, especially if you have a fixed-income pension. You may gravitate toward dividend-paying stocks and the funds invested in them, preferred stock, and perhaps a tiny percentage in income-focused investments, including REITs and certain limited partnerships – provided you are comfortable committing capital to an essentially illiquid investment for some time. Investment income differs from fixed-income pension income in at least one important way: its potential to outpace inflation over an extended period. Even pensions with the cost of living adjustments (COLAs) rarely increase enough to maintain buying power. But if your investment rate of return is sufficiently greater than the rate of inflation plus the rate at which you withdraw from your accounts, your assets can continue to grow in value while providing a source of income.

Getting investment income is not the only way to earn retirement income from your investments. You can also sell your assets and get money if it costs more than you paid.

4. Taxation on retirement income

Despite the significant changes that retirement is likely to bring, you won’t be able to avoid taxes entirely if you have income from a job, a pension, investments, or Social Security. In fact, income taxes can be your most significant expense when you retire.

When you stop working, you stop paying Social Security and Medicare taxes. That can add several thousand dollars to your bottom line. In addition, if you earn a pension in one state but move to another, you don’t have to pay taxes on the pension income to the state where you earned it. (But you will be a taxpayer in the state where you live.) Finally, when you reach 65, you may qualify for a larger standard deduction when filing your federal tax return.

Most retirement income is taxed based on the type of income it is. Here’s an overview of federal rules that apply:

Annuity income: A portion of each annuity payment is considered a return of principal and is not taxed unless purchased with pre-tax dollars. Earnings are taxed at your regular rate.

Capital gains: Profits from the sale of stock, mutual funds, your home, and many other equity investments are taxed at your long-term capital gains rate, provided you have held the assets for the required period.

Interest income is taxed at your regular rate. Dividends from qualifying stocks and mutual fund distributions of those dividends are taxed at your long-term capital gains rate.

IRA distributions: All earnings in a traditional IRA and any contribution for which you took a tax deduction are taxed at your regular rate when you withdraw the money. Withdrawals of nondeductible contributions you made are not subject to tax. Additionally, income from a Roth IRA is not taxed if you are at least 59½ and your account has been open for five years or more.

Lump-sum distributions from pensions, 401(k)s, and other salary-reduction plans are taxed at your regular rate.

Pension annuity income is taxed at your regular rate.

Rollovers from pensions, 401(k)s, and other salary reduction plans remain tax-deferred until you withdraw.

The amount of tax you owe on your regular income depends on your filing status, the rates at which various levels and types of income are taxed, and the tax bracket you’re in.

Managing Retirement Income. Complete Guide by Inna Rosputnia

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