This is the third in a series of articles.
My original intent was to retire when I turned 70. However, as I noted in Part 2 of this series, the realization that “it’s time” bumped up my retirement to this fall, when I turn 67. Thus the mental switch was flipped, then the “Can I afford to retire?” review and decision was made. A large number of people find that their retirement plan (IRA, 401k, 403b, company pension, profit sharing, or other) account is the biggest part of their financial picture, often bigger than any Social Security benefits for which they qualify. My own picture is probably not that much different.
Social Security retirement benefits are much more modest than many people realize, according to the Center on Budget and Policy Priorities. Benefits represent 90% or more of income for 41% of those receiving benefits. My wife and I are most fortunate to not be in this situation. The Social Security retirement benefits my wife and I will receive, along with other sources of income, and with realistic expected reduced spending (no mortgage or credit card debt), help make possible the expected delay of our retirement account withdrawals.
Folks who have a pension account, such as public employees or state teachers, will already have received an estimate of their benefits, based on when they retire. Regardless of the kind of retirement account, tax planning is important, since there is a good chance it will be necessary to file quarterly estimated tax payments. Tax planning allows me to know what I must set aside for taxes and what net, after-tax dollars I will have available for cash flow.
My own situation should allow me to not touch my retirement account (currently in a 401k plan) until I am 70 ½, when I must begin taking Required Minimum Distributions each year. The rule is that the initial RMD must take place by April 30th of the year following the year in which I turn 70 ½. For me, that means my first distribution must take place by April 30, 2021. But since this distribution is for the previous calendar year, I will also need to take a distribution by December 31st of the same year for 2021. To avoid being forced to take two distributions in the same year, I will move up my first RMD to 2020. Yes, it sounds complicated, but once you get the first one out of the way, the rest simply have to be done by December 31st of each year. Whether I need dollars from my retirement account or not, once I turn 70 ½, I must start annual distributions. The percentage required increases each year, but starts at around 3.6% of the value of the account as of December 31st of the previous year.
If I want to make any large charitable contributions prior to my RMDs, I can make a distribution from my retirement plan, no taxes withheld, and the charitable gift will offset the distribution, with no tax consequence. Once I am in the RMD phase, I can designate part or all of my RMD be sent directly to my charities of choice, with no taxes withheld. However, I do not get to also claim the gift as a deduction.
The next question is how to transition my retirement account from one of accumulating assets to one of planned distributions. I know for sure I do not want to convert my account to an annuity of any kind. Interest rates for fixed annuities are abysmal now, and the equity-indexed annuities being pushed by commissioned salespeople are very expensive and extremely complicated. The only ones who benefit from them are the insurance companies.
In fact, I can structure my account to send money directly to my bank account each month. This is especially attractive to people (my wife included) who like knowing that on the 30th day of each month, a specific dollar amount will be deposited to their bank account. And the ability to withhold federal and state taxes (or not) is also a plus. Thus, I can establish my own “annuity”, but keep expenses low and retain control of the dollars and the income I receive.
I like to have 4-6 years of cash flow needs from an account invested in short-term bonds, CDs or cash for clients taking distributions. The rest of the retirement account can be invested in line with long-term goals, time horizon, and risk tolerance. This protects cash flow needs so that we don’t need to sell equities when the market is down. The 4 to 6-year timeframe will likely cover most bear markets. In good years, we might sell equities and leave the fixed assets alone. This strategy allows flexibility, something true annuities cannot do.
In summary, there can be a lot of moving parts to calculating what retirement cash flow will be. Retirement accounts like 401k, IRA, profit sharing and others may be the biggest piece for many retirees. It’s important not only to plan when distributions will start, but also to plan how they will happen and to create a flexible investment allocation that reflects a well-thought out strategy.
Now that I have my income stream plotted, I will take a look at health care planning in the next chapter.