Transitioning into Retirement

Transitioning Into Retirement

Transitioning into retirement can be exciting and daunting.  Many retirees work with a professional financial advisor to navigate the multiple life changes.

Income.  You will need to reinvent your income in retirement.  You will most likely receive Social Security and/or pension income.  You may want to continue working part time.  Most retirees need additional income to maintain their desired lifestyle.  Hopefully, you have been able to accumulate retirement investments that can be used to create income.  It is a different mindset and strategy to position your portfolio to provide an income versus accumulation.  There is a general rule of thumb that you can draw 4% from your portfolio and have it stay intact (e.g. a $1,000,000 portfolio could produce $40,000 of income per year).  Generally speaking, expenses increase in the initial years of retirement (for travel, as an example), then reduce as we age, and again increase later in life for additional health care expenses.

Investments.  As people near retirement, it is common to be more concerned about protecting your portfolio than seeing it grow.  If so, your portfolio risk should be adjusted to accommodate this.  I often layer risk through various “buckets.”  I recommend leaving one-year of anticipated expenses in guaranteed vehicles (savings, CDs, treasuries).  The balance of your portfolio might be divided into a conservative bucket, moderate-risk bucket, and growth bucket.  You want to position your portfolio so that you don’t have to sell more aggressive investments when there is a market downturn.  Drawing from the conservative bucket allows the more aggressive ones to continue to grow without disrupting your retirement income.  Most people roll their retirement plan over to their IRA when they retire.  IRAs provide significantly more investment options and flexibility, and can be professionally managed.  Another option to potentially consider is an annuity for a portion of your portfolio.  There are several types of annuities, with their own pros and cons.  The main benefit of most annuities is that they can provide guaranteed income for your life.

Health Care.  Most retirees need to transition from health insurance provided by their employer.  If you are 65 years old, Medicare is typically the main source of health insurance.  There are several components and options within Medicare and supplemental insurance plans.  I recommend speaking with an insurance agent that specializes in Medicare.  If you are younger than 65, you will need to obtain private health insurance, which can be costly.  Your Medicare and health insurance premiums are impacted by your taxable income.  You should also consider long-term care expenses and insurance as part of your retirement planning.

Taxes.  There are some unique opportunities with tax planning once you are retired, and I find tax planning becomes more complex for many clients.  If you live in Massachusetts and are 65+ years old, you may be eligible for the Senior Circuit Breaker credit.  There is a formula based on your income and how much you pay for either real estate taxes or rent that determines how much of a tax credit you receive.  You can influence your overall taxes based upon how you draw from your investments.  For example, it’s possible that money in non-retirement brokerage accounts can be drawn down with less taxes than your 401(k) or IRA.  You may have money in Roth IRAs that provide tax-free income.  You do need to be careful about how various income options can impact other parts of your taxes such as the Circuit Breaker Credit and health insurance subsidies if you are under the age of 65.  Generally speaking, I prefer drawing down non-retirement assets first. 

Retirement Distributions

Transitioning into retirement can be exciting and daunting.  Many retirees work with a professional financial advisor to navigate the complexities.

Required Minimum Distributions (RMDs).  The IRS requires that you begin taking distributions from retirement plans at a certain age.  This is known as your Required Minimum Distribution (RMD) age.  Not too long ago, you did not need to begin your RMD until age 70½.  In 2019, Congress changed the RMD date to age 72.  In the final hours of 2022, Congress changed the RMD age yet again as part of the SECURE 2.0 Act!  If you were born 1951 to 1958, your new RMD age is 73.  If you were born in 1959 or later, your RMD age will be 75.

Your RMD is calculated each year based on the value of your account on December 31 and your life expectancy according to an IRS table.  Your initial RMD is typically about 4-5% of the value of the account, and this increases a little bit every year.  If you fail to take your RMD, there is a penalty tax between 10% and 50%!!!  So, it is important to pay attention to your RMDs.  RMDs need to be calculated for ALL retirement accounts, such as IRAs, 401k plans, 403b plans, etc.  Also, if you have multiple types of accounts, such as an IRA and 401k, you need to take a distribution from both of them.  Roth IRAs do NOT have a required distribution, unless received as an inheritance.

I should also note, if you INHERITED a retirement plan, the RMD rules are entirely different.  You are generally required to begin RMDs immediately, unless the plan is inherited by a spouse.  The inherited RMD rules are too complex to explain in this article, so please speak with your tax and/or financial advisor.

Distributions from retirement plans are generally taxed as ordinary income (unless you made Roth contributions).  Because of this, many people try to delay retirement distributions as long as possible.  For example, you may have money in non-retirement investment accounts or Roth IRAs that you can spend down during initial years of retirement. 

Tax Strategies.  It may seem counterintuitive to pay taxes sooner than you are required, but it may make sense to take some distributions from your retirement plan sooner than your RMD age.  The IRS has a graduated income tax schedule, meaning that as your income increases, your tax rate on income goes up.  The Federal tax rate starts at 10% and eventually increases to 37%.  Depending on the size of your retirement accounts, your tax rate may be higher if you wait until your RMD age.  For example, you may be able to pull money from your retirement plan and have it taxed at 15% or 22%, but this may go up to 24% or 32% later in retirement.  Paying taxes today at 15%, may be better than deferring taxes and paying at a rate of 24%, for example.

If you are over the age of 70½, it is possible to donate money from your retirement plan directly to charities without paying taxes.  This is called a Qualified Charitable Distribution (QCD) , and is a great strategy if you regularly donate to charities.  You don’t have to pay taxes on the distribution and your charities directly benefit!

Roth Conversions.  If you want to take advantage of lower tax rates but don’t need money for your expenses, you can also consider a Roth Conversion.  When you do this, you convert a taxable retirement account into a Roth IRA, which grows tax free!  Roth IRAs do NOT have RMDs, so the money can grow tax-free until your death.

Lars Lambrecht, Rehoboth resident and Certified Financial Planner, is available to answer questions or meet for a consultation.  617-947-6428