Episode 16: Income in Retirement

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We’re glad you’ve taken an interest in talking about a fundamental aspect of financial planning, income in retirement.

 Our financial professionals, Roger and Jake have taken a few minutes in this podcast to explain the importance of creating your personal cash flow, which is different from a budget, defining the various options you have, determining how to balance that income with your investments to achieve your retirement goals, and even finding a way to be tax efficient!

 When we talk about income in retirement, we cannot separate it from one of the major components of financial planning, and it's all about cash flow, right? Jake and Roger say that all the time. It's about cash flow.

We’re specifically going to look at the income related to your cash flow for this topic, but the first thing you need to do is complete your cash flow, right? We need to figure out what you're spending. What are the mandatory things? What are your expenses that are non-discretionary, and what are the things that are discretionary? So, to have the best information to plan for your retirement, you really need to do a detailed cash flow. A goal-based financial plan just is not going to cut it. There are just too many things going on.

And completing your cash flow is just a wonderful exercise for anybody to go through. You're going to see where you're spending your money today. This is not a budget. We don't put people on a budget. We just want to know where you're spending.

And we kind of joke around about it because when we get into the discussions about the cash flow with our clients, it's almost like a confession, right? Especially if the other spouse didn't know the complete spending picture. We’ve found that a lot of that revolves around Amazon.

Just know that the cash flow is just a tool. Where you spend your money tells a lot about what's important to you, what do you value, and helps to determine what you may continue spending on going forward.

So once you have those cash flow numbers in place, now you've got to start looking at your income streams. Where am I going to get the money to pay for everything?

First and foremost, you do need to establish your spending budget. And from that point, you have to coordinate the different income sources that you may have in retirement to figure out the most, ideally, tax-efficient way to cover those expenses. So if you've got a certain spending need that we've defined, there are different income sources that you can choose from to fulfill that need.

Social security is a big one that most people qualify for.

Some people still have pension plans.

And maybe you have some rental income or you’re going to semi-retire and you plan to earn some additional income in retirement.

There are a lot of different factors for planning with each of these income sources, but ultimately what we're trying to determine is to meet your living expense need, what do we need to withdraw from savings? That's the biggest thing for us as advisors and portfolio managers to determine with you.

We need to know what your withdrawal needs are, and we're going to try to coordinate those withdrawals for tax efficiency. And, crucially, we always try to maintain an amount of cash inside of your investment portfolio for some of these dedicated withdrawal needs. That amount is somewhere between 6 to 12 months’ worth of expenses, enough that we can keep your withdrawal going, especially in bad market years to avoid withdrawing from investments at a loss, but also not too much cash so that we're causing a drag on portfolio performance. It's a rather delicate dance that we have to do, but it’s helpful for strategic success.

One of the biggest mistakes that we can make is ignoring where we're going to get this income from, right? I mean, that's one of the biggest challenges that we have, especially in retirement.

A lot of folks will just say, “hey, I want to take all of my liquid savings out of the bank, and I'm not going to pay any taxes.” Because that's savings that you've already paid taxes on. So they think that for the first three to five years, they’re just going to withdraw everything that they’ve got in liquid savings at the bank, and avoid taxes all together. And that’s going to ensure that maybe there will also be a nice discount or subsidy from the Marketplace on their health insurance. This is speaking of health insurance that you have to buy pre-Medicare before you become eligible for Medicare. 

Well, let’s think about that a bit more. I mean, you can still take taxable withdrawals maybe out of an IRA and coordinate those withdrawals from the money that you have sitting in savings at the bank that you already paid taxes on and still keep you in an income level that will still allow you to receive benefits from the Marketplace on your health insurance and keep you in a lower bracket, too. It's a matter of really analyzing the options and finding the best one for you, not just blindly saying “this is what I'm going to do” because maybe you read it in an article somewhere or just don’t want to pay any taxes.

There are ways to minimize your taxes and still reap the benefits, as it relates to health care, keeping your income in a lower tax bracket.

Just a little bit about pension income. Pensions have kind of gone by the wayside. A lot of companies have terminated their pension plans in recent years, because think about it… It’s this payment after you retire that you receive every single month for you and for your spouse's lifetime that's guaranteed throughout your lifetime. If you still have one, most likely what's going to happen when you retire is the company's going to come to you and say, “we'd like to give you a big lump sum payout.”

Well, the key there is to do the math to determine if that lump sum that they're giving you is enough. Is it enough? To find out, you need to do what we call a net present value calculation. We can help you with it, but you need to do the analysis to make sure the lump sum that they're offering you, and it's going to look pretty awesome because it's usually a six-figure number and people get all excited, but what's the rate of return that you're going to have to earn on that lump sum to make sure that you replace those income streams they're guaranteeing? And when you're comparing apples to apples, the rate of return you should be using is probably kind of a low one because that would be more along the lines of a guaranteed rate of return. Because you were going to receive a guaranteed income stream.

So if you're working with someone and they say, “we can take that lump sum and we can make 5%, 6%, 7%, 8%,” those rates of return require some risk. It's not a foregone conclusion that the return is going to be guaranteed like the payments you were going to receive.

So that's why with a pension, after you do that calculation, oftentimes it does make sense to take the payments from the company. Take the guaranteed income stream because it is for the rest of your life and/or your spouse's life. So that's something that we can always factor into what your withdrawal needs are going to be in retirement.

The other income stream that everyone thinks of in retirement is Social Security.

And the timing of when you take it matters.

Should I take it early?

Should I take it late?

What are some other factors that I need to think about when deciding when to enroll?

We're doing the analysis all the time for each one our financial plans. And we’re looking at something called a breakeven.

We discuss Social Security all the time, often in the context of something like this:

     I'm 62, I'm taking my money. I'll work my whole life.

     I'm going to get my money before Social Security is belly up.

Maybe you've said that. We’ve heard it a lot. But when you sit down with us and start doing the math you begin to see a more complex picture with more to think about.

Everybody's breakeven is going to be different. You should be running that in your financial plan.

But as a general rule of thumb regarding taking your Social Security benefit early at 62, you're going to have to promise us... the best thing is that you die before age 78 1⁄2. Because if you live longer than that, you should have delayed until your full retirement age to take it. You outlived your breakeven age. If you delay taking it until age 70 for those additional retirement credits, then promise Jake and I that you’ll live past 83 1⁄2 years old.

If you live past 83 1⁄2 years old, good job! You did a good thing. You optimized your social security benefit by delaying and now you've got this larger income that continues through the duration of your life past 83 1⁄2 years old.

So what's the key thing regarding your Social Security income? What do we need to know? When you're going to die. 

That's what you've got to know. That's what we're all trying to figure out and none of us have that answer. If we had that answer, it'd be a heck of a lot easier. I don't know if I'd even want to really know that answer. I'm good with guessing, right? 

Another component of Social Security income that you've got to consider is income thresholds or earned income thresholds. This is all about the coordination of these income sources. If you're going to semi-retire and you're going to earn income above a certain earning threshold (and that is earned income, so your pension income does not count towards this calculation), and you're going to earn that income before you reach your full retirement age - and that is primarily for most people nowadays age 67 - you'll see what yours is right on your Social Security statement. If you're going to earn income before 67 or your full retirement age and take your Social Security before that point, your benefit may be reduced.

The threshold changes every year, and in 2025 it's around $24,000. If you know that you're going to earn more than that, even if you consider it a part-time job, it behooves you to delay your Social Security because you don't want your benefit to be not only taxable but also reduced.

So you have to coordinate those things, and that's where ultimately when we're determining what your income sources are, we're going to figure out what makes sense to take. When are you going to start taking your pension, if you have one? When are you going to take your Social Security? And when it comes to taking withdrawals from your retirement savings, try to do it in the most tax-efficient way possible. In planning for this, we call the strategy “filling up the tax bracket.” We're going to look at the current tax law and take IRA distributions that will maybe be taxed at 10% or 12% income tax and then look at other income sources, whether it be a trust account, an unqualified savings account, a cash account at the bank, so that we can have a little bit more control over those taxes.

Another factor to be mindful of is what happens with your Medicare premiums, given the level of income that you have. It may not apply to everybody, but coordinating these income streams in certain years, especially if you anticipate you're going to have a major windfall, whether it's delayed vacation pay or whatever it may be, if it's taxable income, it can affect what you pay in premium on your Medicare Part B and Part D. So what do you do? Well, if you can at all, maybe you coordinate how or when you receive that income. Do you have to take it all in one year? Can you spread it over a two- to three-year period, which then protects you to be able to pay the lower premium on your Medicare.

And here’s another strategy that affects your income choices and taxes - people go blindly into doing Roth conversions. When you do Roth conversions, that's taxable income. And you know what happens then? Your premium on Medicare may go up in that year. So you love it because what are you earning is tax-free. You're creating a tax-free asset, right? But at the same time you're increasing your Medicare premium. And Medicare does not catch up with you immediately. There's like a two-year delay. So you're in 2025 and you look at your premium on your Medicare Part B and D and you think, hey, what happened? My premium went up from last year! It may be because you had a big windfall in 2023. So you're going to want to make sure that you coordinate those things too, looking at everything.

Gosh, there's so many moving pieces with your income in retirement that you want to make sure that you're looking at it every single year.

It's what Jake and Roger call a game day decision. Every year we go back and say, “hey, this is what we did last year, but this is what we need to do now to manage your needs and goals,” making sure that you're reviewing everything. We also are mindful of these things that become a requirement when you get a little bit older, around 73 years of age, maybe even 75 for some folks, you’ve got to start taking RMDs, required minimum distributions. And they can be tough.

We can do all kinds of planning, figure out exactly what our client needs to spend, what they need to withdraw, and then they turn 73 or 75 and the government tells them what they have to take out. The IRS provides RMD tables that help determine how much you need to take out of your IRA, your pre-tax assets. And for some clients, it's more than they actually need for their income. So what does that mean? They're paying more taxes than they actually need to pay because they must withdraw more money per government rules.

In an effort to try and avoid paying these taxes as much as possible, some of our charitably minded clients are implementing what are called qualified charitable distributions. And these can actually start at age 70 and a half. You don't have to wait until 73 or 75. If you want to give money to a charity, the most tax-efficient way to do it is actually out of your IRA once you turn 70 and a half. Because it isn't included as taxable income. If you've got your requirement minimum distribution amount, and you determine you only need half of it to live on, for example. You could transfer the other half directly to the charity or charities of your choice. It counts towards your RMD. You meet that dollar amount that is stipulated. You don't have to pay income taxes. And you can check the box on being charitably minded as well.

So it really gives you a lot of flexibility to keep those charitable giving desires going but also to control the income taxes you're paying.

It's so important to look at all these different factors. There are so many moving pieces. Hopefully it sounds easy when you're talking about the cash flow. I don't know how easy it really might be. … It's easy. We think it's easy because that's what we do. It's not easy to stomach. That's the best thing to say because it's a little bit of, “hey, I didn't really realize we were spending that much.”

Nobody likes to do it. And we hope that when both spouses are in the room that they've actually communicated to each other what those expenses look like.

So when you're coordinating all these different income streams, and looking at where they're coming from, and when you're going to take them, this is all a part of a major complex process that you go through every single year. It's something that you always have to be looking at and you have to revisit. It's not just a one-timer and then you're done.

And all that coordination, all that monitoring, really, when you're looking at these different income streams is the process that you follow to really bring life and finances together.

Thanks so much for reading and for learning about income in retirement with us. For questions about our financial services or finances in general, please send us an email, give us a call, and of course, please like and subscribe to our podcast and stay tuned for our next episode.