Just because you’re no longer working doesn’t mean that you don’t deserve a paycheck. In retirement, however, it will be up to you to create that paycheck. Income sources may include Social Security benefits, investment dividends, IRA or 401(k) plan distributions, pensions, and others. There are various reasons to choose one source over an another in a given year depending on your tax situation and age. Here are a few potential sources and strategies to keep in mind:
Social Security: Generally, it’s most lucrative to take your maximum benefit at age 70. Reasons to take it sooner may include a shorter life expectancy, cash flow restrictions, or if you’re looking to implement a benefits strategy with your spouse. Such a strategy may be to take ½ of your spouse’s benefit while delaying your own. This option is available for people born before January 2, 1954^1.
Investment income: Being in a low-interest environment doesn't mean that you can’t create dividend income. It just means you can’t create dividend income from cash since most banks offer almost nothing in terms of interest rates. You’ll have to accept some investment risk in order to create sufficient dividend income. This may come from a real estate investment property, stocks, or bonds. Some investments offer tax benefits over others. Long-term held investments and qualified dividends can be tax-free and rental property losses can offset other income if you’re under a certain income threshold. Keep in mind the investment risk that you’re accepting and don’t let the tax benefits sway your good judgment.
Pensions: A pension may have been offered to you by your employer and can be a great benefit that lasts until death. Generally these benefits don’t increase with inflation, however, it was a life-saver for many retirees over the last decade because there was little inflation. Some pension companies offer a ‘buy-up’ of additional service credits, which would increase your lifetime benefit. It's worthwhile to the calculation with your financial advisor.
Retirement plans: Your 401(k) and Traditional IRAs can be distributed at will once you retire. Generally, distributions are taxable as ordinary income, and depending how much is taken, it can make your Social Security benefit partly taxable as well as make your investment income taxable. Understanding your tax situation may encourage you to take a larger distribution from a retirement plan in a low-income year.
If you’re approaching retirement, you still have time to design a strategy that will provide you with the most tax-advantageous situation from now through retirement. This may include contributing to “after-tax” and Roth IRAs while you still work. These accounts could provide you with tax-free income during retirement.
At Eureka Wealth Management, I help my retiree clients recreate their paycheck in the most optimal way. There are many possibilities to consider and each choice can affect the other not to mention have a lasting, permanent impact. I also provide investment management and estate & tax strategies as these come into play as you receive your income in retirement. Call me for a free, initial consultation at (760) 537-0791 or online at eurekawealthmanagement.com.