Retirement typically brings many lifestyle changes, some of which may require a change in perspective. Switching from a savings state of mind to a spending state of mind upon entering retirement can be challenging. All of a sudden, retirees are expected to watch their retirement accounts drop in value over time instead of celebrating the milestones they reach as more and more funds are added to their incomes. Throw in the necessary math to confirm that the funds will last throughout retirement, and the shift in perspective can feel very stressful. Fortunately, people retire every day, and there are many tips and tricks available to help people “win” at their retirements.
Understand where your income in retirement will be coming from.
Retirees get income from a variety of sources, depending on how they invested during their working years. Veterans may receive military pensions and/or disability payments – stable income that they can expect to collect every month for the rest of their lives. However, these benefits typically end or are reduced when the veteran dies and do not continue to their families. Other retirees may have funds stored in a traditional retirement account, like a 401(k), 457(b), IRA, or TSP account – money that was tucked away over a number of working years and can be accessed after age 59 ½ without penalty. Still others may have funds stored across a variety of investments in a non-retirement portfolio of real estate, stocks, and bonds. At age 62 (at the earliest), an individual could choose to initiate their Social Security income payments, which also provide stable monthly income.
When creating a spending plan in retirement, consider using guaranteed income (pension, disability, annuity, and Social Security income payments) to cover your needs and using your less predictable income (withdrawals from variable retirement and brokerage investment accounts, along with income from dividends) to cover discretionary expenses. By ensuring that your needs are covered by payments that will not decrease during an economic downturn, you can make it more likely that you will have enough money to cover your basic living expenses. If the economy does take a turn for the worse and your investments suffer, you can always pull back on discretionary spending until the economy (and your account balance) recovers.
Consider adding earned income in retirement.
Many individuals retire without a plan to stay busy. They then find that retirement can be a little more boring than they expected. Not only can a part-time job facilitate human contact and engagement and keep one’s mind occupied, it also provides income to retirees so they don’t have to pull quite so much money out of their retirement or investment portfolio each year. In years of high inflation, income from a part-time job can offset some of the costs that are passed on to the consumer and it reduces pressure to draw down retirement funds, which can allow them to continue growing. (The longer that dedicated retirement funds can stay invested, the more money that will generally be available when withdrawals need to be made.) Note that income from a part-time job is taxable and, depending on the amount of income earned in a given year, may affect a retiree’s Social Security income payments, if they are receiving them, as well as their taxable income.
Rebalance investments to trend more conservative as you get closer to retirement age.
Traditional wisdom suggests that your asset allocation should trend more conservative with age, because your funds have less time to recover from dramatic market changes when you’re older and (closer to) making withdrawals in retirement. Reallocating the funds within your investment accounts to less risky options (e.g., shifting away from stocks and toward bond funds) can protect you from changes in the market that may be triggered by the global economy or politics. Many retirement accounts (including TSP) offer age-based targeting for retirement portfolios, and automatically adjust your asset allocation the closer you get to retiring. A quick rule of thumb encourages investors to have the percentage of bonds in their portfolio equal their age, so a 40-year-old would have a retirement portfolio consisting of 60% stocks and 40% bonds, while a 65-year-old’s portfolio would consist of 35% stocks and 65% bonds.
Annuities can provide a predictable source of income in retirement and can be purchased with money drawn from riskier investment options. Pulling money out of stocks and using those funds to purchase an annuity can provide stability, tax-deferred growth, and the option to create another guaranteed source of income that can be structured as either a temporary bridge of income or income that lasts for life.
Delay Social Security, if possible.
If you can afford to delay initiating your Social Security income payments, it can pay off, literally. Claiming Social Security benefits before you reach your full retirement age (currently defined by the Social Security Administration as 67 years old) will permanently reduce your benefits by 6.67% per year. Delaying your benefits claim until after you reach age 67 will increase your benefits by 8% per year (up to age 70). Delaying results in higher monthly payments for the remainder of your life. The higher benefit level of a couple’s Social Security continues to the surviving spouse after the first to die, so making claiming decisions that consider both persons’ gender, age, and health is crucial to develop an optimal strategy. Social Security payments are a source of guaranteed income that increases annually with cost of living adjustments and are not affected by changes in the financial market.
Note that if you choose to work part-time, your job may temporarily affect your Social Security benefits. If you claimed Social Security income payments early, there is a limit to how much other money you can earn while still collecting your full Social Security benefit. In 2024, the limit is $22,320 if you are under full retirement age and $59,520 during the year you reach full retirement age. Note that these withheld benefits will be factored back into your retirement benefit after you reach full retirement age.
Consider how you want to make withdrawals from your investment portfolio.
There are three methods that people commonly follow when making withdrawals from their investment portfolios:
- Withdraw only earnings.
- Withdraw a percentage each year.
- Withdraw a set amount each year.
If you withdraw only your earnings, your portfolio can hypothetically provide a stable source of income in years to come. This method works best for individuals with large investment portfolios that have the potential to generate a significant amount of earnings through interest, dividends, and market growth, and especially in combination with other stable income sources. However, withdrawal amounts typically vary by year and with market performance.
Other individuals may choose to withdraw only a certain percentage (e.g., 4%) of their funds or withdraw a certain amount (e.g., $35,000) from their accounts each year. Depending on the rate of inflation, you may need to withdraw more than planned if your cost of living ends up being higher than expected, which means that your withdrawals could outpace your savings and decrease the overall longevity of your portfolio. If you experience a loss due to market conditions, you may have to adjust your withdrawals, which could decrease your standard of living.
Note: Outside of investment accounts, you should also plan on making withdrawals from your dedicated retirement accounts. Once you reach age 73, you will be required to make withdrawals, called required minimum distributions (RMDs), from traditional retirement accounts. Failure to make these withdrawals will result in IRS-imposed penalties.
Understand taxation.
When you withdraw money from your investment and non-Roth retirement accounts, you adjust your taxable income. Depending on how much you take out, this could increase your tax bracket and your overall tax bill in a single year. However, there are ways to be strategic when making withdrawals to lessen your overall tax burden during retirement.
- Withdraw from Roth accounts when you are approaching the income threshold for the next tax bracket. Withdrawals from these accounts are not taxed and will not increase your taxable income.
- Consider tax-loss harvesting. If you sell investments (held outside of a tax-deferred retirement account) that have lost value, these losses can be used to offset gains realized by the sale of other investments or offset up to $3,000 per year of ordinary income.
- When selling investments outside of a retirement account, consider the length of time you’ve owned them. You have to pay ordinary income tax on investments that you have held for less than a year (short-term capital gains). Long-term gains on investments may be taxed at a lower rate.
Consider downsizing.
Do you need a large home or would investing in a smaller home provide you with enough living space while reducing your housing costs? Retirees may find that aging in place is difficult and involves installing accommodations, especially if their home has multiple stories and a significant amount of square footage. If you can afford it, it may be simpler to move to a community built for retirees. If you are open to moving and the math indicates that you would make enough money from the sale of your home to purchase a smaller property outright, you could preserve extra profits for retirement to supplement your income during your golden years. However, depending on your age and how long you’ve owned your home, it is important to talk to a tax adviser about potential capital gains on the sale – and the tax bill that may result.
Transitioning to retirement is tricky. A financial or tax adviser can help you create a spending plan that maximizes the longevity of your retirement portfolio. If you need more information about TSP withdrawal options in retirement, our Education Team can be reached at 888-298-4442. If you’re interested in learning more about the benefits of an annuity funded with after-tax dollars not held within a retirement account, schedule a consultation here.
The Navy Mutual blog is meant to provide basic information that generally applies to most situations and should not be construed as legal or tax advice. It is not meant to replace the services of a financial planner, insurance counselor, attorney, or tax adviser. Information contained in this blog post may change on occasion.