The new 2018 tax law brings about some of the most sweeping changes we’ve seen in decades. For those of us facing retirement or already enjoying retirement, these changes bring about big questions. Primarily, what is the best way to structure retirement income in 2018?
Your income sources and investments may include a 401(k) or IRA, savings, stocks, mutual funds, real estate, and the like. Keep in mind: How much and in which order to pull from these sources can make or break a sustainable retirement plan.
First: Know your needs
It’s not always easy to assess your spending needs in retirement, but there are basic guidelines you can set.
If you are preparing for retirement, one way to calculate your needs is to take your current income level and then back out nonrecurring expenses.1
If you are already retired, review your withdrawal rates to ensure you have a sustainable plan. A simple calculation to determine your withdrawal amount is to subtract your income from non-portfolio sources from your total annual spending.2
Second: Understand the basics of the new tax law
Tax rates have come down for most people, but there are plenty of planning opportunities for retirees. For example, the federal taxation of a Roth conversion may be 20% less than it was in 2017.
Items to keep an eye on:
Third: Follow the basic withdrawal sequence
Finding the right balance between tax-deferred accounts, passive income, and tax-exempt accounts may not only maximize your income today, but also set you up, so the required minimum distributions at age 70-1/2 are not burdensome.
If you have been holding off on taking tax-deferred monies from your assets, you may be in for a surprise. After 70, those required distributions from Social Security, pensions, 401(k)s, and IRAs are taxable. That extra income may bump you into a higher tax bracket, which means less money in your retirement pocket.
Every retiree’s situation is unique. If you are fortunate enough to have more than one source of income, how and when you draw from such assets will impact your financial health both in the short and the long term. Determining which accounts to draw from, which to defer, and how much to take matters.1
401(k)s, IRAs, and retirement accounts
Don’t automatically defer your retirement accounts. Why? With a few exceptions, such as older 401(k)s that include “after-tax” dollars, distributions from retirement accounts are taxed as ordinary income. For many folks, it makes financial sense to distribute some of that income well before the IRS demands it at 70-1/2. Depending on your needs, you may do so monthly or annually without penalty as early as age 59-1/2.
There’s no cookie-cutter solution for when you should elect to draw Social Security. Your age, your marital status, whether you are widowed, how much money you earned during your working years, your current financial status, and a host of other factors play into your decision.
If you claim benefits as early as 62, you can let your other assets grow. Or, you can defer until you are 70 and live off your other assets in the meantime. What’s important is that you educate yourself on the ins and outs of the laws to see what makes the most sense for you.
Stocks, mutual funds, and non-retirement account securities
Such investments can be a great source of income, with the added benefit of control. That is, you can time your taxation based on when you sell and trigger a capital gain.
Dividends from mutual funds are typically quarterly and end-of-year capital gains distributions. You may also set up a Systematic Withdrawal Plan (SWP) that allows you to devise a plan that works best for your needs, whether it be monthly, quarterly, semi-annually, or annually.4
You may feel the need to dip into savings and money market accounts for some extra spending money. This may be a wiser choice than tapping further into your IRA or 401(k) and face paying greater taxes.
Depending on how much you have in reserve, drawing down from your savings may be a better choice for short-term as well as long-term tax planning.
It’s always a good idea to keep cash on hand for emergencies and unforeseen events. However, once your savings are gone, they’re gone.
Real estate and other assets
Take a good look at what you have and how it affects your bottom line. Do you have business investments or real estate income that is paying off? Great! But be sure you are getting the most bang for your buck. If you find that upkeep, repairs, or depreciation values are hitting you hard, it may be time to rethink how you can turn those assets into new investments.
Most importantly: Your distribution plan is not a one-time process. Mistakes can be costly. Review and analyze your plan to ensure that it’s best for you, considering your age and the current tax year.
Keep in mind what’s new for this year will change in the coming years. This is why it’s necessary to regularly review where you stand with the order and structure of your distribution income.
As your needs and desires shift in retirement, so may your strategy for financial sustainability. The staggering truth is that many Americans are woefully underprepared for retirement. According to the Social Security administration, 23% of married couples and 43% of unmarried persons count on SS benefits for more than 90% of their income.5
That’s why it’s so important to think ahead.
With foresight, preparation, and sound advice from experts you trust, you can make the smart choices you need to structure the plan that maximizes your retirement this year, as well as in the years to come.