User:FiveK/Retirement income planning

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 discusses what to consider when there is a choice among different income types. The primary assumption is that you want the maximum after-tax spendable amount, consistent with your risk tolerance. There is no one-size-fits-all strategy, but there are some simple guidelines that will work well enough for most.

This article complements Prioritizing investments: that article discusses how to put money in, while this article primarily discusses how to take money out.

Income sources
You may have heard the analogy to a three-legged stool, one that many financial planners once used to describe the three most common sources of retirement income: Social Security, employee pensions, and personal savings.

When to begin receiving Social Security (SS) benefits is an oft-debated issue with no one-size-fits-all answer. One useful approach is to start with the Open Social Security: Free, Open-Source Social Security Calculator tool. Because that tool looks at SS in isolation, other factors may suggest earlier (e.g., if income is needed for basic necessities) or later (e.g., if deferring would allow more useful Roth conversions) start dates.

Although the availability of employee pensions has decreased, they remain important for many, particularly among government employees. If there is no benefit to deferring a pension’s start date, you should begin it as soon as possible after retirement. If, like SS, you get a larger annual amount in return for deferring the start date, the best choice will depend on your specific options. You may also be given the choice to take a lump sum vs. a pension – see that wiki article for more.

Other “retirement” income streams include rental income, part-time work, annuities in the payout phase, etc. This article does not delve into whether you “should” have such income or not: if you do, you do, and if you don’t, you don’t.

That leaves the remaining stool leg: personal savings. Due to the different tax laws governing annual withdrawals from the taxable, traditional, Roth, and HSA accounts in your portfolio, taxes – both current and across your projected retirement years – are often an important consideration.

Base income
Although you may choose when to begin taking Social Security, or whether to work part time, or invest in something that pays no interest or dividends, for the purpose of this article we will assume that the decisions that lead to these sources of income are made independently. These income sources should be budgeted for spending before optional sources below.


 * Non-portfolio sources, such as Social Security (SS), pensions, part-time work, annuity payments, etc.
 * Portfolio based, such as interest and dividends in a taxable account
 * Required Minimum Distributions (RMDs)

Optional income
If you need more than your base income to meet expenses, how you generate that income affects the marginal tax rate you will pay. Optional sources of income include:


 * Ordinary income from taxable withdrawals from a traditional 401(k), IRA, etc.
 * Non-taxable withdrawals from a Roth IRA or HSA
 * Capital gains (long or short term) and return of basis from taxable sales

Good planning requires some predictions. At a minimum, consider what tax rate you may be paying after starting SS and RMDs. If you wish to go further, consider what tax rate your heirs may pay on what they inherit from you.

Adjusting income each year to keep your tax rate constant throughout retirement is an excellent approach. There are various ways to do this (see below for some tools that may be helpful), but this simple strategy is a good way to start and may in fact be all that is needed. The appropriate mix of traditional/taxable/HSA/Roth withdrawals will vary from person to person to fulfill this strategy.

Your marginal tax rate may be very different from your tax bracket, due to phase-ins of Social Security and qualified dividend taxation, phase-outs of various tax credits, IRMAA, and other effects. It's usually best to check your actual marginal tax rate curve using software (such as the Personal Finance Toolbox), or by consulting a tax professional.

Withdrawals from retirement accounts before age 59.5 are assessed a 10% early withdrawal penalty, unless an exception applies. Early retirees looking to tap retirement assets should consult the options below.

If you have an inherited retirement account, it is usually better to withdraw from the inherited account before an individually owned account. Inherited accounts must be emptied within ten years of the owner's death, or according to RMD tables that are more aggressive than for individually-owned accounts.

Tax planning
Once your current income needs are met, you might consider additional tax-planning transactions such as Roth conversions, tax loss harvesting, or tax gain harvesting. These transactions will affect the current year's taxes, but might increase after-tax spendable income in future years.

Retirement income planning tools
To go beyond the first approximation of “keep your tax rate constant throughout retirement,” or simply to help with the year-by-year estimate of what Roth conversions will do to RMDs, multiple tools already exist. The wiki article linked above discusses many of them.

Before age 55

 * Retirement account withdrawals before age 59.5 are assessed a 10% penalty, but there are numerous exceptions.
 * Early retirees looking to access pre-tax accounts without penalty can use a Substantially Equal Periodic Payments (SEPP) program or a Roth conversion ladder.
 * Roth IRA funds can partially tapped penalty-free according to the Roth IRA distribution rules. For example, contributions are withdrawn first, and are always tax- and penalty-free.
 * 457(b) withdrawals made at any age are not subject to early withdrawal penalties.

Age 55-59.5

 * The IRS imposes no early withdrawal penalty on 401k/403b withdrawals if you leave your employer in or after the year you reached age 55. Your employer’s plan, however, may or may not allow partial withdrawals.

Withdrawing from taxable accounts
1) Sell investments with losses and withdraw the cash proceeds 2) Withdraw from cash and cash-like accounts, such as checking and savings accounts 3) Sell investments with gains, starting with lots having the smallest percentage of gains
 * To minimize the current tax impact, and provide the most benefit for heirs, take withdrawals in the following order:

Asset protection

 * Money in Non-government 457(b) plans is not protected in the case of employer bankruptcy, so there is some risk reduction by withdrawing that money before other employer plan money.
 * Money in retirement accounts has increased asset protection compared to a taxable account, so you should tend to spend taxable assets first if asset protection is a concern.

Health Savings Accounts (HSAs)

 * Withdrawing HSA funds tax-free (based on current or past medical expenses for which you have saved receipts) should always be prioritized over retirement account withdrawals.
 * For most, cumulative eligible medical expenses (e.g., Medicare premiums, dental, vision, etc.) will eventually exceed your HSA balance, even if you pay your current medical expenses out of pocket and let the HSA grow.
 * Taxable HSA withdrawals should usually be a much lower priority, because there is usually a possibility of future medical expenses that would allow the same money to be withdrawn later tax-free.
 * If you have non-charitable heirs, ideally you would withdraw the last dollar from your HSA account the day before you die without having a surviving spouse. That’s because any remaining money in the HSA becomes taxable that year to your non-spouse heirs.
 * How closely you want to play that game is up to you, but it would not be unreasonable to empty your HSA “some years” prior to when you expect to die without having a surviving spouse.