Thinking about retiring soon? If so, it’s crucial to plan for this next phase of your life.
We’ve all heard the platitudes about money not buying happiness. However, a lack of money in retirement can result in unhappiness and even depression.
In a 2017 survey, the Nationwide Retirement Institute found that more than 80 percent of recent retirees said income worries made life worse.
If you are preparing for retirement within the next five years, it’s time to start asking some tough questions. Here are three of the most common questions we get from pre-retirees.
How can I create cash flow in retirement?
Decades ago, the common wisdom was to live off the interest and dividends a portfolio pays, while not touching the principal. This old-fashioned way of thinking reminds me of the idea of “clipping coupons” from bearer bonds before investments were stored electronically.
The challenge for today’s retirees is knowing how to generate cash from various investments to produce monthly income. Pulling money from the wrong investment at the wrong time can have lasting effects on the sustainability of a portfolio during retirement.
A well-planned cash flow strategy takes into account:
• Other sources of income such as a pension, part-time work and Social Security.
• The proper mix of stocks, bonds and cash based on your risk profile. Like Goldilocks, you’ll need a mix that’s just right for you.
• The tax ramifications of taking money out of different investments and types of vehicles, such as Individual Retirement Accounts or annuities. Taxes generated by selling highly appreciated securities in a taxable account also need to be evaluated.
• The correct selection of assets to sell, in order to generate the cash you’ll need.
Do I need cash and bonds as well as dividend-paying stock?
If you are nearing retirement, make sure to have cash and short-term bonds to weather any market downturn. That’s what folks didn’t do in 2008 when the market crashed. Sadly, we all heard the stories of retirees losing half of their hard-earned savings.
Had someone with a fiduciary duty been guiding those folks during that crisis, they would have had a strategy for withdrawing from investments that were less risky. In most cases, people who planned and acted properly during the financial crisis were at least back to even, and usually better, by 2010 or 2011.
We recently had a client, we’ll call him William, who came to us for help in generating income starting at age 66. He thought he would spend down his cash and then start taking Social Security at age 70. The task was to figure out the best way to replace the funds he would have received from Social Security for the next four years and beyond.
Required Minimum Distributions must be taken out of many retirement accounts at age 70½.
However, in William’s case, taking distributions starting at age 66 accomplished a few goals: The income was sufficient to meet his needs, the taxes were spread out over a longer period of time, and the retirement account value declined, reducing the amount he would need to take at age 70, when Social Security kicked in.
What remained was to determine which assets to liquidate in order to raise the cash needed for the distribution. That decision needs to be made closer to the planned sell date, as it is determined by a multitude of factors, such as market conditions, interest rates and capital appreciation, to name a few.
Should I have a traditional IRA or a Roth IRA?
This is a question that comes up frequently, accompanied by that familiar enigmatic answer: It depends.
Here’s the deal: Contributions to a Roth are considered “after tax.” In other words, there’s no tax break at the time you put money into a Roth. What’s the advantage? You don’t pay tax on your Roth distributions after you retire.
With a traditional IRA, you typically won’t pay taxes on the amount you contribute. However, you do pay taxes when you withdraw that money. You may take out the money penalty-free after age 59½, but you are required to make withdrawals starting at age 70½.
A Roth IRA does not require that you make withdrawals at 70½, since you’ve already paid the taxes on the amount contributed. Also, if you still have earned income from a job or freelance or consulting work after age 70½, you may still contribute to your Roth. That is not the case with a traditional IRA, where contributions are disallowed after that age.
People often ask me if they can continue contributing to either kind of IRA after retirement. For example, can you contribute money from an inheritance or some other source? Unfortunately, you must have earned income. Rental income and other “passive” income sources do not count; contributions have to come from W-2 or 1099 earnings.
Kate Stalter, founder of the independent firm Better Money Decisions, helps people throughout Northern New Mexico plan for retirement. To learn more about the comprehensive program, Financial Wellness For Life, contact her at 844-507-0961, ext. 702, or firstname.lastname@example.org.