"How does it work?"
That's the big question I'm always asked.
By the time you are ready to put in your final notice, you've got money squirreled away in a million different places; 401(k)s, IRAs, Roth IRAs, brokerage accounts, savings accounts the list goes on. And all you really want to know is, "How do I actually take the money out?"
I hear you. Here are 5 helpful tips to create retirement income without creating retirement headaches.
1. Don't make things too complicated.
If you have more than one type of account to pull from, where do you pull from first?
In many cases, it pays not to overthink it. Simply take a proportionate amount of income from each type of account you own, and that will get the job done.
Now I know some of you are thinking: "Wait, I have to pay taxes when I take income from an IRA. If I have money in a brokerage account, shouldn't I use that first to avoid the taxes as long as possible?"
And the answer is yes, you do have to pay taxes on income from an IRA.
But later on I'll explain why pulling from your IRAs early in retirement could put you in a more secure position than if you wait.
2. Don't make things too simple.
The allure of guaranteed income entices many retirees to convert their investments to financial products called 'annuities.'
The idea behind annuities is that you are giving a firm - usually an insurance company - a big chunk of cash, that they then invest and send you an agreed upon monthly income. They keep the profits from your investments, and although your income probably won't go down, it probably won't go up either.
It's also much more difficult to withdraw the principle from an annuity than it is from a normal investment account. So if you or your partner have a health emergency, for example, and all of your assets are tied up in an annuity, guess what?
You just limited your options in favor of guaranteed monthly income.
Keep things simple, but make sure your income strategy can handle multiple scenarios. You'll be glad you did.
3. Don't draw down all your non-IRA accounts first.
A successful retirement income strategy is about control and flexibility.
I've seen too many retirees later in life who only had IRAs remaining to draw on ... right about the time they had major, unforeseen expenses.
By pulling exclusively from non-IRA accounts you might avoid income taxes in the beginning, but when IRA money is all you have left, you end up paying the income taxes all at once, right when you can't afford to lose money.
Make sure that when the big expenses come around 5, 10, or 20 years into retirement, you're ready to deal with them without putting yourself into a higher tax bracket.
4. Plan for Required Minimum Distributions (RMDs).
A Required Minimum Distribution is just what it sounds like; the minimum amount you are required to distribute from your IRAs starting at 70 ½, so the IRS can collect income tax on the distribution.
The amount required is based on how much is in the IRA and how old you are. The larger the account balance, and the older you get, the more you have to distribute.
But if you pull income proportionately from each of your account types - as discussed in Tip #1 - then by the time you reach 70 ½, your IRA account balance should be lower, and so is your RMD.
5. Plan for your ultimate beneficiaries.
Some types of accounts are better than others when it comes to leaving money behind.
For non-IRA accounts, there isn't much that needs to be done. You've already paid tax on those assets, and assuming you haven't crossed the estate tax threshold, your heirs won't need to pay anything for the transfer.
IRAs, on the other hand, often are subject to full taxation at whatever tax bracket beneficiaries are in at the time they receive the funds. And that includes taxes on the state level, depending on where you live.
However, Roth IRAs may be able to pass to family tax-free. So if you have money in a Roth IRA, and you plan to leave a gift for your beneficiaries, you should consider saving that account for last.
Bottom line? Good planning can not only help produce a solid and sustainable stream of income, but can also help you prepare for the big expenses life is bound to through your way.
It's not that hard, once you know how it works!