Retirement Cash Flow Strategies

Credit: anankkml

For most people, cash flows in retirement look different from cash flows while working. The difference is a transition that I have helped many clients through. Cash flow strategy is one of the most important parts of planning for retirement, but it can be complicated since cash flows frequently come from different sources, start at different ages, and carry varying tax implications. People who develop a good plan and stick to it can often add stability and peace of mind, take advantage of tax saving opportunities, and even generate more income in retirement. Let’s look at a few areas:

• Pension Annuity vs. Lump Sum – For retirees who get to choose a pension payment option, this can be one of the most important decisions they ever make. Actuarially speaking, there’s a good chance that your employer is thinking they are offering you the same amount of money whether you elect an annuity or the lump sum, but there are still things to consider. A lump sum offers a surge of money at retirement that can be more easily passed on to your heirs and better protect your purchasing power against inflation if it is properly invested, but a majority of clients I work with seem to find comfort in choosing the annuity option. In most cases, the monthly annuity amount will remain the same until the day you die. This may not help you against inflation, but if you live long enough, it could eventually mean more total money for you. In the meantime, an annuity feels like a paycheck, which is what retirees are used to, and the mental comfort that brings is the main reason I am usually a supporter of a pension annuity election. I also advise most clients to select a “joint and survivor option” if it is available so that a surviving spouse won’t lose their loved one and the benefits of their loved one’s annuity at the same time. This tactic usually costs the spouse whose pension it is a little bit of cash each check, but it can be a tremendous comfort to the other spouse.
• Required Minimum Distribution Planning – I’ve discussed this before, but age 70 ½ is an important half-birthday! I won’t take you back through all of the details we covered in my post “Required Minimum Distributions,” but I will say that you should factor this into your retirement planning. If things are a little tight on you before you have to start these distributions, or if the distributions are going to put you in a higher tax bracket once they begin, it may make sense to start prudently withdrawing from your retirement accounts before 70 ½. This could save you tax dollars and allow you a steadier lifestyle throughout retirement as opposed to cutting it close in your 60s and rolling in cash in your 70s. It’s just a thought, but one you should consider if you’re over 59 ½ (there could be penalties if you withdraw from retirement accounts before 59 ½).
• Social Security Strategy – Many people, including me, are concerned about the long-term solvency of the program as we know it going forward, but there are some Social Security strategies you should consider if your retirement cash flows are doing just fine when you turn 62. If you decide to claim Social Security retirement benefits at age 62 (the earliest applicable age), you are deemed to be collecting benefits “early,” and will only receive around 75% of the benefit you would receive at your “full retirement age.” (Currently, full retirement age is usually between age 66 and 67 for most people, but take a look at this chart to find your specific full retirement age.) If you wait until your full retirement age, you can receive 100% of your benefit, but if your retirement cash flow is still doing just fine at your full retirement age, it might be worth waiting until age 70, when you could receive around 132% of your benefit! That’s around 8% growth per year from age 66 to age 70, and that’s not a bad investment return if you ask me! Putting off claiming Social Security could provide you with more money in retirement if you live long enough, but at the same time, you could be shooting yourself in the foot if you end up passing away relatively young. I would suggest you consider your health and family history, and then consider how much Social Security income at age 62 would help before you decide to delay filing. If you do decide to delay, you can always start before your full retirement age or age 70 if you need to with a partially higher amount of benefits, but it’s probably not worth having beanie weenies in your 60s so you can have filet mignon in your 70s.

I hope you’re beginning to see that if you consider your spending and saving now versus later, the importance of starting off strong, your humble abode(s), your health insurance, and your retirement cash flow strategies, that there are many things you can do to put yourself in the position of having a chance to retire early. That being said, I’ve met plenty of people who could retire early but don’t and plenty of people who did retire early and wish they hadn’t. Some even went back to work! The How to Retire Early Series will conclude next week with a look at why you might not want to retire early even if you followed the advice of my previous posts and could. I hope you’ll check it out.

-Tom

Required Minimum Distributions

Credit: Stuart Miles

In my line of work, I get to surprise people all of the time. Sometimes my advice or the conclusion of my financial analysis evokes an elated and relieved response. Sometimes it does not, but instead confirms a painful reality or brings about sadness and temporary distress (not to worry: I’m happy to develop a new plan or strategy for my clients who find themselves in temporary distress).

One of the most frequent surprises I get to deliver is the news that in the year you become 70 ½ years of age, if you have certain retirement investment accounts like a 401(k), Traditional IRA, or qualified (tax-deferred) annuity, you are required to start taking minimum distributions, whether you want to or not! Technically, you could choose not to take your minimum distributions and agree to pay one of the most onerous IRS penalties of 50% of the amount you should have withdrawn, but since I’ve never had any takers on that strategy, let’s push forward assuming you will take your required minimum distributions (RMDs).

The amount that has to be distributed is based on IRS life expectancy tables and the age of your spouse (or designated beneficiary). It’s a relatively simple multiplication problem consisting of your account’s previous year-end value and your applicable life expectancy factor, but there are so many tables and beneficiary circumstances to consider that I’d suggest you let your financial advisor or CPA do it for you. There are some brokerage firms and custodians that will actually calculate your RMD for you on your brokerage statements when they become required, but please note that brokerage firm calculations will only be relative to the accounts you have with them. If you have multiple accounts that require RMDs, you’ll need to be careful, and make sure you take enough in total and from each account to avoid the before-mentioned “bear” of a tax penalty.

This required distribution can be a good surprise. If you’re not already withdrawing from your retirement account, this distribution can feel like a little extra income that could be used for anything from family trips to home renovations. I should mention, though, that your distribution does not have to be spent! You have to withdraw it and you have to pay taxes on your withdrawal, but you’re welcome to top off your savings account or reinvest the proceeds in your after-tax brokerage account.

This required distribution can be a bad surprise if you didn’t know you had to do it (or forget to do it), but even if you’re on top of things, it still stinks because the tax man cometh. Uncle Sam wants to wish you a happy birthday from age 70 ½ on, and to commemorate the occasion, he’s going to want ordinary income taxes from your distribution amount to help fill his empty coffers.

If you’ve read this post, there is no reason to let RMDs surprise you. If you are 70 ½ or older, please double check with your financial advisor and CPA to make sure you are taking your RMDs. If you’re almost 70 ½, I’d urge you to meet with your financial advisor and make sure you have a game plan in place for your RMDs as there is often an opportunity for meaningful and significant tax and cash flow planning. If you’re nowhere near 70 ½, I bet you can think of someone you care about who is and would appreciate you looking out for them.

-Tom