Life seems easier in your early working life. All you have to do is save some money for retirement each month and get on with the rest of your life. But when you enter your 40s and 50s, questions like “Have I saved enough money?” and “Will I run out of it?” may gnaw at your peace of mind.

You can answer these questions—and combat the anxiety that questions like these bring—by taking steps now to control your income (and taxes) in retirement. This article will show you how.

 

Why Your Grandparents’ Rules Don’t Apply

Your grandparents lived by a set of rules that do not apply in today’s investing environment. When they retired, they relied on income from dividend-paying investments, but in our current environment of low-interest rates, dividends are not going to provide enough income to live on.

So what to do? Consider adopting a total return approach. With this approach, you invest for a total return (capital gains plus income and dividends) while taking systematic withdrawals from your portfolio. The advantage of this approach is that you can control taxes better by determining which of your income sources you will tap throughout the year, thus giving you more money to spend.

The 50/50 Ideal

When planning for your income, remember the 50/50 ideal. This means that your ideal retirement portfolio should have about 50% in pre-tax accounts and 50% in post-tax accounts.

Examples of Post-Tax Accounts

Examples of Pre-Tax Accounts

INCOME YOU CAN'T OUTLIVE

401(k)

ANNUAL ADJUSTMENTS FOR INFLATION

403(b)

SURVIVOR BENEFITS

Individual retirement
account (IRA)

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Regular brokerage and bank accounts

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Roth IRA

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Health savings account (HSA)

In striving for the 50/50 ideal, you can gain more control of your tax bracket. This is a crucial consideration for retirees because controlling your taxes can add to how much you get to spend.

It is also crucial because you have income sources, such as Social Security and required minimum distributions (RMDs), that can push you in a higher tax bracket. The 50/50 portfolio can help offset the tax-raising effect of these income sources.

 Asset Location Is Important Too

Most of us have heard of asset allocation, in which we invest in multiple asset classes to diversify our portfolio. However, fewer of us have heard of asset location, even though it can play a crucial role in tax impacts.

Look at it this way: The more tax-efficient your investments are outside of your retirement plans, the more room you have on your tax return to do other things. Thus with your taxable accounts (such as standard brokerage accounts), you should consider focusing on index or low-turnover investments. These types of investments typically will not distribute as much in capital gains or income each year.

Investing for lower income may seem counterintuitive. But, again, the advantage is that you gain more control of your taxes by determining which of your income sources you will use throughout the year.

To Delay or Not to Delay (Your Social Security)

When you approach retirement, you face a crucial decision: whether to take Social Security early at 62, wait until you reach full retirement age (66–67 depending on your birth year), or delay even further, up until 70.

For each year that you delay, your monthly benefits increase. However, delaying poses a problem: You need to spend other money down in your early years of retirement, which reduces the money you have for the future.

Spending money early may be a difficult idea to stomach, no matter how much you have saved for retirement. In deciding whether to delay, you should look beyond your savings:

INCOME YOU CAN'T OUTLIVE

Taxes

You may be able to keep your tax bracket down by delaying Social Security. This in turn may allow you to convert IRAs to Roth IRAs in low tax brackets. It may also allow you to take capital gains in the 0% tax bracket.

ANNUAL ADJUSTMENTS FOR INFLATION

Asset Location

As mentioned, saving money in a regular brokerage account (or Roth IRA) can give you access to money with fewer tax consequences. You can then delay Social Security benefits, keep your tax bracket low, and do more Roth conversions or 0% capital gain moves as mentioned in the previous point.

SURVIVOR BENEFITS

Spending

If you will be subject to the estate tax, then you might want to spend more in early retirement. People usually focus on reducing their estate tax by giving away assets, but nobody said you can’t just spend it away.

Obviously, there is no one-size-fits-all answer to the “To delay or not to delay?” question. For most people, delaying Social Security will probably be the best answer since the benefits are a form of longevity insurance. If you are struggling with your answer, you might want to talk with a financial planner, who can assess how your benefits would work with your overall situation.

The Planning Opportunity with Your RMD

One of your largest income sources in retirement will probably be your retirement accounts, such as your 401(k) or IRA. The distributions, or withdrawals, from these accounts can present a planning opportunity.

You can start withdrawing money from your accounts at 59½ without penalty, but you are required to take distributions (better known as RMDs) at 70½. That makes tax planning before 70½ important since you may have the ability to take money out in lower tax brackets.

The key is assessing what your potential tax bracket will be at 70½, especially if you delay Social Security and other income. The goal is to “use up” the lowest tax brackets while assuming you will be in higher tax brackets later.

But what if you don’t need the money that you would be pulling out? You can achieve the same outcome through a Roth conversion. Roth conversions are taxable in the tax year they are created, but they grow tax-free and distributions will not be taxed as long as you follow the rules.

Keep in mind that a Roth conversion is irrevocable, so you should carefully analyze its potential impact on your tax bracket. An experienced financial planner can help you determine whether a conversion would work for you.

 Putting It All Together

Use this calculator to determine how much monthly income your retirement savings may provide you in your retirement. Your annual savings, expected rate of return, and your current age all have an impact on your retirement's monthly income. View the full report to see a year-by-year breakdown of your retirement savings.

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Schedule a Free Consultation

Retirement planning is a complicated process, and calculating your retirement income is just one component of that process. You may find it helpful to work with a financial advisor who can handle the details so you don’t have to.

We have been helping couples and individuals retire with peace of mind since our founding. As an independent Registered Investment Advisor, we manage approximately $300 million in assets for 150-plus clients in Minneapolis-St. Paul. Our fee-only, fiduciary role means we put your interests first, even ahead of our own.

We offer a free consultation in which we can discuss your concerns and how we can help. Please contact us today to get started.