Maintaining lifestyles in retirement

A heavyweight champion turned entrepreneur, George Foreman, made the following astute statement about retirement: “The question isn't at what age I want to retire, it's at what income.”  While retirement is an inevitability, doing so comfortably is not.  And even though every person’s retirement is different, when it comes to maintaining a lifestyle, there are a few guidelines that make sense for most people.

After more than 30 years in the financial advisor industry, I have observed that there are usually three stages of retirement, each requiring different levels of funding. The first few years can be relatively expensive, with increased travel and possible moving/transition expenses.  The second stage is usually more economical —travelling has become less appealing (“been there, done that”), and there are fewer transitions to fund. The final stage involves higher costs, with more spending on health care and/or long-term care.

Cash flow generated by Social Security — a major source of income for most retired individuals who have met the eligibility requirements — is one way to pay for these stages of retirement. Deciding when to start receiving benefits depends on many factors, including age, health, family history and access to supplementary funds. Generally speaking, the longer one can wait to receive benefits, the better. But remember, up to 85 percent of Social Security income may be taxed on the federal level, depending on other sources of income.

Pensions are another source of retirement cash flow. Prior to retiring, employees should speak with their HR department to ensure that they fully understand the options for pension payouts because timetables for payouts vary between plans. And since monthly pension payments are taxable income subject to federal and Virginia state tax, retirees are well advised to specify how much tax should be withheld from a pension payout so that they can avoid a big tax bill at year end. 

Additionally, employees should be sure they truly understand the nature of their pension. Government pension recipients can be subject to a formula that reduces the amount of Social Security benefits they receive. Pension recipients in the private sector are not subject to such a reduction.

Tax-deferred accounts, such as employer-sponsored retirement plans — 401(k)s and 403(b)s — and individual retirement accounts (IRAs), are popular and smart ways to save for retirement. Contributions are made with pretax money, grow without a tax drag, and taxes are deferred until a distribution is taken. Withdrawals are treated as regular income. Retirees should wait until they are 59½ or older before withdrawing from this type of account since taking money out of an IRA before that age is considered an “early distribution” and the withdrawal is subject to a 10 percent penalty tax.
Prior to the age of 70½, retirees should pull retirement income from taxable accounts. By tapping money from savings and investment accounts, retirees will not be paying much in taxes since many of those funds are considered return of capital.  Once  retirees reach 70½, they must begin taking RMDs (Required Minimum Distributions) from their tax-deferred accounts.

Another excellent savings tool, a Roth IRA (funded by after-tax income), is the last savings tool that retirees should tap. Since RMDs do not apply to Roth IRAs, retirees should defer withdrawing from this type of account as long as possible to let their investment continue to grow — using other sources of income to fund their lifestyle. If the account is at least five years old and the investor is 59½ or older, withdrawals from Roth IRAs are tax-free.

Since Roth IRAs have these special tax benefits, investors would be wise to consider a Roth conversion (converting another tax-deferred account into a Roth IRA). In this scenario, there will be taxes due — for converting pretax money into Roth money — but a Roth conversion can still be advisable. It’s best to pay the taxes owed for the conversion out of pocket rather than sacrifice IRA money.

Putting these savings strategies into practice will not only help retirees maintain their lifestyle but will also enable them to relax and enjoy their retirement years.  

Michael Joyce, founder and president of JoycePayne Partners of Richmond, Va., and Bethlehem, Pa., is responsible for overall investment strategy, management of investment portfolios and financial counseling services.  He can be reached at [email protected].