Mike and Debbie spent their entire lives saving diligently for their retirement:

• Adding to their account balances.
• Adding to their portfolio.
• Adding to their net worth.

And then… retirement!

And that’s mostly a good thing. Except suddenly they’re faced with what feels like the biggest, most profound, and perhaps the most difficult shift of their entire financial life.

Their relationship with money has suddenly and fundamentally changed.

The change: from feeding their wealth to needing their wealth to feed them!

At the most fundamental level, the priority becomes: Replacing their paychecks with new disposable income for retirement.

Not work income. Income from their savings and investments.

But that can feel terrifying.

How long will their nest egg last? Will there be enough for later, based on what they take out today?

They don’t want to spend it too fast. And they certainly don’t want to spend it all.

And yet, they’ve done a good job saving and investing. They want to feel free to spend a little today. They want to make the most of their well-earned retirement. And they have certain needs to meet every month.

That all requires spending money.

Which gets to the all-important question…

“How do we replace our paychecks?”

Mike and Debbie here are fictional, but they represent the very real challenge many clients face.

After spending most of their lives earning a regular paycheck for their work, they’re suddenly left without that income in retirement.

And their need for new sources of income starts as soon as their paycheck stops.

The good news is that for many retirees — especially those who’ve been saving for retirement — there’s actually opportunities for multiple sources of income in retirement.

The bad news is that making the most of these multiple income sources adds a lot of complexity to income planning. Complexity you didn’t have to deal with when working for a paycheck. Especially in the beginning, when you have to make critical decisions that could impact your income for the rest of your life.

First: Make the most of Social Security, pensions, and other similar income.

Social Security is an important income source for most American retirees. Once you apply for and start receiving your benefits, it’s structured to provide at least some level of monthly income for the rest of your life. (The amount is based on your earnings history and at what age you claim benefits.)

But the decision itself is complex. Economist Laurence Kotlikoff has revealed that the typical worker leaves roughly $182,000 in lifetime income on the table, by claiming Social Security at a suboptimal time. Not only that, there are big questions about the program’s ability to continue to pay benefits at current levels, complicating the decision further.

Those with pensions often face similarly-difficult decisions. You may have the choice to take monthly annuitized payments, or a lump sum distribution. And each of those choices may be further complicated by spousal benefits, or what to do with the distribution.

And for Social Security as well as most big pension decisions, you only have one shot to get it right. Then you’re locked in for life.

Even then, many retirees find neither Social Security nor their pension fully covers their retirement income needs. There’s a gap between their income from these sources and their regular retirement expenses.

And that gap needs to be filled by their savings and investments.

Second: Create an income plan from your portfolio.

One of the best-known rules for creating sustainable income from your portfolio is called “The 4% Rule.”

Put simply, following the 4% Rule means you withdraw 4% of the starting balance of your portfolio in your first year of retirement. Then adjust that withdrawal for inflation each year. And based on the historical data that was analyzed in the creation of the 4% Rule, you have an extremely high statistical probability of your portfolio providing for your income needs for at least 30 years.

Sure, there will be volatility along the way. You can expect there will be future recessions and bear markets. And yet, historically, the market has recovered — and gone on to new heights.

And if you’re concerned about how your stock portfolio will hold up against inflation, again historical data can be reassuring — even if it can’t predict the future.

Last month, we compared stocks vs. inflation going back to 1960. Spoiler alert: over the long run, stocks have dramatically outpaced inflation.

From 1960 to present, the cost of living has increased 11X due to inflation. Which is a lot!

And yet, over that same period the average dividend yield of the S&P 500 has increased 40X. And share prices themselves have grown by 118X — beating inflation by a factor of 10!

All of this to say, a well-planned withdrawal strategy from a diversified investment portfolio has historically been a good way to enjoy income throughout a long retirement.

So what does this actually look like, in practice?

Could it be as simple as claiming Social Security, starting a pension if you have one, and withdrawing 4% of your portfolio?

Not necessarily!

There are two big considerations we haven’t touched on yet:

• Taxes…
• And asset location.

And they’re closely connected.

There are at least 3 major categories of account, based on different tax treatments.

• Tax-deferred, such as a traditional IRA or 401(k). Qualified withdrawals from these accounts count towards your taxable income in retirement. You didn’t pay taxes while saving, your taxes become due when you withdraw.
• After-tax, including savings and standard brokerage accounts. Only investment gains and income are taxed. Dividends and interest typically add to your taxable income, and capital gains on your profitable investments have their own tax treatment.
• Tax-free, such as a Roth account. Qualified withdrawals from a Roth are tax-free, including any investment income or gains realized with the account.

Not only that, certain accounts have rules governing when you can take money out, unless you’re willing to pay an extra tax penalty. For most tax-deferred accounts, you can’t take a penalty-free withdrawal until age 59 ½. That age drops to 55 for certain situations covered by “The Rule of 55.” An after-tax brokerage account, on the other hand, allows you to access the money at any time without extra tax penalties — only the income and capital gains taxes you may owe.

And depending on your assets and personal situation, different strategies may make more or less sense for you.

For example, if you have other assets to draw from, you may choose to delay filing for Social Security in order to get a bigger monthly benefit when you file. Or you may choose the reverse, to file for Social Security earlier to avoid tapping your savings.

And even then, you have to decide which accounts make the most sense to withdraw from first — potentially mixing withdrawals across tax-deferred, after-tax, and tax-free accounts, to manage your annual tax obligation.

Your retirement income strategy is deeply personal.

As you can see, retirement income planning can get complicated fast.

Deciding where your retirement paychecks will come from — starting with that very first one — needs to match your circumstances and your goals.

This is an important part of what we do with every client, leading up to and as they make the transition into retirement.

It’s important to us to work with you to come up with a plan to help you pursue your long-term goals, and be confident in your retirement.

And if you’re starting to think about retirement, know that we’re here to guide and educate you as you make these decisions and as we develop these plans.

This article was written for financial advisory clients of Asset Strategies. If you’re not yet a client and you’d like to connect with an advisor and see how they may be able to help you work towards your goals, request a Ready for Retirement Review here.