Ready For Retirement
Ready For Retirement
3 Steps to Build a Retirement Paycheck That Lasts
Early retirement income can feel complicated, but a steady paycheck from savings starts with a simple framework. This episode reframes withdrawal decisions, explains why a fixed 4 percent rule can be too conservative in some cases, and shows when a 5 percent starting point may fit with the right allocation and ongoing adjustments. A million dollar case study turns rates into an annual paycheck while addressing sequence risk and flexible spending guardrails.
Taxes do the heavy lifting. Retirement income is taxed differently than wages, with no FICA on non wage income, only up to 85 percent of Social Security taxable, and long term capital gains often taxed at 0 or 15 percent. Blending IRA withdrawals, brokerage draws, and Social Security can produce the same 100,000 dollars of cash flow with a lower tax bill than a 100,000 dollar salary. The discussion covers thresholds, brackets, the higher standard deduction after age 65, and tactics to keep more of the portfolio working.
The episode finishes by assembling the paycheck. IRA, brokerage, Roth, Social Security, and pension income are coordinated so deposits match spending rhythms, with room for the retirement spending smile, one time costs, healthcare, and annual tune ups as markets and laws evolve.
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Advisory services are offered through Root Financial Partners, LLC, an SEC-registered investment adviser. This content is intended for informational and educational purposes only and should not be considered personalized investment, tax, or legal advice. Viewing this content does not create an advisory relationship. We do not provide tax preparation or legal services. Always consult an investment, tax or legal professional regarding your specific situation.
The strategies, case studies, and examples discussed may not be suitable for everyone. They are hypothetical and for illustrative and educational purposes only. They do not reflect actual client results and are not guarantees of future performance. All investments involve risk, including the potential loss of principal.
Comments reflect the views of individual users and do not necessarily represent the views of Root Financial. They are not verified, may not be accurate, and should not be considered testimonials or endorsements
Participation in the Retirement Planning Academy or Early Retirement Academy does not create an advisory relationship with Root Financial. These programs are educational in nature and are not a substitute for personalized financial advice. Advisory services are offered only under a written agreement with Root Financial.
Create Your Custom Strategy ⬇️
You've saved for decades, but here's the challenge. Your 401k plan does not automatically turn into a paycheck for you. You have to create one yourself. And if you don't do it correctly, you're either going to outspend your portfolio, run out of money, or you're going to spend far too little and not fully enjoy what you've worked so hard for. So in today's video, I'm going to show you three simple steps that will allow you to take those retirement savings and turn that into a paycheck that will support your retirement needs. Now the steps themselves are simple. It's the nuance within these steps is what gets people tripped up. So the steps here are number one, understand your portfolios, sustainable withdrawal rate. Number two, factor in taxes. And then number three, coordinate with other income sources. Now the steps themselves are simple. It's the nuance. That's where people get tripped up. It's a nuance in here that allows you to optimize this paycheck. And if you don't factor it in correctly, it could be the thing that caused you to run out of money. So to make this video as helpful to you as it can possibly be, let's not just look at the steps, but let's apply it to a real example or a sample example. Let's take Mary and let's assume that Mary is 65 years old and she has$1 million in her portfolio,$700,000 of which is in her traditional IRA,$300,000 is in a brokerage account. And of that$300,000, let's assume it's all in an S P 500 index fund. Let's make the assumption that she purchased that for$150,000 years ago and it's now worth$300,000. So as we go through these steps, let's actually apply it to her situation so you can see where the nuance comes into play. So number one, start with understanding your portfolio's sustainable withdrawal rate. Why do I say your portfolio? There's all kinds of rules of thumb or research that shows how much you can spend from your portfolio without running out of money in retirement. But here's the thing: not all scenarios are created equal. This largely depends upon how are you invested and how long are you planning your retirement to be. Someone who's already 90 years old can spend a whole lot more from their portfolio than someone who's 50 years old, simply due to how long they need that money to last for them. So in Mary's case, let's assume she has 30 years, traditional research, you might have heard of the 4% rule. The 4% rule says that if you have 30 years of retirement in front of you, 4% is the amount you can take out of your portfolio. And even if you retire into some of the worst time periods that we've ever had here in the US, your portfolio would last for those 30 years. We're talking about periods like the Great Depression, we're talking about time periods like the 70s when you had horrible inflation combined with serious down markets. That 4% rule became something that a lot of people adopted and use it for their retirement needs. Here's the interesting thing though. For most people, that 4% ends up being far too conservative. In fact, I had a conversation on this channel with Bill Bangin not too long ago, and Bill Bangin is the initial author of that 4% rule research. He did this way back in the 90s, and that 4% rule is where that started. But in his words, that 4% rule for most people is far too conservative. In fact, most people would be well served by taking 6-7% plus from their portfolio each year if they had the benefit of hindsight. I say if they have the benefit of hindsight because the problem as retirees is we just don't know what 30-year time period we're going to retire into. If we knew that it was going to be an average time period, even, we could spend a lot more. But the thing is we don't know. Are we going to retire and have another 2008 type event? Or are we going to retire and have wonderful markets in front of us? Because we don't know that, we have to lower at least our initial withdrawal rates to make sure we're not pulling too much money out too soon, especially if you combine that with a big bear market. But here's what Bill himself said. He said that a sustainable withdrawal rate today, if you invest your portfolio correctly and if you account for certain things along the way, is probably closer to 5%. Could be much higher, depending on how the market does, but something closer to 5% might be more realistic for most people. So let's go back to Mary's example. She has a million dollars in her portfolio. We simply apply a 5% withdrawal rate to that. What that means is Mary, as you're looking to create your paycheck,$50,000 of that paycheck can be thought of as coming from that portfolio. But before we start thinking that that's it, there's two more things that we need to consider. It's not as simple for Mary to just say, I'm going to take$50,000 and that's what I can now live on for the rest of my life. The second thing you need to do is factor in taxes. Taxes are a huge one. When you take that$50,000, that$50,000 isn't yours free and clear. This is where tax strategy and tax planning and just general tax awareness comes into play in retirement. Because here's the thing: when you are working, your taxes are much different than when you're retired. At the federal level, the same tax rates still apply, but the makeup of your income and the way that it's taxed is significantly different in retirement. Now I'm going to show you real numbers with real tax planning software so you can see how dramatically different it has the opportunity to be. But to start, just understand a few different things. Number one, in your working years, you are paying payroll taxes, FICA taxes. This is up to 7.65% of every dollar that you earn, you are paying into Social Security and Medicare. That's what your payroll taxes fund. Now, in addition to this, when you retire, Social Security tends to be a big portion of your paycheck. Social Security, a maximum of 85% of it, will be included in the amount that you pay federal taxes on. At the state level, depending on what state you're in, most states don't actually tax Social Security at all. So when you look at the difference between where your income's coming from, that is a big difference. Now your standard deduction. Once you're 65 or older, you get an enhanced standard deduction, which means you can deduct more of the income coming in, which means you have less of taxable income. Then if you look at things like brokerage accounts, if you're starting to live on a brokerage account, the long-term gains on an account are taxed more preferentially than are ordinary income rates, things like wages, IRA distributions, et cetera. Or you might be pulling some of your money from Roth IRAs. And Roth IRAs, of course, are completely tax-free. Same with HSAs, if you're using that money for qualified medical expenses. So when you look at just the general changes, you can start to see that there's the potential for your tax situation in retirement to look significantly different than your tax situation when you're working. Let's actually look at an example right now. So what I'm doing in this first scenario is I'm looking at this for Mary last year. So I'm making the assumption that last year she was still working and she earned$100,000, just to use super simple numbers. What would her tax situation be? And then let's compare that to what would her tax situation be if she earned$100,000 in retirement. Well, if this$100,000 is just wages, all of it is included in her adjusted gross income. She would have a standard deduction for 2024. That number is$14,600. Once you back out the standard deduction from her total income or her total adjusted gross income, her taxable income is$85,400. That's the amount she's actually paying taxes on. So if we scroll down here, what we can start to see is some of that$85,000 and change is taxed at 10%. The first$11,600 is taxed at 10%. Then the next amount from$11,600 to$47,150 is taxed at 12%. Then the remaining amount is taxed here at the 22% tax bracket. If we look at all of this, her total federal tax is$13,841. That's not the entirety of her tax picture. That's just federal income taxes. She also is paying 7.65% for FICA taxes on the entirety of this$100,000. So that's an additional$7,650 that she's paying in FICA taxes. Now let's just assume that she doesn't have any state income taxes to keep this as simple as possible. But the reality is if she lives in a state where there are income taxes, she would owe even more. But if we add up Mary's payroll taxes plus her federal income taxes, she's paying just under$21,500 in taxes if she earns$100,000. So an effective tax rate of about 21.5% when you include federal and payroll taxes. So keep that percentage in mind, about 21.5%. Now let's assume that this year Mary retires. And this year Mary retires and her income sources are as follows. She receives$2,500 per month from Social Security, which is$30,000 per year. She takes$40,000 from her IRA this year. So so far we're at$70,000, 30 from Social Security,$40,000 from her IRA. The remaining$30,000, let's assume she takes that from her brokerage account. Like I said, her brokerage account, she put money in, she acquired her investments at$150,000. They're now worth$300,000. So half of what she pulls out of that account is a return of what she already put in and what was already been taxed, and half of it is a long-term capital gain. So the tax impact of pulling that$30,000 is$15,000 of it is tax-free. She's already paid taxes on it. There's not an additional tax. But the$15,000 of gains, that is taxed, but it's taxed at long-term capital gain rates, which are lower than ordinary income rates. Using those assumptions, let me show you how dramatically different her tax situation is going to be with those numbers in her retirement years than it would have been earning$100,000 in ordinary income in wages prior to retiring. So here's that same tax report for Mary, but it's now using her retirement numbers. Right off the bat, we see something that looks much different. Previously, her total income was$100,000. It's still$100,000 if we're including her cash flow, the income to her. So why is it that that shows$80,500 and not$100,000? Well, number one, Social Security. As I mentioned, some of Social Security is not going to be taxable.$30,000 is her total benefit, but$25,500 of that. So this is that 85% of her social security benefit. That is the portion that she pays taxes on. So$4,500 is tax-free, is another way of thinking about that. That doesn't account for everything. There's another$15,000 that's not included here. Well, that$15,000 is when she pulled money from her brokerage account. Keep in mind,$15,000 of that was a return of principal. She's already paid taxes on that. She's not doing it again. So she's now living on that$15,000, which means that$80,500. We're not including$15,000, that's a return of principal, and we're not including$4,500 of Social Security, that's completely tax-free. That is why adjusted gross income here is$80,500 instead of$100,000. That's not the only difference. Here's some other differences. Her deduction is now higher. Last year it was lower, partly because every year the standard deduction does go up a little bit. But also, once you're 65 or older, you get an extra senior deduction. Not just that, but for the next few years, as part of the most recent tax legislation, there's an additional senior deduction. And you can see that amount for her is$5,670. This amount does start to phase out as your income goes up, but this is an additional deduction amount. Going back to what I said, of your tax situation in retirement can look dramatically different due to a number of factors. Some is assets or income sources being taxed less, others is having more deductions than you otherwise would have in your working years. So this deduction, when we start to look at this, if we take the 80,500 of adjusted gross income, back out her normal deduction, back out her enhanced senior deduction, what we get is a taxable income of$57,080. Now, if we look at that, some is taxed at ordinary income rates. So the portion of Social Security that is taxable, her IRA distributions, those are subject to ordinary income rates. But the$15,000 of long-term gains, that is subject to long-term capital gains rates. So we have to look at what's a combined tax when we look at some of her income on this schedule and some of her income on that schedule, we can do so here. What we can start to see is$4,811 of taxes that she owes is based upon the income she has that's subject to ordinary income rates. These ordinary income rates go up to 37%. Now, one more thing to note here before we look at what taxes she pays on the capital gain side, and this is crucially important for those of you who are retiring.$42,080 is the amount of ordinary income she has before we factor in capital gains. Let's take a look at that next. Capital gains, you can see if your taxable income is under$48,350, you pay a 0% capital gain tax on any capital gain income, long-term capital gain income, up until that threshold. Meaning the difference between$42,080 here and$48,350, that is subject to a 0% long-term capital gain tax. Meaning of the$30,000 pulled from her brokerage account, half of it was already tax-free because that was the amount she put in. Another approximately half of the gains are tax free because she's under this threshold, and that means they're subject to a 0% capital gain tax bracket. It's only the excess. So the approximately$8,700 above that, above this threshold of her long-term capital gains that she pays a 15% tax on. But when we look at her capital gains tax of$1,300 and her ordinary income tax rate of just over$4,800, her total tax is$6,121. So that's her total federal tax. Plus, as I mentioned, there is no more payroll taxes. When you're retired, if there's no wages, you're not continuing to pay into Social Security and Medicare via payroll taxes. So if we looked at her previous year's tax bill, it was about 21.5% total that was paid into taxes of the$100,000 that she took out. This year, in her retirement years, still taking out$100,000, but the total tax liability is about 6.1% of that. So by the way, this strategy that Mary's employing isn't necessarily the most optimized strategy. There are ways to improve it and lower her lifetime tax liability. This is just trying to illustrate how taxes are going to be different in your retirement years than they are in your working years. But an awareness of tax planning and a general awareness of how are different things taxed is going to make a huge difference when it comes to step two, which is understanding how much of the income that you're pulling out to create that retirement paycheck is going to be subject to taxes. And then finally, the third step in creating your own paycheck in retirement is coordinate your portfolio income sources with other income sources. This is typically things like Social Security or pension or rental income. When you look at your portfolio, don't just think of that as a big number. Think of that as one component of the income that you can create, the paycheck that you can create. The difference between retirement and your working years is typically in your retirement, your paycheck is going to be a combination of smaller amounts of income that make up one bigger paycheck for you as a whole. So if I go back to Mary's example, if$50,000 is the amount she can pull out of her portfolio, and let's assume that there's a 6% effective tax rate on that,$47,000 of that, more or less, is actually going to hit her bank account after taxes are accounted for. Now, just a big disclosure here, that's not going to be the same tax rate every year. That was very much based upon how much she was taken from her IRA this year and from her brokerage account this year. That was also based upon an enhanced senior deduction that's only going to last for the next few years. So this is where tax planning really strongly comes into play to say what's the right order to take things out in. So when I say a 6% tax, that's no indication that's going to be your tax rate forever. That's just this single year looking at the tax projection we ran. But she now needs to coordinate that with Social Security, with pension, if there's rental income. So that when it comes time to say, how much can I spend? How much can Mary spend, it's going to be a combination of all those sources. Here's the cool thing. You get complete control, well, mostly complete control over the timing of when that happens. Unlike your paycheck, that's maybe the first and the 15th or every other Friday, you get to decide when do you want your income in retirement. I have some clients, let's say they want$8,000 per month. They say, send me that$8,000 per month on the first. I want it, I'll allocate it, I'll spend it throughout the month, and then I automatically get another$8,000 on the first of the next month. I have others that like feeling like they're continuing to get a paycheck. They say, no, continue on the first and 15th schedule. Send me$4,000 per month every single month on the first of the month, and$4,000 every single month on the 15th of the month. They then use that to recreate the paycheck that they had on an ongoing basis. Then finally I'll have others who say, you know what? Of that$8,000 per month,$1,500 of it I'm putting into a vacation fund so that we can take a great vacation every four months, every six months, every eight months, whatever it is. So you know what, James, actually of the$8,000, send$1,500 to the separate savings account and$6,500 to my core checking account to be used for normal everyday expenses. You have flexibility in your retirement to create the type of paycheck that supports your lifestyle. Then finally, something to note with Social Security is you don't actually have control over that. The thing that you don't fully have control over is the timing of when you receive Social Security. You have total control over when you file for benefits, but the actual monthly income, you can't tell Social Security you want that in the first of the month or the 15th of the month. If your birthday is between the first and the 10th of a month, you're gonna receive your social security check on the second Wednesday of each month. If your birthday is between the 11th and the 20th of a month, you're gonna receive your social security check on the third Wednesday of each month. And finally, if your birthday is between the 21st and the 31st of the month, then you're gonna receive your social security check on the fourth Wednesday of the month. So you don't have control over that, but you do have control over the timing of when you pull your income from your portfolio. So those three simple steps will help you to create your own paycheck in retirement. Now there are some nuances, things I'd be remiss not to mention here. A big one is what about those other expenses? Whether that's a long-term care event, whether that's a cost of a big renovation, whether that's the cost of supporting a family member temporarily, or maybe doing a big family vacation every once in a while. Your retirement paycheck is typically not just gonna be consistent across the board. Along those lines, research actually shows you're gonna spend a lot more money in the first several years of retirement, and that's gonna start to dwindle over time. In your latter 70s and 80s, even you're probably not spending as much as you were in your early and mid-60s. Now, towards the end of your life, you might be spending more due to enhanced or increased medical expenses, but there's something called the retirement spending smile, where your spending starts higher, it starts to diminish in the latter, the medium parts of retirement, and then it increases again towards the later stages as you incur more medical expenses. And then finally, you should also factor in things like home equity. To what extent you're gonna stay in your home? Are you ever gonna sell? Are you gonna downsize? What other things might be unlocked, whether it's home equity, inheritance, things of that nature, that could enhance or increase what you're able to do with your retirement portfolio. So I hope this helps. I hope this is something you're doing as you create your paycheck for your retirement. If you need help with this, this is what we do at Root Financial all day, every day for our clients. You can reach out to us. A link to our website is in the show notes and the resources below. If you need help with us, reach out. But at a minimum, make sure that you understand the process by which you can create that paycheck, which is understand what a sustainable withdrawal rate is for your portfolio, understand the impact of taxes on that, and then make sure you're coordinating your portfolio withdrawals with other income sources.
