You can't just put your personal finances on autopilot the moment you retire even if you planned carefully for these years. You'll still have to manage your income, your investments, and your expenses. They may need minor tweaks now and then or a major overhaul if your situation changes in a big way.
Key Takeaways
- Retirement can last a while so be sure to take a close look at your expenses, investments, and retirement programs so you can draw up a plan that works for you over the long haul.
- You can fill the gap in several ways, including through withdrawals and part-time work, if your expenses begin to exceed your income.
- Be mindful of age requirements on retirement plans, such as required minimum distributions that are required by the IRS, forcing you to withdraw funds from your IRAs beginning at age 73.
- Some investors target a withdrawal rate of 4% of their total portfolio each year to ensure that their current needs are met while they still hold onto capital for the future.
Managing Your Income in Retirement
Having several streams of income can help you achieve greater financial stability in retirement. They might include a pension from a former employer, income from your retirement accounts and other investments, Social Security benefits, and possibly a paycheck from part- or full-time work.
Your 401(k) and Similar Plans
Defined contribution plans such 401(k) and 403(b) plans have different sets of rules. You can typically start taking penalty-free withdrawals as early as age 59½ but some exceptions such as disability allow for earlier withdrawals.
You must begin withdrawing required minimum distributions (RMDs) at age 73 using an Internal Revenue Service (IRS) formula based on your age. You can draw a steady, taxable income from your plan between the age of 59½ and your early 70s, at which point you have no choice but to begin taking withdrawals.
The IRS early withdrawal policy means that withdrawals taken before age 65 will result in an additional 10% in income tax.
You'll want to consider your safe withdrawal rate when you're deciding how much money to take from your retirement plans to supplement your other sources of income. That's how much income you can safely draw from your accounts each year without running the risk of depleting them before you die.
A guideline known as the Four Percent Rule was popular for many years. This rule suggested that you could safely withdraw 4% each year (plus an adjustment for inflation) from a diversified investment portfolio to live a 30-year retirement with little risk. Some experts have questioned this rule, maintaining that 2% or 3% is a more realistic figure. Other experts set a safe withdrawal rate even higher than 4%.
There are many unpredictable variables here, such as your return on investments and the rate of inflation over the several decades you may be retired. A lot depends on how much money you have and how comfortable you are with risk. Suppose you have an investment portfolio worth $100,000. You could expect it to provide $4,000 a year in income at a 4% withdrawal rate. A $500,000 portfolio would provide $20,000. A $1 million portfolio would provide $40,000.
Order your copy of the print edition of Investopedia's Retirement Guide for more assistance in building the best plan for your retirement.
Your Pension
If you have a traditional, defined benefit pension from a former employer or labor union, you can find out when it's set to start paying you income by consulting the Summary Plan Description (SPD) or a similar document, which the plan's administrator is required to provide you.
Many plans begin payments at age 65 but some allow you to start collecting sooner. One important decision you may have to make is whether to take your benefits as a single lump sum or in a series of regular monthly payments.
Your Social Security Benefits
U.S. citizens and lawful U.S. residents with 40 or more Social Security credits based on their taxed income can begin collecting Social Security benefits by age 62, regardless of whether they've retired. You're not required to start collecting at age 62, however. It's very important to decide when you want your benefits to begin. Different people's financial situations suit different social security timelines.
Your monthly benefits will be permanently reduced if you begin collecting Social Security as early as age 62. Your monthly benefits will increase if you delay collecting. Your benefits max out at age 70, however, so there's no further incentive to delay and you might as well sign up at this point.
When you should activate Social Security depends largely on how much you need the money. You might want to wait if you can get along fine without payments until age 70 and if you expect to still have many years of life ahead of you. You might plan to begin collecting sometime between ages 62 and 70 if you need money sooner than that.
Try to wait until you reach full or "normal" retirement age as Social Security defines it for your age group. This is ages 65 to 67 depending on your year of birth. Doing so will help you maximize your Social Security benefits.
Another complication is whether you have a spouse who will be collecting spousal Social Security benefits. A spouse can earn a maximum of 50% of their partner's Social Security benefits but they can't begin collecting until their partner does. It can make sense for a spouse to wait until the earning partner reaches retirement age to be paid 50% of their full retirement benefit.
Your Other Investment and Savings Accounts
You can also draw income from your non-retirement accounts at any age without concerning yourself with any required minimum distribution requirements. It's wise to time these withdrawals in coordination with your other income sources.
Your Job Income, If You Work
You'll want to be aware of how it can affect your Social Security benefits if you're planning to do paid work in retirement.
Social Security will reduce your monthly benefit by $1 for every $2 you earn over an annual limit if you haven't yet reached your full retirement age of 65 to 67 years depending on the year you were born. That limit is $22,320 in 2024. Your benefits will be reduced by $1 for every $3 you earn over a different limit beginning in January of the year you reach full retirement age. This limit is $59,520 in 2024.
But there's no limit to how much you can earn beginning with the month in which you reach full retirement age. Your benefits aren't reduced after this time and the reduction in earlier years isn’t money that’s permanently lost. Social Security will recalculate your benefit when you reach full retirement age and increase it to make up for the money that was withheld earlier.
Managing Your Investments in Retirement
You'll also want to keep an eye on how your money is invested and perhaps make some changes along the way. Retirees often transition to more conservative and less risky asset allocations as they get older, putting more emphasis on preserving their wealth than on growing it. The focus changes to making income from your investments.
One common rule of thumb suggests that people subtract their age from 110 to determine a percentage of their money to keep in stocks. Following that guideline, a 65-year-old retiree might aim for an asset allocation that's 45% stocks and 55% bonds, the latter being considered less risky. The retiree might switch to 35% stocks and 65% bonds by age 75 under this rule.
There are also mutual funds and other investments that automatically adapt for you over time. Target-date funds base their allocations on the year you plan to retire, gradually decreasing the risk as you get older.
Make sure to consider the tax consequences if you're adjusting your asset allocation on your own. You can move money from one investment to another within an IRA or another qualified retirement account without triggering any tax liability. Switching investments outside of a retirement account can subject you to capital gains tax, however.
Managing Your Expenses in Retirement
You can try to increase your income, reduce your expenses, or perform some combination of the two if you find that your retirement income isn't adequate to cover your retirement expenses. Expenses may be where you have the most control.
Housing costs are a major budget item for most people so this can be a good place to start. How would you feel about moving to another area with a lower cost of living or staying in your current area but moving to a smaller, less expensive home, otherwise known as downsizing?
You may also be able to reduce your insurance costs. You may not need life insurance or as much of it if you have children who are grown and self-supporting. You can save on auto insurance and maintenance costs if you have two cars but could easily get by with one.
It can be worthwhile to dedicate a rainy afternoon to going through your credit card and checking account statements to look for expense items that you can trim. You might not be fully aware of where all your money goes unless you have the evidence right in front of you.
What Is the 25 Times Rule for Retirement?
A very broad rule of thumb for retirement savings is to have 25 times your planned annual spending saved before you retire. Unspent savings can accumulate and grow so this doesn't mean that you'll be limited to having only 25 years' worth of savings. Instead, retirees should be mindful to only withdraw what they need and keep the rest in investment vehicles that can continue to grow.
What Is the 4% Rule for Retirement?
Most retirees aim to withdraw between 3% and 4% of their investment savings each year to cover their living expenses. A commonly held belief is that retirees can withdraw up to 4% each year for 30 years before their retirement savings are gone, subject to several assumptions. This broad stipulation creates a roadmap for those in retirement to avoid drawing too much from their account each year and to ensure that enough savings are available in the future.
Can I Still Contribute to Retirement Accounts When I Am Retired?
Yes, retirees can still contribute to retirement accounts such as traditional or Roth IRAs. There used to be an age restriction to which individuals could contribute to traditional IRAs but that limit has since been struck down. Individuals may now contribute to their IRAs regardless of age, although there are restrictions on how much they can contribute based on earned income and age.
The Bottom Line
Many individuals look forward to retirement after long careers but financial complications can come with no longer working. They include required minimum distributions imposed by the IRS, age guidelines on Social Security benefits, and employer-specific pension plans. Retirees and prospective retirees should therefore keep careful track of their investments, expenses, and tax liabilities.
Correction–April 12, 2024: This article has been updated to clarify full retirement age as defined by the Social Security Administration as well as its implications.
