How to Manage Income During Retirement

Managing retirement income is different than managing income during your working years for a number of reasons. Mainly, as a retiree, you likely receive income from multiple sources, including Social Security, one or more individual retirement accounts (IRAs), possibly a pension, and an investment account or two.

When you are employed, you generally receive a regular paycheck, such as every two weeks. When you are retired, you might receive income monthly, quarterly, annually, and even sporadically. And part of your retirement income likely will come from investments (savings)—which you must protect to make them last.

You'll also need to consider different tax implications, such as those that apply to tax-advantaged retirement accounts. Finally, you need to understand how to manage any income you make from another job and when to take required minimum distributions (RMDs).

Regular Retirement Income

There are two main types of retirement income—regular and potential. Regular retirement income is like a paycheck. It arrives on a set schedule and will continue for the rest of your life. Here are some examples of regular retirement income:

Social Security

This government pension program makes up a significant part of regular retirement income for many people. It is based on your earnings during your working years and distributed to you monthly. Social Security is adjusted annually for inflation, so the amount you receive will often increase.

Defined-Benefit Pension

A defined-benefit plan, similar to Social Security, offers regular monthly lifetime income based on your earnings during your working years. These traditional pension plans are increasingly rare, but some people still have one. Most people who retire from a job that offers a defined-benefit pension take their money in the form of an annuity.

Annuitized Defined-Contribution Plan Pension

Defined-contribution plans—401(k) plans, for example—are now more common than traditional pensions. Some employers allow retiring workers to annuitize their defined-contribution plan to produce a lifetime income stream, such as that from a defined-benefit pension. Annuitizing frees you from making investment decisions and provides a regular income for life, but it often comes with high fees and little or no inflation protection.

Employment

Working full or part-time in retirement is one way you can increase the amount of your regular retirement income. Some people gain both social and financial benefits by remaining in the labor force.

Potential Retirement Income

The second type of retirement income comes from savings and investments, including 401(k)s and IRAs. This is potential income either from regular withdrawals or by taking money out as needed. Here are some examples of potential retirement income:

Tax-Advantaged Accounts

Your employer may allow you to take your defined-benefit or defined-contribution plan funds in a lump sum. You can roll the funds into an IRA to defer taxes until the money is withdrawn or pay the taxes and access the funds immediately. You also may leave a defined-contribution plan, such as a 401(k), in place at a former employer, if that is permitted. In all cases, the money is typically invested.

Investment and Savings Accounts

You may have one or more taxable investment accounts that can be a source of income as needed. And, as financial advisors recommend, you may also have an emergency fund with three-to-six months worth of monthly expenses.

Reverse Mortgage

A reverse mortgage allows you to convert home equity to a loan. You can take the proceeds in a lump sum (to invest), a series of regular payments, or a line of credit. Because it is a loan, the money isn’t taxable. The downside is that you must repay the loan when you die or sell your home.

Cash Flow and Timing

First, subtract regular retirement income from essential monthly expenses, including housing, transportation, utilities, food, clothing, and healthcare. If regular income doesn’t cover everything, you may need more income. Nonessential expenses—such as travel, eating out, and entertainment—come last and are often paid for by withdrawing from retirement savings and investments.

Withdrawal Plan

Before taking money from investments, you need a plan. This is where a trusted financial advisor can help. One common system, the 4% rule, involves withdrawing 4% of the value of your total cash and investment accounts each year and giving yourself an annual 2% inflation “raise.”

You could also take a portion of your savings and investments and buy an immediate payment annuity to provide continuing cash flow for essential expenses.

Order of Withdrawal

Withdraw funds from taxable investment accounts first to take advantage of lower (dividend and capital gains) tax rates. Next, take funds from tax-deferred accounts such as 401(k)s, 403(b)s, and traditional IRAs. You should draw on tax-free retirement accounts, including Roth IRAs, last to allow the money to grow tax-free for as long as possible.

Tax Management

If state or federal taxes are not withheld from some of your retirement distributions, you likely will need to file quarterly estimated taxes. Some states do not tax retirement income, while others do. The same goes for local taxes.

Taxable investment account distributions are taxed based on whether the investment sold was subject to short-term or long-term capital gains tax rates.

Withdrawals from tax-deferred accounts are treated as ordinary income. Finally, consider rolling over lump-sum distributions to a tax-deferred account to avoid a significant single-year tax bill.

Managing Required Minimum Distributions (RMDs)

Once you reach 72 ((or 73 if you reach age 72 after Dec. 31, 2022), you must begin taking required minimum distributions (RMDs) from all retirement accounts except your Roth IRA. The amount of the distribution must roughly equate to your account balance at the end of the previous year, divided by your statistical life expectancy.

You must take this money out by April 1 of the year following the year you turn 72 or 73. After that, all RMDs are due Dec. 31. Any amounts you take out during the year count toward your RMD. All RMDs are taxable as ordinary income except those from a Roth 401(k)—you do need to take out an RMD from a Roth 401(k), but you won’t owe taxes on it.

If you’re still working at 72 or 73, you don’t have to take an RMD from the 401(k) at the company where you are currently employed (unless you own 5% or more of that company). You will, however, owe RMDs on other 401(k)s and IRAs that you own.

Depending on your plan, you may be able to import a 401(k) still with a previous employer to your current employer to postpone RMDs on that account.

Working in Retirement

When you work in retirement, such as with a part-time job, you will have yet another income stream to manage. Your income can provide you with more financial security and additional means to pay for your lifestyle. However you will need to understand how it can impact other types of income, particularly your Social Security.

However, taking income as you take Social Security can also work in your favor in another way. Social Security benefits are based on your 35 top-earning years when your Social Security check is determined. So, if you are making income is among your highest earnings years as you take Social Security, it can increase your Social Security benefit.

Working in retirement may also allow you to delay withdrawing from your investment accounts, which can allow them to grow more. You may also be able to continue to contribute to a retirement account if you continue to work.

The Bottom Line

Managing retirement income is more than receiving the money and using it to pay bills. Some people consolidate their retirement accounts to make it easier to manage them. Depending on the nature and features of your accounts, such as fees, this may or may not be in your best interest. Also, money in a 401(k) may be more protected against creditors than funds in an IRA.