Choosing The Right Retirement Income Strategy
Planning for retirement involves selecting the right strategy to generate a consistent income stream that will last throughout your retirement years. Choosing the right retirement income strategy depends on your specific needs, preferences, and financial situation.
Whether your desired option is:
- Maximizing Guaranteed Income,
- Living off Dividends,
- Investing in Cash-flowing Real Estate, or
- Applying a Dynamic Withdrawal Rate
Understanding the critical issues for each strategy is an important aspect of building and protecting your income to ensure you maintain your quality of life and meet your needs once you stop working.
Let’s break down each area …
1. Maximizing Guaranteed Income Sources
Social Security
Maximizing guaranteed income sources involves focusing on income streams that are secure and predictable, such as Social Security. Ideally you would like to delay taking Social Security to age 70, which would maximize your monthly payment for the rest of your life.
Issues to Consider:
- Future changes to Social Security, which are likely, also poses a risk the strategy.
- The Social Security Administration (SSA) instills an income gap penalty on you when you decide to take your payment prior to the peak retirement age of 67.
2. Fixed Annuities add Value in Retirement
Customizable fixed annuity offer incredible value in retirement. Most importantly they allow you to transfer retirement income risk to an insurance company. Plus, they guarantee you will not outlive your income in retirement.
Other important features of Fixed Annuities include:
- No upfront sales charge and no annual fees
- Annual Access to your money with free partial withdrawal provisions
- No risk for loss of principal risk while still participating in upside stock market gains
- They avoid the probate process, which will save your beneficiaries time and money
3. Living off Portfolio Dividends
Historical data shows that during significant market downturns, such as the 2007-2009 Great Financial Crisis, dividends decreased by only 23%, while the stock market dropped by 56%. In 2022, while the S&P 500 dropped over 18%, dividends increased by over 10%.
In retirement and especially in today’s market environment you still may want to limit your percentage holding of stocks to 25% and also hold stocks with great cash flow, low debt, and dividends that may keep up with inflation.
Protection of your assets is equally as important and increasing your asset values in retirement.
4. Investing in Cash-flowing Real Estate
Investing in real estate that generates positive cash flow can provide a stable income stream. The real key here is positive cash flow, meaning owning a home, with rental income that more than covers the mortgage payment.
Think about having a mortgage on your house in an inflationary period similar to today. You may be paying 4% – 6% interest on your mortgage but if/when inflation rises back to 8-10% you are doing very well. Here is why …
Inflation increases the wealth of debtors (people who borrow) because the borrowers owe a fixed amount on their loan while inflation is increasing the amount of money being created in the system .. Therefore, money and debt created in that money are losing value but the “real asset” home you own is gaining in value, thanks to inflation. It is a win/win for you.
Cash Flow Management in Retirement
Break-Down the Flow of Your Retirement Income
Reserves
Investment Opportunities
Investment Opportunities
IRAs
Annuities
Mutual funds
CDs
Stocks
Bonds
Realestate
and legacy
Investment Opportunities
and legacy
Taxation of Specific Retirement Income Sources
Federal and State Taxes on Retirement Income
Understanding how different types of income are taxed in retirement is crucial for effective financial planning. This report explains the various taxes retirees might encounter and provides strategies to minimize their tax liabilities.
When you retire and no longer earn a wage, certain taxes are no longer applicable:
- Payroll Taxes (FICA): No longer applicable on wage income.
- Social Security Tax: 6.2% on wages up to $168,600.
- Medicare Tax: 1.45% of all wage income, with no cap.
Federal and State Taxes on Retirement Income
While payroll taxes may cease, retirees still face federal and state income taxes, which vary based on the type of income received. The key distinction is between ordinary income tax rates and long-term capital gain tax rates.
Ordinary Income Tax Rates
- Range: 10% to 37% depending on income level.
- Applicable to: Wages, pensions, traditional IRA distributions, interest income, non-qualified dividends, and r ental income.
Long-Term Capital Gain Tax Rates
Range: 0% to 20% depending on income level.
Applicable to: Qualified dividends, long-term capital gains from the sale of investments held for more than one year.
Taxation of Specific Retirement Income Sources
Pensions
- Federal Tax: Fully subject to ordinary income tax rates.
- State Tax: Varies by state; some states offer exclusions or reduced rates for pension income.
Interest Income
- Ordinary Interest: Fully taxable at ordinary income tax rates at the federal level and typically at the state level.
- Treasury Bonds and T-Bills: Taxable at federal level, tax-free at state level.
- Municipal Bonds: Tax-free at federal level and possibly at state level if issued within the state of residence.
Dividends
- Qualified Dividends: Taxed at long-term capital gain rates (0%, 15%, or 20%).
- Non-Qualified Dividends: Taxed as ordinary income tax rates.
Capital Gains
- Short-Term Capital Gains: Taxed as ordinary income tax rates.
- Long-Term Capital Gains: Taxed at long-term capital gain rates.
Roth IRA Distributions
- Qualified Distributions: Tax-free at both federal and state levels.
- Traditional IRA Distributions
- Federal Tax: Fully subject to ordinary income tax rates.
- State Tax: Varies by state; some states offer exclusions or reduced rates for IRA distributions.
Rental Income
- Taxability: Net rental income (after deducting expenses like mortgage interest, property taxes, and depreciation) is taxable at ordinary income tax rates.
Additional Taxes to Consider
- Net Investment Income Tax (NIIT): Additional 3.8% tax on investment income for individuals with modified adjusted gross income above $200,000 (single) or $250,000 (married filing jointly).
- IRMAA Surcharges: Additional premiums for Medicare Part B and Part D for individuals with higher income levels.
Strategies to Minimize Taxes in Retirement
- Understand Provisional Income: Managing provisional income can reduce the taxable portion of Social Security benefits.
- Roth Conversions: Converting traditional IRA funds to Roth IRAs can help manage tax brackets and future tax liabilities.
- Qualified Charitable Distributions (QCDs): Donating directly from IRAs to charities can reduce taxable income.
- Tax-Efficient Withdrawals: Strategically plan withdrawals from various accounts (e.g., Roth IRA, traditional IRA, taxable accounts) to optimize tax outcomes.
By being aware of federal and state tax rules and making informed decisions, retirees can optimize their income and preserve more of their wealth.
Legacy RP will guide you through many pitfalls od building and protecting your nest egg through your retirement … Schedule your free consultation today … Our services are complementary, and our goal is to help you achieve financial security and peace of mind, so you live a good life in retirement.
