Retirement Income Strategy – Social Security + IRA Distributions


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This week I want to talk about how I helped one couple realize a dream I’m sure many of you share — early retirement. When the prospect of retirement is only a few years away, many of us get a little senioritis. Just as we couldn’t wait for high school graduation all those years ago, we now anxiously await the freedom of retirement. But “how?” you might ask. Well, with strategic planning and responsible management of your assets and income, we can help you, too, enjoy retirement a little early.

Retirement Income Strategy: Buckets of Money

Set up your retirement for success with this income strategy that uses Social Security and withdrawals from a taxable IRA.

Matching Goals to Assets

When I met Rita and Gilbert, they had a simple enough goal — retire soon and comfortably. Easy enough for Rita as she was already 65 and not working. However, Gilbert was 60.5 — over 5 years away from being able to take his full Social Security benefit. Rita’s Social Security benefit is quite small, as Gilbert has been the primary earner for their household. And with only one person entitled to significant Social Security benefits, retiring early might seem like an impossibility.

Earlier in his career, when earning a higher income, Gilbert managed to fund a substantive 401(k). And when his wife assumed control over their investments, it took off like a rocket — going from $500,000 to $940,000 in just a few years.

Having made impressive gains in their retirement fund, Rita and Gilbert started to realize that retiring early might not be completely out of the question after all, but they weren’t sure how to make sure they didn’t run out of money if they lived a long, full life. Rita knew that she couldn’t leave the money invested as aggressively as it was, and she also knew that the high value could be a tax problem when they needed to access the money.

Before coming to me, Rita and Gilbert decided they would need $5,000 per month (after taxes) to live on. They knew that if they took any money from the 401(k) they would be required to take it all, so they considered cashing it out, but that would leave them with only $500,000 to $600,000 after taxes. Instead of turning it all to cash and incurring hefty taxes, we recommended diversifying their assets.

If retiring soon was going to be an option, the couple would need access to immediate funds, but they also needed to make sure their money would last a long time. We decided the best strategy would be to divvy their money up into 3 buckets: one for short-term spending, one to ensure they didn’t outlive their money, and one to protect the principal and provide financial freedom for any unexpected costs.

Bucket #1: Money for Now

One obvious hurdle was that Gilbert could not collect Social Security for at least another year and a half. Our first bucket helped to cover this gap in their income. This bucket provided the most joy for Rita, as it made it possible for Gilbert to retire right away if he wanted to, something she hadn’t been sure was possible.

We moved about $300,000 from the 401(k) into the first bucket, an IRA. This would provide an initial income for the couple to replace wages when Gilbert retires anytime before 2023. They can withdraw $70,000 per year from the IRA — with $10,000 for taxes, that leaves $60,000 (meeting their $5,000 per month goal).

Once Gilbert turns 62 at the end of 2022, he can finally start collecting his Social Security — but, of course, not the full amount. Once he is drawing Social Security, Rita will be eligible for the 50% spousal benefit. This gives them a total of about $39,200 per year in Social Security benefits. From 2023-2026, by withdrawing $24,000 each year from our first bucket, they can still net a yearly income of $60,000 ($63,200 minus a little less than $4,000 for income taxes).

By the time 2027 rolls around, the IRA should have a balance of around $160,000.

Bucket #2: Money Forever

So what happens after 2026? Well, that’s where our second bucket comes into play. From the original 401(k), we moved $340,000 into an annuity. After 5 years, this will pay out a guaranteed income of $24,812 per year until the second spouse dies–which could be a very long time. No matter how long he/she lives, they are guaranteed this income — even if the balance has long since reached $0.

With the $24,812 yearly payouts from Bucket #2 and the $39,200 paid each year in Social Security benefits, our couple is again comfortably sitting at $60,000 per year. They will not need to make further regular withdrawals from the IRA in Bucket #1 to meet their income needs.

For some couples, this may be the portion of the plan that is most exciting, providing a sense of security and alleviating the fear that comes with not knowing if you have the resources to end your days with the same comforts you enjoy at the beginning of retirement.

Listen to learn more about the bucket strategy:

Bucket #3: Money for the Unexpected

Now, with $60,000 per year for life accounted for in Buckets #1 and #2, you may be asking yourself what the purpose of Bucket #3 is. Some financial advisors may have considered that a job well done and stopped right there. But here at Cardinal, we go above and beyond to meet not only the needs you bring to us but those that are unanticipated and may be hard to identify.

With a $300,000 balance remaining from the original 401(k), we suggested a fixed indexed annuity — our third bucket. With income accounted for in Buckets #1 and #2, we can focus on protecting the principal investment and providing a slush fund for the couple for any unforeseen expenses such as emergency or long-term medical care. This is really important when planning for retirement as more traditional sources of retirement income are fairly inflexible, leaving you with little room to accommodate the unexpected. The money in Bucket #3 can also help protect against inflation if Gilbert and Rita realize they need more than $5,000 per month as the years go on.

The benefits of fixed indexed annuities are two-fold: they not only protect the original investment but can also see a respectable return in years the market does well. And with a 10% withdrawal allowance per year for the first 10 years and unlimited withdrawals after that, this annuity offers some much-needed flexibility in your finances.

One of the most important takeaways is to not underestimate your Social Security benefits. As discussed above, they are an integral part of this couple’s plan to retire. Because these benefits are a constant, we can use them to better manage more flexible funds, like a 401(k) or IRA.

You don’t need a 401(k) of this size to take something from this lesson. At Cardinal, we work with folks of all income levels and every level of retirement savings. We will work with your specific needs and circumstances to help you achieve your retirement goals. If you want a unique retirement plan tailor-fit to your needs, give us a call to get started.

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