How to Set Up Your Retirement Paycheck: In this video and article, Amy Shepard, CFP with Sensible Money, discusses budgeting and managing your money during retirement.
Article: 7 Steps to Set Up Your Retirement Paycheck
Cha-ching! Here’s how to create your retirement income by replicating the paycheck from your working years.
By Amy Shepard, CFP, RMA
The transition from earning a paycheck from work to living off your nest egg is a big one! For many, they are used to steady paychecks to fund their lifestyle so it can be a bit intimidating when those paychecks stop. The good news is that you can replicate that “paycheck” once you retire. Here’s the process we use at Sensible Money to set up retirement “paychecks” for our clients.
1. Review (or Create) Your Budget: In order to determine your withdrawal needs in retirement, you first need a budget. This doesn’t have to be complicated! If you already track your spending, you’ll have what you need. If you don’t have a defined budget in place, I recommend basing your retirement withdrawals on your take-home pay from when you were working.
For example, if your salary was $125,000 but after taxes, benefits, and retirement contributions, your net pay was $2,800 every two weeks (or $5,600 per month), that’s what you can use as a starting point for your retirement budget.
In addition, if you know you weren’t spending the full $2,800 each pay period, either because some automatically went to savings or your checking account balance was regularly growing, you could scale that back as needed.
2. Organize Your Accounts: Ideally, once you get to retirement, you can consolidate your accounts so that you have the following:
- 1 IRA
- 1 Roth IRA
- 1 taxable brokerage account
- 1 checking account
- 1 savings account
For couples, you would each have your own IRA and Roth IRA, but then could share the brokerage, checking, and savings accounts depending on how you handle your finances together.
Consolidating your accounts may result in lower trading costs and more effective management of investment allocations, account withdrawals, conversions, required minimum distributions, and portfolio performance.
3. Determine What Accounts to Withdraw From: For many retirees, this is the hardest part to do on their own because there are so many considerations such as taxes, investments, Social Security decisions, pension decisions, and many other variables. Working with a retirement planner can help tremendously; it’s what we do each and every day at Sensible Money.
In this example, let’s assume that all withdrawals come from the IRA.
4. Evaluate Tax Considerations: When you withdraw from an IRA, typically the full amount is taxable at ordinary income rates (there are exceptions to this, but for simplicity, this example assumes withdrawals are fully taxable).
If you need $5,600 per month to live off of, you’ll need additional money to cover taxes. As a married taxpayer in a state with no income tax, to generate $5,600 per month of spending money ($67,200 per year), you would need to withdraw about $6,080 per month ($73,000 per year) from your IRA. That means about $5,800 per year or $480 per month would need to be withheld for federal taxes.
Again, working with a retirement planner and/or CPA can help tremendously when it comes to calculating these numbers.
5. Decide on Frequency: Once you know your budget, accounts to withdraw from, and any tax implications, you can then decide how to structure the timing of your withdrawals. I find that most retirees tend to prefer one of the following options:
Twice per month: For many salaried employees, this option most closely resembles a paycheck. If you’re used to getting two paychecks per month when working, setting up your retirement income the same way helps for a smooth transition. You can set this up any way you like – the 1st and 15th, the 15th and 30th, or any other combination of days. In the above example, you would do $2,800 twice per month into your checking account.
When factoring in taxes as outlined above, you’d do the following math:
- $73,000 per year divided by 12 = $6,080 per month/2 = $3,040 gross withdrawal twice per month
- less $240 federal tax withholding
- equals $2,800 spending money twice per month
Monthly: With this option, you simply set up your withdrawals to come once per month on the day you prefer. Continuing with the above example, you’d set it up so that once each month, $5,600 gets deposited into your checking account.
When factoring in taxes as outlined above, you’d do the following math:
- $6,080 gross monthly withdrawal
- less $480 federal tax withholding
- equals $5,600 monthly spending money
6. Logistics: The easiest way to set this up so it resembles a paycheck is to have the IRA withdrawals direct deposited into your checking account. In the twice-per-month example, you’d set it up so that for each withdrawal, $3,040 would come out of the IRA, $240 per month would get withheld for taxes and sent straight to the IRS, and the remaining $2,800 would show up in your checking account, just like your paycheck used to when you were working.
7. Making Adjustments: The transition to retirement is just that: a transition. When going through any major changes, it can take time to settle, and often adjustments are needed. When setting up your retirement paycheck, I recommend giving it at least three months to see if that budget you’ve chosen is working. If you realize it’s not enough, then slightly increase what you are taking. On the other hand, if you notice your checking account is growing in value, then decreasing the amount could make sense.
Additionally, retirement is not linear — both income and expenses will evolve throughout retirement. For example, many retirees postpone Social Security claiming to maximize their monthly benefit. That means that in the beginning, they are pulling more money from their portfolio but once Social Security kicks in, the portfolio withdrawals can be decreased accordingly.
The key is knowing and accepting that it takes time to adjust to retirement life and it’s perfectly fine to do some fine-tuning to your retirement paycheck as you get settled into your new routines.
About the author: Amy Shepard, CFP®, RMA®, BFA™, MBA
Amy Shepard, CFP®, RMA®, BFA™, MBA is a Financial Planner at Sensible Money. She has been working with clients since 2013 and loves helping them create and implement a financial plan so they can achieve their life goals. She is involved in the CFP Boards Mentor Program and previously served on the board of the FPA of Greater Phoenix. Outside of work she enjoys spending time with her husband and kids – they have a goal to take a family picture in all 50 states!
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