TODAY IN 10 MINUTES OR LESS, YOU'LL LEARN:
What’s your Safe Withdrawal Rate and how you can use it to set up monthly withdrawals
How to recreate your paycheck in retirement, including taking care of tax withholdings.
Where to find health insurance at an affordable price, when you retire before 65.
Safe Withdrawal Rates
The safe withdrawal rate is the amount of money you can take out of your retirement savings each year without depleting your nest egg prematurely. It's based on extensive historical data, taking into consideration typical investment returns and inflation rates.
The most widely accepted safe withdrawal rate is 4% per year, popularized by the Trinity Study, which suggests that there's a very high likelihood your savings will last 30 years if you maintain this rate.
To apply the safe withdrawal rate to calculate your monthly withdrawals, first determine your total retirement savings.
Let's say you've amassed $1,000,000 in your retirement fund. According to the 4% rule, you would withdraw $40,000 annually. To figure out your monthly withdrawal, divide this annual amount by 12, which in this case would be approximately $3,333.33 per month.
Recreating Your Paycheck
While you work, you get your paycheck and taxes are automatically withheld. You don’t have to worry about them, as they’re already taken out and remitted on your behalf. You just file based on your W2 at the end of the year.
I’ve had many pre-retirees worry that their taxes will be more complicated after retirement because they have to think about their tax withholdings. In reality, it’s incredibly easy to recreate your paycheck and take care of tax withholdings.
First, let’s look at the three sources of income for most retirees: Social Security, pensions, and withdrawals from retirement accounts.
You’ll pay regular income tax on up to 85% your Social Security. You’ll also likely have your Medicare deducted from your Social Security payment. You can, and likely should, have taxes withheld from your Social Security payment. You can do this by calling the SSA or by filling out form W-4V and returning it to the SSA.
Pensions are also taxed as ordinary income. You can request taxes be withheld here as well. You’ll need to contact your pension administrator for this.
When it comes to retirement accounts, there are a couple items to consider. First, if you have a Roth IRA or a Roth 401(k), you won’t owe taxes on withdrawals. If your money is in a Traditional IRA or 401(k), you’ll owe ordinary income taxes on the withdrawals. You can specify how much you want withheld for taxes, so you aren’t surprised at tax time.
Now for the final question, how much should you have withheld? On the Federal side, I recommend looking at your effective tax rate from the previous year and having that withheld. Simply, if you paid $15,000 in taxes on $100,000 in income, your effective tax rate was 15%, which is what I recommend you have withheld. You can do the same for your state taxes, if your state has income tax.
Finding Insurance before 65
If you retire before 65, which is the eligibility age for Medicare in the United States, there are several options you can explore to find affordable health insurance. One option is to maintain your employer-sponsored health insurance through COBRA (Consolidated Omnibus Budget Reconciliation Act). COBRA allows you to keep your current health coverage for up to 18 months after leaving your job. However, this can be expensive since you'll likely be paying the full premium without employer contributions. This is rarely the best option.
You can always look at obtaining coverage through your spouse's health insurance, if that’s an option.
The most affordable option is typically the Health Insurance Marketplace, created under the Affordable Care Act (ACA). Here, you can shop for health insurance plans, and based on your taxable income, you might qualify for subsidies that can significantly reduce your premiums.
The important thing here is to keep your taxable income relatively low. I’ve found that most retirees have relatively low taxable incomes in the first few years of retirement, particularly if you intentionally pull from non-taxable sources such as Roth IRA’s and non-qualified accounts, and this serves to maximize the subsidies available from the ACA.
Additionally, if you're in good health and have a sizable emergency fund, a high-deductible health plan paired with a Health Savings Account (HSA) could be a cost-effective solution. Be sure to compare different options, considering not only the premiums but also out-of-pocket costs, coverage, and network of providers.
-Jeb
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