How Do I Replace My Paycheck When I Retire?


While it doesn’t seem like it, saving for retirement is easy. You set aside a certain amount each month, or each paycheck, and invest it in your IRA or 401(k). That is, of course, an oversimplification. But once you retire and need to figure out how to replace your paycheck, the process becomes a lot more difficult.

While you are working, you are in what is known as the “accumulation phase.” You have a couple of big decisions to make: how much you can afford to save for your future, and how you’re going to invest those savings dollars. If you are lucky enough to have an employer-based retirement plan, you simply decide what percentage of your paycheck you can put into the plan and then choose from the menu of investment choices that the plan offers. If you are saving for retirement outside of an employer plan, saving is a bit more involved. You must be disciplined to put money away on a regular basis without the benefit of payroll deduction, and you need to develop an investment strategy.

There is obviously more to “accumulating” than that. You want to make sure that you build a portfolio that is properly diversified. Your mix of investments should reflect your tolerance for risk as well as your need for risk. You should also keep an eye on the costs of your portfolio, which isn’t always easy. Mutual fund expense ratios, trading costs, account fees, and management fees can all add up and hurt the performance of your portfolio. You also need to manage the portfolio so that it stays appropriate as you move through the stages of your life.


But all of that is a piece of cake compared with what it’s like when you finally retire and get to the “decumulation stage.” Before retirement, you receive a paycheck. When that paycheck stops, you need a plan to replace the income that you have been living on. There may be several pieces of the retirement income puzzle that you will need to put together.

Most of us are eligible for a Social Security benefit. The timing of when you begin your benefit will be a big part of your retirement income plan. Most people begin receiving benefits at age 62, even though they know they will receive a smaller benefit. It often makes more financial sense to wait until you reach your full retirement age, which is 65 to 67, depending upon your year of birth. At least then you will be getting your full benefit. You can also receive a higher benefit by delaying it until you reach age 70. Each year you delay, your benefit will increase by 8%, up until the time you turn 70. When should you start your benefit? That, of course, depends upon your situation.

Pensions used to be a big part of the retirement puzzle, but not many of us are lucky enough to have one these days. If you happen to be eligible for a pension, you may need to decide when to start receiving benefits. Like the Social Security decision, many plans allow you to take a reduced benefit at an earlier age and a full benefit at another. You will also typically have to decide whether to take a benefit for the rest of your life, or to take a reduced benefit and provide for your spouse at your death. Your best strategy? Again, it depends.


Finally, you’ll need to come up with a plan on how to start drawing cash flow from your investment accounts. You should note that I said “cash flow” and not “income.” It might simply be a semantics issue, but I’ll explain. All too often, I see retirees trying to generate enough income from their investment portfolio to meet their spending needs. They think of “income” as interest and dividends and will tend to focus on investments that pay higher levels of both. Unfortunately, that mindset can often lead to problems with their portfolio. When “chasing higher yields,” investors are taking on more risk. When they go after higher dividends, we often find them heavily concentrated in large dividend-paying stocks. This approach leaves them with little or no exposure to other important asset classes. I recommend taking a cash flow approach, where the cash flow is made up of a combination of interest, dividends, capital gains, and occasionally principal, from the investment portfolio.

The tax status of your retirement investments will also have an impact on your cash flow decisions. You may have some money in after-tax investment accounts, some in tax-deferred accounts like an IRA, and some in tax-free accounts, like a Roth IRA. By properly managing your distributions, you can exert some control over the taxes that you will pay in your retirement years.

It’s easy to see that making the transition to retirement involves a lot of planning. You have several decisions that need to be made, and many of them will have long-lasting effects on your retirement lifestyle. Make sure you understand the implications of each decision. And if you would like some help, feel free to reach out. This is what we do, and we are happy to help.