How to Ride the Retirement Income Roller Coaster

Jacqui Kenyon
Posted

How should you manage your money in retirement?

People who are retired are often referred to as having a “fixed income,” or living on a set amount of money each year from Social Security, retirement accounts or pensions.

However, in practice, your income could be anything but fixed from year to year—at least in the eyes of the government.

See, one of the determining factors of your tax bill every year is your taxable income. And, as Ellen Derrick, a certified financial planner™ with LearnVest Planning Services, puts it, withdrawing more money from a tax-deferred account for expenses one year is equivalent to having a greater taxable income for that year. And that, of course, means a higher tax bill.

Since you want your retirement savings to last as long as possible, you should pay what you owe in taxes, but not more than you have to. For that reason, you’ll want to be strategic when it comes to withdrawing from your retirement accounts and even when it comes to buying or selling things (like property) that can change your tax bill.

As you probably know, different retirement accounts have different tax treatments. When you contribute to a traditional 401(k) or IRA, the money is usually put into the account pre-tax. Though you’ve skipped paying Uncle Sam at the time of contribution, you will have to pay taxes on that money when you withdraw it. On the other hand, money that’s in a Roth IRA or Roth 401(k) has already been taxed, so when you withdraw that money, you won’t pay taxes on it. So when you’re retired, strategically drawing from different types of accounts can help minimize your taxes.

RELATED: Which Is Better? IRA vs. 401(k)

We’ll explain why retirement income fluctuates and how to make sure you maximize your retirement savings.

How and Why Retirement Income Fluctuates

Although it’s important to figure out how much money you’re going to need for a comfortable retirement and plan your contributions so you can meet that number, it’s impossible to foresee exactly how much you’ll require to live on each year.

Here are a few factors that can affect your retirement income:

Variation in Living Expenses

Just like during your working years, during retirement, you’ll have large expenses some years and not others. Buying a new car, going on a fancy vacation or remodeling your kitchen, for instance, are not purchases that you make on an annual basis. Of course, when you’re working, your purchases in any given year would never determine your income. (If it did, then life would be a lot easier!) But in retirement, your expenses actually can determine your income because, in order to pay for these things, you will be pulling money from your retirement accounts and paying income tax on that money (unless it’s a Roth account).

Selling Property

“Selling a home or a second home can also change your income, and many people sell property in order to downsize during retirement,” Rachel Sanborn, a LearnVest Planning Services certified financial planner™, says.

When you’re selling a property that you’ve owned for many years, the value typically will have increased since the time of purchase. For example, if you purchased a home for $100,000 30 years ago, and it’s now worth $750,000, you will be able to claim an exemption on your taxes for $500,000 of that gain if you are married filing jointly. (If you file singly, you can exclude $250,000 of the gain.) But you’ll still have to pay taxes—typically 15%—on the remaining $150,000 as capital gains.

RELATED: 8 Top Home-Selling Mistakes People Often Make