How to Create a Retirement Paycheck

Collecting a paycheck during your working years is typically straightforward: You put in your time and get paid on a biweekly basis, perhaps with an annual or semiannual bonus. Retirement is different.

Absent a full-time employer, you'll need to cobble together a sustainable cash-flow strategy that will not only cover your expenses but also prioritize which sources of income to use—and when.

"Retirement is often presented as a single date on the calendar," says Rob Williams, managing director of financial planning and wealth management at the Schwab Center for Financial Research. "But as a practical matter, it's an exercise in sustained spending from finite resources over an unknown time horizon—and that can be an uncomfortable transition for those accustomed to a steady stream of outside cash."

Meeting your financial needs in retirement will depend on a range of circumstances—and you'll likely want to flesh out the details of a plan with the help of your Schwab financial consultant. Here are some rules of thumb that can help get you thinking about a retirement-income strategy.

"An emergency fund is critical for everyone, but especially for retirees," Rob says. "This fund should have enough ready cash to cover a year of spending—minus any guaranteed retirement income like a pension or Social Security." High-yield checking or money market accounts are good places to park money you'll need in the next year or so since they're not subject to market risk.

In addition, Rob suggests retirees consider maintaining two to four years' worth of anticipated portfolio withdrawals in relatively liquid, stable investments—such as certificates of deposit (CDs) or high-quality, short-term bonds or bond funds—to avoid having to sell more-volatile investments with potential for long-term growth during a down market.

"Predictable income can be the foundation of your retirement cash flow," Rob says. That includes:

Generally speaking, anyone who has worked at least 10 years in a job covered by Social Security can collect benefits. You're eligible at age 62, but you'll receive reduced benefits for life if you collect before your full retirement age (FRA)— between 66 and 67, depending on birth year. Conversely, each year you delay beyond your FRA earns you an 8% bump in benefits—up to age 70, after which there is no incremental benefit. (You can see your monthly benefit estimate starting at various ages at ssa.gov.)

"The age at which you start collecting benefits is an essential aspect of retirement," Rob says. "If you can afford it and are in good health, we generally suggest you wait at least until full retirement age, or up to age 70 if possible, in order to maximize the payout from what is in effect a guaranteed lifetime annuity."

That said, there are special considerations for married couples:

• If you both can't wait until FRA or later to collect benefits, consider having the higher earner delay as long as possible to enhance the larger of your two benefits.
• At full retirement age, you can take either 100% of your own retirement benefits or 50% of your spouse's, whichever is higher.
• If you're widowed, you can collect either your own retirement benefits or up to 100% of your spouse's benefits, whichever is higher.

If you're divorced and you were married for 10 years or more, you can still receive benefits based on your ex-spouse's Social Security record (up to 50% of their full retirement benefits).

A traditional defined-benefit pension plan from a former employer can be a steady source of retirement income. You'll typically have a choice between receiving a lump-sum payment or lifetime monthly payments—a complex decision that hinges on factors such as plan specifics, life expectancy, and the tax implications of each approach.

In return for contributions—often a lump-sum payment—these insurance contracts provide regular income, now or in the future. Payouts can be fixed or fluctuate based on prevailing market conditions. "At their best, annuities can give you greater flexibility in terms of when and to what degree you tap your portfolio," Rob says, "and in that sense should be used in combination with, rather than in place of, more traditional savings."

While some may not be guaranteed, these income sources typically provide predictable cash flow:

A ladder strategy entails a portfolio of individual CDs or bonds that mature on different dates. "This approach is designed to provide regular income in the form of staggered interest payments, plus the principal when the bond matures, while helping to minimize exposure to interest rate fluctuations," says Cooper Howard, a fixed income strategist at the Schwab Center for Financial Research. "With a bond ladder, you know what to expect and when to expect it, unlike the variability of some other forms of investment income." However, some bonds have greater risks than others, which could lead to higher volatility or price changes within that part of your investment portfolio.

About 19% of adults ages 65 and older are employed, according to Pew Research. Some may work to earn extra cash, while others do so to help keep themselves occupied. Be aware, however, that:

• If you're younger than your FRA for the entire year, working could mean a temporary reduction in your Social Security benefits—$1 for every $2 you earn above the annual limit ($22,320 in 2024).
• In the year you reach FRA, $1 in benefits is deducted for every $3 you earn in the months leading up to your FRA, but the limit is much higher ($59,520 in 2024).
• Starting with the month you reach your FRA, there is no reduction in benefits no matter how much you earn.

Once you stop working, the Social Security Administration will recalculate your benefit amount to give you credit for the months it reduced or withheld benefits due to your excess earnings.

Some retirees may opt to rent out a second home, an investment property, or even their primary residence if they live somewhere else part of the year, for example. The income can help capitalize on a major asset and may offer tax benefits, but it can also come with hidden costs, such as property management fees and upkeep.

Your more predictable sources of income are unlikely to cover all your expenses. That's where tapping your investment accounts comes in.

Once you turn 73 (75 starting in 2033), the IRS mandates required minimum distributions (RMDs) based on the year-end value of the account, your age, and your life expectancy—unless you're still working, in which case you may be able to delay withdrawals from your current employer's 401(k) plan. If you miss a deadline or don't withdraw your full RMD, you'll owe a penalty of up to 25% of the amount you failed to withdraw. For example, if your RMD was $100,000 but you withdrew only $50,000, you'd owe a quarter of the shortfall ($12,500) as a penalty.

However, the IRS does not require you to wait until RMD age before you can begin withdrawing from such accounts. If you want to retire early or could use the money for a large expense, for example, you may start making withdrawals at age 59½ without paying a penalty. "Even if you don't need the money from your traditional 401(k) or IRA, if you have significant savings, you may not want to wait until your RMDs kick in," Rob says. By waiting until RMD age to take withdrawals, more money will likely accumulate in such accounts—which is a good thing—but this may also result in larger RMDs later. "Because RMDs are taxed as ordinary income, the bigger your distribution, the bigger your tax bill," Rob says. "Drawing down these accounts before you reach RMD age tends to be more efficient from a tax perspective."

Taxable brokerage accounts aren't subject to RMDs and can generate income in one of three ways:

• Interest, which is taxed as ordinary income unless it's from a municipal bond or municipal bond fund, which are exempt from income taxes.
• Dividends, which are often taxed at the lower long-term capital gains rates of 0%, 15%, or 20%, depending on your income level, how long you've held the asset, and other requirements.
• Proceeds from a sale, which also could be taxed at the lower long-term capital gains rates of 0%, 15%, or 20%, depending on your income level, how long you've held the asset, and other requirements.

Funds from these accounts aren't subject to RMDs, and the distributions are tax-free so long as you make withdrawals after age 59½ and have held the account for at least five years. This makes them beneficial for funding large, single expenses—such as a trip or a down payment on a second home—because the additional income won't subsequently push you into a higher tax bracket.

While retirement might seem like the final step of a journey, your goals and lifestyle will likely continue to evolve—and your income strategy should reflect that. "Over the next five years or so, for example, you'll want to know you can meet your income needs with relatively little downside," Rob says. "Beyond that, your appetite for risk—and the potentially larger returns that come with it—may be greater."

That's why it's wise to review your spending and income plan annually, or whenever you experience a major life event, such as divorce, marriage, or the death of a spouse. "The key is to create a reliable, sustainable, and tax-efficient paycheck that can comfortably see you through all the chapters of your retirement, without worrying too much about the inevitable ups and downs of the market," Rob says.