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How do I set up my Retirement Paycheck Replacement Plan?

How do I set up my Retirement Paycheck Replacement Plan?

May 17, 2024

One of the first concerns my clients have when we start the “when is retirement” conversation is how we will replace their paycheck.  For many, they are paid every two weeks or twice a month.  They have become accustomed to paying many of their living expenses with the first check of the month and paying the rent or mortgage with the second check of the month.  Yes, a monthly check would work just fine for those retirees.

Retirement is a very scary and sometimes dramatic time for many.  Many times, there are friends at work.  These co-workers have shared many of the ups and downs both at work and away from work.  For some, their job was their “purpose”.  It was their identity.  If they are no longer a nurse or an X-Ray technician or executive at this hospital, is there still somewhere they are needed?  Getting out of bed and putting on your scrubs or getting dressed to go to work has been your routine.  You need a new routine.  Changing how you are paid just adds to the anxiety.

Our opinion is when you retire, you REALLY DON’T KNOW, what your retirement expenses will be early on.  You can certainly do a great job of estimating.  If you spend a good amount on dining out or traveling while you are working, you can see you will be cutting back on that, but it is unrealistic to thin that early on.  In my last blog with my client who had long drives to work, she DID see a reduction in gas and car expenses, but other areas’ expenses did increase.

It has long been considered safe to plan on replacing 60-80% of your income in retirement.  If you hear this, do you wonder if they are asking you to cut out 20-40% of your pre-retirement spending?  Not usually, they are considering quite a few variables.  Your current paycheck has Social Security, state disability, 401k/403b savings, etc being deducted that will no longer be needed.  You will still certainly pay federal and many times state income taxes from any pension or retirement plan distributions.  But there will be a few expenses from your paycheck that will be eliminated.

Because you really don’t know what your expenses are going to be in retirement AND you are wrestling with the other changes in your life, our team works on replacing 100% of your income the first 6 months of retirement.  How do we do this?

Instead of asking what your income is, we review your paystubs and determine what you are actually taking home as pay.  After all of your deductions are taken out, what are you spending monthly?  You MAY have some of that spending money deposited directly into a savings account.  We will have to take that from the total.  As an example, lets assume you are paid $5000 every two weeks.  From all of the deductions, you actually deposit $2500 into your checking account.  You automatically transfer $250 each pay period to your savings account at the bank.  You have no excess credit card debt you are carrying.  This means you are spending $2250 a pay period or about $4500 a month.  That is the after-tax income we need to replace.

Depending on our income sources (taxable, partially taxable or tax free), we will have to work backwards to figure out how to send you $2250 every two weeks.  Best plan is to deposit $2250 from two different sources.  One COULD be Social Security or your pension, one could be your IRA distributions. 

With some clients, the pension and Social Security may cover the income needed to replace.  Most of my clients have one or the other.   One of our main challenges here centers around that irrevocable decision around the payment options to choose from our pension and exactly when to claim our Social Security. 

If we have $3000 from Social Security, we need to come up with another $1500 after tax in our example.  We will send out money from the IRA.  We will be replacing 100% of their take home pay.  

Replacing 100% of take-home income takes away the question of how to I replace that bi-weekly paycheck.  This is something we don’t want them to worry about.  In addition to the income, we always want at least 3-4 months of this income in the savings account at the bank in the event the first checks are delayed for some reason.

After 6 months, we need to re-visit our income.  This is actually one of our FIRST questions we always ask our clients at our reviews.  “How is your income?”  Many times, early on, replacing 100% of the income was more than they needed.  We know how much they had in their savings account 6 months ago.  What is that balance now?  Has it increased, decreased or stayed the same?  If it has increased, we know we are probably sending them more money than they needed.  Has it decreased?  Was there a large purchase they made or a large expense they had the last 6 months to explain the decrease?  If so, do we need to replenish that?  We will have a discussion about our spending at that point.  This could be a hard discussion or a fairly easy discussion.  If the income needs to increase, we can “turn the faucet up” a little and give them some more income.  If we don’t need as much, let’s lower the taxable income down and “turn the faucet down”. 

We see a few major challenges when we retire.  One we expect and have planned for most of the time, the second is a harder discussion.  Many times, once our clients retire, they know they are staying in their home.  They had planned for so many years to update and/or fix their home.  They are going to be spending more time there.  We SHOULD do what we can to celebrate this time.  As we do our planning, we have asked that question and we have planned on where that money will come from.

Another challenge is around our children.  There is no doubt that our children are a blessing.  However, some of us have children that need help financially.  We tend to help them as they need it because we always know another paycheck is coming.  Any savings we have for ourselves, sometimes goes to help our children buy a new home, start a new business, fund a divorce, etc.  We love our children, and we want to help.  When helping them hurts you and your retirement, we have ADDITIONAL retirement challenges and apprehension.  I have advised many of my clients to make sure the kids know; the paychecks are stopping.  Income is limited now.  You need this money to only fund YOUR retirement now, and your potential health challenges.  Many times, we have the children involved in the parents’ retirement planning if the parents are comfortable sharing their hard work. 

Replacing your paycheck can be scary.  Having a game plan and a retirement map becomes a requirement.  Understanding the pension and Social Security decisions around this paycheck and wrapping taxable and/or non-taxable income around those amounts that can be adjusted based on your post-retirement income needs is the value of working with a CERTIFIED FINANCIAL PLANNER™ practitioner.  Seek out a CFP® you trust to guide you both to and through your retirement. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mike Lockwood (CA Insurance License #0730158) is a registered representative of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors Corp. a broker/dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln Marketing and Insurance Agency, LLC and Lincoln Associates Insurance Agency, Inc. and other fine companies. 17400 Laguna Canyon Road, Suite 125, Irvine, CA 92618, Phone: (949) 341-4277. Lincoln Financial Advisors Corp and its representatives do not offer tax or legal advice.  Individuals should consult their tax or legal professionals regarding their specific circumstances. Oakwood Wealth Partners is not an affiliate of Lincoln Financial Advisors Corp. CRN-6593737-050124