3 Retirement Income Mistakes to Avoid

If your first few years of retirement coincide with a stock market decline, it may seem that you'd need to sell more of your assets to meet your retirement income goal—leaving you with fewer shares and limiting your portfolio's ability to recover during a potential market rally. If the decline is particularly steep or lasts for an extended period, it's even harder to bounce back.

Should a similar decline occur later in your retirement, you may not need your portfolio to last as long or continue generating earnings for a lengthy retirement, so you may be in much better shape to fund withdrawals.

In this scenario, both hypothetical investors started with a balance of $1 million in their brokerage accounts. They each took an initial withdrawal of $50,000 their first year of retirement and increased withdrawals 2% annually to account for inflation.

Investor 1's portfolio assumed a negative 15% return for the first two years of retirement and a 6% return for years 3–17. Investor 2's portfolio assumed a 6% return for the first eight years of retirement, a –15% return for years 9 and 10, and a 6% return for years 11–20. Whereas Investor 1's account was depleted after 17 years of drawing income, Investor 2 still had more than $100,000 in their account after two decades.

So, what's an investor to do? 

- Adjust your allocation: Consider moving a portion of your assets into investments that are more likely to weather market disruptions and volatility. We suggest that retirees keep a portion of their retirement portfolio in cash or cash alternatives to help fund expenses. Then, consider allocating some to less volatile investments, such as high-quality, short-term bonds or short-term bond funds. This can help reduce the risk in a downturn and can be especially important early in retirement.

- Stay flexible: Regardless of when a downturn occurs, it's important to remain flexible with your spending plan. If you're able to reduce your expenses or delay large purchases, your portfolio will tend to have a better chance of enduring a decline.

It's an age-old question: When should I start collecting Social Security? You can opt to collect as soon as you become eligible at 62, but taking benefits before you reach full retirement age (from 66 to 67, depending on your birth year) means settling for smaller payments—for life. But if you are in good health, have a spouse, and are able to wait even a few years longer, you stand to receive a much larger monthly check.

If you start collecting $1,706 from Social Security beginning at age 62, you would receive 30% less in monthly benefits than if you had waited until full retirement age (FRA)—and roughly 56% less than if you had waited until age 70.

Waiting to file for Social Security can also help extend the life of your portfolio. Indeed, you'll have to rely on your savings and other retirement benefits for several years before you start collecting Social Security, but the increased income that comes with deferral—which is guaranteed for as long as you live—can help preserve your portfolio down the line.

And unlike most other retirement income sources, your Social Security benefit is adjusted upward in response to inflation—so cost-of-living increases mean bigger checks. That said, delaying benefits is feasible only if you don't require the funds right away, so discuss your income needs and longevity expectations with a financial planner to bridge the gap if your paycheck stops before Social Security starts.

When it's time to turn your retirement savings into income, it might not be as simple as selling investments and pocketing the proceeds. You should consider timing, life expectancy, and, most importantly, the way withdrawals from different accounts or securities are taxed.

Keep a close eye on taxes and timing—especially once you reach age 73 (75 for those born in 1960 or later). That's when the IRS obliges you to take required minimum distributions (RMDs) from your 401(k) and tax-deferred retirement accounts, such as SEP, SIMPLE, and traditional IRAs. If your RMDs push you into a higher tax bracket, you could end up paying more on your regular income and owing taxes on your Social Security benefits as well as long-term capital gains and qualified dividends in your nonretirement accounts.

This is where a retirement income plan and tax-efficient distribution strategy can help. For example, you might choose to take withdrawals from tax-deferred accounts like traditional IRAs prior to your RMD age—when you have more flexibility to decide how and when to take distributions—to help reduce the balance and, in turn, the amount of tax on RMDs in the future.

In fact, it may make sense to withdraw earlier, both to have the funds available to support your more active years of retirement and reduce income taxes over your lifetime. Keep in mind, however, that withdrawals from tax-deferred accounts prior to age 59½ may be subject to a 10% penalty.

You may also consider converting some of your retirement assets into a Roth IRA, which is not subject to annual RMD requirements and also offers tax-free withdrawals. Just be aware you'll owe taxes on the converted amount at the time of conversion, and the funds will be subject to a 5-year holding period before you can withdraw earnings tax-free.

You can't control the markets, but with thoughtful retirement planning, you can better manage your emotional response to market volatility, taxes, and the timing of your withdrawals to help ensure you'll have enough income to meet your financial goals. A financial planner and tax advisor can help you think through the details of your investment—and distribution—strategy.