How to Create a Retirement Paycheck

August 16, 2024
From understanding your income sources to prioritizing your order of withdrawals, creating a steady income stream in retirement is a complex undertaking. Consider these five rules to help guide you.

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.

Rule 1: Shore up your emergency fund

"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.

Rule 2: Determine your guaranteed income

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

Social Security

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).

Pension payments

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.

Annuities

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."

Rule 3: Consider other relatively reliable sources of income

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

A bond or CD ladder

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.

How to build a bond ladder

Staggering your bonds' maturity dates can create a steady stream of income from your portfolio.

To build a bond ladder:

  1. Purchase a number of bonds with varying maturity dates so they come due at regular intervals—say, every 12 months for the next 10 years. (For adequate diversification, consider a ladder of at least 10 high-quality bonds.)
  2. To keep the ladder going, reinvest the principal from the maturing 1-year bond in a new 10-year bond and so on as each bond comes due. But remember, the timing and frequency of each rung in the ladder should vary based on your financial situation.

If you decide to perpetually reinvest your principal, you can more frequently capture prevailing interest rates—both the highs and the lows—spreading out your portfolio's yield over time. What's more, many bonds make their interest, or coupon, payments twice a year (barring default); these, too, can be staggered to provide a predictable flow of income.

If you need additional funds to cover living expenses, you could use the principal from maturing bonds to support your spending needs rather than reinvesting it, though this would disrupt the bond ladder and its potential benefits. Keep in mind, vetting bonds can be a significant time commitment at the outset of the ladder, and regular research will be required as you seek to replace maturing bonds.

Staggering your bonds' maturity dates can create a steady stream of income from your portfolio.

To build a bond ladder:

  1. Purchase a number of bonds with varying maturity dates so they come due at regular intervals—say, every 12 months for the next 10 years. (For adequate diversification, consider a ladder of at least 10 high-quality bonds.)
  2. To keep the ladder going, reinvest the principal from the maturing 1-year bond in a new 10-year bond and so on as each bond comes due. But remember, the timing and frequency of each rung in the ladder should vary based on your financial situation.

If you decide to perpetually reinvest your principal, you can more frequently capture prevailing interest rates—both the highs and the lows—spreading out your portfolio's yield over time. What's more, many bonds make their interest, or coupon, payments twice a year (barring default); these, too, can be staggered to provide a predictable flow of income.

If you need additional funds to cover living expenses, you could use the principal from maturing bonds to support your spending needs rather than reinvesting it, though this would disrupt the bond ladder and its potential benefits. Keep in mind, vetting bonds can be a significant time commitment at the outset of the ladder, and regular research will be required as you seek to replace maturing bonds.

Part-time work

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.

Rental income

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.

Rule 4: Leverage your investment portfolio

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

Traditional 401(k)s and IRAs

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."

Brokerage accounts

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.

Roth IRAs and Roth 401(k)s

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.

Creating tax-smart withdrawals during retirement

Schwab Intelligent Income®—a feature of Schwab Intelligent Portfolios®—is an automated income solution that helps generate a predictable, tax-smart, monthly paycheck from your investments.

Deciding which accounts to draw from, harvesting your losses, and prioritizing RMDs to generate tax-smart income from your portfolio can be complicated. Schwab Intelligent Income handles that complexity, using sophisticated algorithms to consider enrolled assets across your taxable, tax-deferred, and tax-free retirement accounts and making tax-efficient withdrawals for you.

Learn more or get started.

Rule 5: Think of retirement in stages

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.

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors.

Annuity guarantees are subject to the financial strength and claims-paying ability of the issuing insurance company.

Please note that annuity withdrawals are taxed as current income, not capital gains. This may or may not be beneficial, depending on your tax bracket. Please consult a tax or accounting professional.

Bond ladder strategies, depending on the types and amount of securities within, may not ensure adequate diversification of your investment portfolio. This potential lack of diversification may result in heightened volatility of the value of your portfolio

There are risks associated with investing in dividend paying stocks, including but not limited to the risk that stocks may reduce or stop paying dividends.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Tax-loss harvesting is available for clients with invested assets of $50,000 or more in their account. Clients must choose to activate this feature.

Neither the tax-loss harvesting strategy, nor any discussion herein, is intended as tax advice and Schwab does not represent that any particular tax consequences will be obtained. Tax-loss harvesting involves certain risks including unintended tax implications. Investors should consult with their tax advisors and refer to the Internal Revenue Service (IRS) website at www.irs.gov about the consequences of tax-loss harvesting.

Schwab Intelligent Income® is an optional feature for clients to receive recurring automated withdrawals from their accounts. Schwab does not guarantee the amount or duration of withdrawals nor does it guarantee meeting Required Minimum Distributions. You may incur IRS penalties for early withdrawal of funds depending on the account type.

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