How To Organize Your Finances When You Retire
Everyone tells you that you need to organize your finances for retirement, but no one teaches you how to do it! Today we’re going to discuss the 7 accounts that you will likely use during retirement.
But not only are we going to list these accounts, we are going to discuss how these accounts can work together so you can have a tax-efficient retirement strategy to help you minimize the risk of running out of money or paying more than your fair share of taxes. You’ll want to make sure you understand how these accounts work together so you can create your dream retirement.
Checking Account
You are probably familiar with this account, as this is probably where most of your transactions occur. Well, this account and the next one we are going to discuss. During retirement, you’ll want to make sure that you maintain a minimum balance in your checking account to avoid overdraft and account fees. You’ll also want to keep a couple of month expenses in this account as a buffer.
2. Credit Card
While most people don’t consider a credit card an “Account,” they should. In fact, I would be willing to bet that for the majority of people, most of their transactions occur in this account, as credit cards are frequently used for recurring payments and subscriptions.
When it comes to your credit card account, make sure you have an account that has zero fees when the balance is paid off timely. If you want to explore rewards or points cards, make sure you have a plan for how it will fit into your overall financial goals. For example, if you enjoy travelling, use a card that rewards travel activity the most. Or if you do most of your shopping at your favorite warehouse, use that credit card. Be intentional and avoid the notorious credit card fees.
3. High Yield Savings Account
Let’s face it, interest rates on traditional savings accounts are horrible. While a traditional savings account may offer something like 1-10 bps today (that’s 1 to 10% of 1%) high-yield savings accounts are paying an interest rate closer to 4%. That is like a massive difference!
Online banks seem to offer the best rates on these types of accounts. But using an online bank can create a bit of a delay when transferring cash to your checking account at a traditional bank. So, make sure you are mindful of this delay when you need to get money from these accounts. Also, make sure your high-yield savings account is FDIC ensured.
4. Employer Sponsored Retirement Plan
These are the retirement plans offered by your employer, typically 401ks and 403bs.
While working, these accounts are helpful because you contribute to these accounts and potentially reduce your taxable income. Because of this feature, these accounts can have substantial balances in them.
While these accounts were effective in helping you reduce income taxes during your working years, the opposite is true when you begin to draw the funds from these pre-tax accounts. In fact, these accounts can trigger large tax liabilities later in retirement once RMDs kick in. More on that below.
5. IRA
IRAs or Individual Retirement Account can be of the Traditional (meaning your pay taxes when you take the money out) or Roth (meaning distributions from the account are tax free) variety.
Regardless of what type of IRA, all the activity that occurs within the account is tax-free. So, any interest, dividends or capital gains are not taxed in the year earned. This is an important aspect of these accounts. We’ll expand upon that a little bit later.
These are accounts that you have established for yourself, as opposed to the employer sponsored accounts we just discussed. By transferring your employer retirement plans to these types of accounts, you can have greater control over your investments.
6. Brokerage Account
Brokerage accounts are your standard investment accounts. You can pull money from this type of account at any time. Interest, dividends and capital gains recognized in this account are taxable in the year the transaction occurs. Also, the capital gain treatment of sales of assets in this account can lead to lower tax rates if the investment is held for longer than a year.
7. Health Savings Account
If you are close to retirement and don’t have an HSA, then it may be too late.
These accounts are triple tax free: 1. You receive a tax deduction when you contribute to them, 2. The growth inside the account is tax -free and 3. When used for qualified medical expenses, the withdrawals are tax free.
So, if you are planning for retirement, you may want to consider funding this type of account. Just remember that they need to be paired with a high-deductible health plan.
But beware, the tax treatment of these HSA accounts can be less tax-efficient when you pass on. This will be discussed in more detail below.
How These Accounts Can Work Together
Now that we have identified these 7 accounts, what are the best ways to use them? These are the actions that most people don’t take but should, if they want to have a successful retirement.
Checking and Credit Card Accounts
Use these accounts to track expenses and monitor spending. Make sure you have autopayment on the credit card and sufficient cash in the checking account to pay it off every month to avoid the awful fees. Always maintain a couple of months of expenses in the checking account. The last thing you want to do is incur overdraft or late payment fees. That’s just setting money on fire.
Also, with respect to credit cards, review the charges periodically. All too often, we sign up for a free trial that is simply too good to pass up on. But then forget to cancel and have a recurring charge that we completely forgot about. Review your credit card charges periodically to ensure none of these exist, and if they do, cancel them immediately.
High-yield Savings Account
Use the high-yield savings account as a cash reservoir to replenish your checking account. But rather than holding such large balances in your checking account that don’t early any interest, the high-yield savings account earns interest while you wait. Figure out the number of months expenses you want to keep in cash to cover any emergencies or rainy days. If it’s more than a couple of months, invest the rest in a high yield savings account.
But a word of caution. Make sure you keep your eye on the interest rate the account is earning. These aren’t like CDs where the rate will stay the same until the CD matures. The rates of these can change at any time. So, if they rate on yours drops, look for alternatives.
Also, make sure you know the number of days it will take for the cash to transfer from an online high-yield savings account to your brick-and-mortar bank’s checking account. The last thing you want to do is create an overdraft situation in your checking account because the funds from your high-yield savings account did not arrive quickly enough.
Employer sponsored retirement plans & IRAs
Your 401k or 403b plan was incredibly helpful to defer income taxes while you were working. But if you are getting close to retirement and no longer work for your old employer, you may want to consider transferring these assets to an IRA account. Doing so can help you consolidate your old 401k accounts into one account. This is important if you have multiple 401k accounts from several past employers and are finding it difficult to keep track of everything, particularly RMDs. Also, your employers plan may have limited investment offerings, or the fees may be too high. If that is the case, consider moving these accounts to an IRA.
Planning around IRAs is both an investment and tax management strategy. You want to make sure you have these accounts invested in a portfolio that will help you make sure you don’t run out of money. As I mentioned earlier, one key point about these accounts is that the activity within the account happens tax free. Meaning, any dividends, interest or capital gains occurring in these accounts won’t be taxed at the time it incurs. However, you will be taxed as you take distributions from these accounts. So, you will want to make sure you manage these distributions in a tax efficient manner, especially when considering RMDs. Making sure you have both traditional and Roth balances will provide maximum tax flexibility. And consolidating multiple employer retirement accounts into a single IRA can greatly simplify RMDs once you become subject to them.
Brokerage Account
The brokerage account is your standard investment account. Any activity in this account, like interest, dividends and capital gains, is taxed in the year it is incurred. However, you can draw money from these accounts completely tax free. Consider tax-efficient drawdowns along with your IRA accounts when deciding where to draw money from to cover your living expenses. A couple of strategies to use can be tax-loss harvesting where you can manage any capital gains you trigger by offsetting with losses. Also, you’ll want to consider tax location of assets by holding assets that may create a lot of income in the IRA accounts and those that don’t in the brokerage accounts.
Health Savings Account
While the HSA has beneficial tax treatment during your lifetime, it may not be when you die. If your spouse is the designated beneficiary, then the HSA status is preserved. However, if it goes to anyone else, it may become taxable in the year that it is transferred. If you have an HSA are in retirement, you may wish to prioritize spending down the funds in these accounts on the qualified medical expenses before you pass so they don’t get taxed upon your passing.
Summary
Understanding the accounts that you have and how they work together is an essential component of any retirement plan. Identify the accounts that you have and create a strategy that will be both easy to manage and tax and cost efficient.
There is more to retirement planning than what the balance is in your accounts. Structure your accounts so that things are easy to track and tax efficient, so you can keep more of what you have earned.
Presented by Irvine based Financial Advisor JP Geisbauer,CPA, CFP®, of Centerpoint Financial Management.
About Our Presenter:
JP Geisbauer is a Certified Public Accountant, a Certified Financial Planner ®, and the founder of Centerpoint Financial Management, LLC, a financial planning, investment management, and income tax planning firm located in Irvine, CA. JP Geisbauer is dedicated to helping California-based business owners and executives transition into retirement. He has been quoted in many news outlets including Forbes, Newsweek, US News & World Report, MarketWatch, YahooFinance, CNN and NerdWallet.
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Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes individual financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, consult with your own financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.