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You've saved for decades. But here's the challenge. Your 401k plan does not automatically turn into a paycheck for you. You have to create one yourself. And if you don't do it correctly, you're either going to outspend your portfolio, run out of money, or you're going to spend far too little and not fully enjoy what you've worked so hard for. So, in today's video, I'm going to show you three simple steps that will allow you to take those retirement savings and turn that into a paycheck that will support your retirement needs. Now, the steps themselves are simple. It's the nuance within these steps is what gets people tripped up. So the steps here are, number one, understand your portfolio's sustainable withdrawal rate. Number two, factor in taxes. And then number three, coordinate with other income sources. Now, the steps themselves are simple. It's the nuance. That's where people get tripped up. It's a nuance in here that allows you to optimize this paycheck. And if you don't factor it in correctly, it could be the thing that caused you to run out of money. So to make this video as helpful to you as it can possibly be, let's not just look at the steps, but let's apply it to a real example or sample example. Let's take Mary, and let's assume that Mary is 65 years old and she has $1 million in her portfolio, $700,000 of which is in her traditional IRA, $300,000 is in a brokerage account. And of that $300,000, let's assume it's all in an S&P 500 index fund. Let's make the assumption that she purchased that for $150,000 years ago, and it's now worth $300,000. So. So as we go through these steps, let's actually apply it to her situation so you can see where the nuance comes into play. So, number one, start with understanding your portfolio's sustainable withdrawal rate. Why do I say your portfolio? There's all kinds of rules of thumb or research that shows how much you can spend from your portfolio without running out of money in retirement. But here's the thing. Not all scenarios are created equal. This largely depends upon how are you invested and how long are you planning your retirement to be. Someone who's already 90 years old can spend a whole lot more from their portfolio than someone who's 50 years old simply due to how long they need that money to last for them. So in Mary's case, let's assume she has 30 years. Traditional research, you might have heard of the 4% rule. The 4% rule says that if you have 30 years of retirement in front of you, 4% is the amount you can take out of your portfolio. And even if you retire into some of the worst time periods that we've ever had here in the US your portfolio will would last for those 30 years. We're talking about periods like the Great Depression. We're talking about time periods like the 70s when you had horrible inflation combined with serious down markets. That 4% rule became something that a lot of people adopted and use it for their retirement needs. Here's the interesting thing though. For most people, that 4% ends up being far too conservative. In fact, I had a conversation on this channel with Bill Bangin not too long ago and Bill Bangan is the initial author of that 4% rule research. He did this way back in the 90s and that 4% rule is where that started. But in his words, that 4% rule for most people is far too conservative. In fact, most people would be well served by taking 6, 7% plus from their portfolio each year if they had the benefit of hindsight. I say if they have the benefit of hindsight because the problem as retirees is we just don't know what 30 year time period we're going to retire into. If we knew there was going to be an average time period, even we could spend a lot more. Who? But the thing is, we don't know are we going to retire and have another 2008 type event, or are we going to retire and have wonderful markets in front of us because we don't know that we have to lower at least our initial withdrawal rates to make sure we're not pulling too much money out too soon, Especially if you combine that with a big bear market. But here's what Bill himself said. He said that at a sustainable withdrawal rate today, if you invest your portfolio correctly and if you account for certain things along the way, it's probably closer to 5%, could be much higher depending on how the market does. But something closer to 5% might be more realistic for most people. So let's go back to Mary's example. She has $1 million in her portfolio. We simply apply a 5% withdrawal rate to that. What that means is, Mary, as you're looking to create your paycheck, $50,000 of that paycheck can be thought of as coming from that portfolio. But before we start thinking that that's it? There's two more things that we need to consider. It's not as simple for marriages to say I'm going to take 50,000 and that's what I can now live on for the rest of my life. The second thing you need to do is factor in taxes. Taxes are a huge one. When you take that 50,000, that 50,000 isn't yours. Free and clear. This is where tax strategy and tax planning and just general tax awareness comes into play in retirement. Because here's the thing. When you are working, your taxes are much different than when you're retired. At the federal level, the same tax rates still apply, but the makeup of your income and the way that it's taxed is significantly different in retirement. Retirement. Now I'm going to show you real numbers with real tax planning software so you can see how dramatically different that has the opportunity to be. But to start, just understand a few different things. Number one, in your working years, you are paying payroll taxes, FICA taxes. This is up to 7.65% of every dollar that you earn. You are paying into Social Security and Medicare. That's what your payroll taxes fund. Now, in addition to this, when you retire, Social Security tends to be a big portion of your paycheck. Social Security, a maximum of 85% of it will be included in the amount that you pay federal taxes on at the state level, depending on what state you're in. Most states don't actually tax Social Security at all. So when you look at the difference between where your income's coming from, that is a big difference. Now your standard deduction, once you're 65 or older, you get an enhanced standard deduction, which means you can deduct more of the income coming in, which means you have less of taxable income. Then if you look at things like brokerage accounts, if you're starting to live on a brokerage account, the long term gains on an account are taxed more preferentially than our ordinary income rates, things like wages, IRA distributions, etc. Or you might be pulling some of your money from Roth IRAs. And Roth IRAs of course, are completely tax free. Same with HSAs if you're using that money for qualified medical expenses. So when you look at just the general changes, you can start to see that there's the potential for your tax situation in retirement to look significantly different than your tax situation when you're working. Let's actually look at an example right now. So what I'm doing in this first scenario is I'm looking at this for Mary last year. So I'm making the assumption that last year she was still working and she earned $100,000. Just to use super simple numbers, what would her tax situation be? And then let's compare that to what would her tax situation be if she earned $100,000 in retirement? Well, if this $100,000 is just wages, all of it is included in her adjusted gross income, she would have a standard deduction for 2024. That number is 14,600. Once you back out the standard deduction from her total income or her total adjusted gross income, her taxable income is $85,400. That's the amount she's actually paying taxes on. So if we scroll down here, what we can start to see is some of that $85,000 and change is taxed at 10%. The first $11,600 is taxed at 10%. Then the next amounts from $11,600 to $47,150 is taxed at 12%. Then the remaining amount is taxed here at the 22% tax bracket. If we look at all of this, her total Federal tax is $13,841. That's not the entirety of her tax picture. That's just federal income taxes. She also is paying 7.65% for FICA taxes on the entirety of this $100,000. So that's an additional $7,650 that she's paying in FICA taxes. Now, let's just assume that she doesn't have any state income taxes to keep this as simple as possible. But the reality is, if she lives in a state where there are income taxes, she would owe even more. But if we add up Mary's payroll taxes plus her federal income taxes, she's paying just under $21,500 in taxes. If she earns $100,000. So an effective tax rate of about 21.5% when you include federal and payroll taxes. So keep that percentage in mind, about 21.5%. Now, let's assume that this year Mary retires, and this year Mary retires. And her income sources are as follows. She receives $2,500 per month in Social Security, which is $30,000 per year. She takes $40,000 from her IRA this year. So so far we're at $70,000, $30,000 from Social Security, $40,000 from her IRA. The remaining $30,000, let's assume she takes that from her brokerage account. Like I said, her brokerage account she put money in, she acquired her Investments of $150,000. They're now worth $300,000. So half of what she pulls out of that account is a return of what she already put in and what has already been taxed. And half of it is a long term capital gain. So the tax impact of pulling that $30,000 is $15,000 of it is tax free. She's already paid taxes on it. There's not an additional tax, but the $15,000 of gains that is taxed. But it's taxed at long term capital gain rates, which are lower than ordinary income rates. Using those assumptions, let me show you how dramatically different her tax situation is going to be with those numbers in her retirement years than it would have been earning $100,000 in ordinary income in wages prior to retiring. So here's that same tax report for Mary, but it's now using her retirement numbers. Right off the bat, we see something looks much different. Previously, her total income was $100,000. It's still $100,000 if we're including her cash flow, the income to her. So why is it that that shows $80,500 and not $100,000? Well, number one, Social Security, as I mentioned, some of Social Security is not going to be taxable. $30,000 is her total benefit, but $25,500 of that, so this is that 85% of her Social Security benefit. That is the portion that she pays taxes on. So $4,500 is tax free. As another way of thinking about that, that doesn't account for everything. There's another $15,000 that's not included here. Well, that $15,000 is when she pulled money from her brokerage account. Keep in mind $15,000 of that was a return of principal. She's already paid taxes on that. She's not doing it again. So she's now living on that 15,000, which means that 80,500, we're not including $15,000. That's a return of principal. And we're not including $4,500 of Social Security. That's completely tax free. That is why adjusted gross income here is 80,500 instead of 100,000. But that's not the only difference. Here's some other differences. Her deduction is now higher. Last year it was lower, partly because every year the standard deduction does go up a little bit. But Also once you're 65 or older, you get an extra senior deduction. Not just that, but for the next few years. As part of the most recent tax legislation, there's an additional senior deduction. And you can see that amount for her is $5,670. This amount does start to phase out as your income goes up. But this is an additional deduction amount. Going back to what I said of your tax situation in retirement can look dramatically different due to a number of factors. Some is assets or income sources being taxed less. Others is having more deductions than you otherwise would have in your working years. So this deduction, when we start to look at this, if we take the 80,500 of adjusted gross income back out, her normal deduction back out, her enhanced senior deduction, what we get is a taxable income of $57,080. Now, if we look at that sum is taxed at ordinary income rates. So the portion of Social Security that is taxable, her IRA distributions, those are subject to ordinary income rates. But the $15,000 of long term gains, that is subject to long term capital gains rates. So we have to look at what's the combined tax when we look at some of her income on this schedule and some of her income on that schedule, we can do so here. What we can start to see is $4,811 of taxes that she owes is based upon the income she has that's subject to ordinary income rates. These ordinary income rates go up to 37%. Now, one more thing to note here before we look at what taxes she pays on the capital gains side, and this is crucially important for those of you who are retiring, $42,080 is the amount of ordinary income she has. Before we factor in capital gains, let's take a look at that next capital gains. You can see if your taxable income is under $48,350, you pay a 0% capital gain tax on any capital gain income. Long term capital gain income up until that threshold, meaning the difference between $42,080 here and $48,350 that is subject to a 0% long term capital gain tax. Meaning of the $30,000 we pulled from her brokerage account, half of it was already tax free because that was the amount she put in. Another, approximately half of the gains are tax free because she's under this threshold. And that means they're subject to a 0% cash capital gain tax bracket. It's only the excess. So the approximately $8,700 above that, above this threshold of her long term capital gains that she pays a 15% tax on. But when we look at her capital gains tax of $1,300 and her ordinary income tax rate of just over $4,800. Her total tax is $6,121. So that's her total federal tax. Plus, as I mentioned, there is no more payroll taxes. When you're retired, if there's no wages, you're not continuing to pay into Social Security and Medicare via payroll taxes. So if we looked at her previous year's tax bill, there's about 21.5% total that was paid into taxes of the $100,000 that she took out this year in her retirement years, still taking out $100,000, but the total tax liability is about 6.1% of that. So, by the way, this strategy that Mary's employing isn't necessarily the most optimized strategy. There are ways to improve it and lower her lifetime tax liability. This is just trying to illustrate how taxes are going to be different in your retirement years than they are in your working years. But an awareness of tax planning and a general awareness of how are different things taxed is going to make a huge difference when it comes to step two, which is understanding how much of the income that you're pulling out to create that retirement paycheck is going to be subject to taxes. And then finally, the third step in creating your own paycheck in retirement is, is coordinate your portfolio income sources with other income sources. This is typically things like Social Security or pension or rental income. When you look at your portfolio, don't just think of that as a big number. Think of that as one component of the income that you can create. The paycheck that you can create. The difference between retirement and your working years is typically in your retirement, your paycheck is going to be a combination of smaller amounts of income that make up one bigger paycheck for you as a whole. So if I go back to mary's example, if $50,000 is the amount she can pull out of her portfolio, and let's assume that there's a 6% effective tax rate on that, $47,000 of that more or less is actually going to hit her bank account after taxes are accounted for. Now, just a big disclosure here. That's not going to be the same tax rate every year. That was very much based upon how much she was taken from her IRA this year and from her brokerage account this year. That was also based upon an enhanced senior deduction that's only going to last for the next few years. So this is where tax planning really strongly comes into play to say, what's the right order to take things out in. So when I say a 6% tax, that's no indication that's going to be your tax rate forever. That's just this single year, looking at the tax projection we ran. But she now needs to coordinate that with Social Security, with pension, if there's rental income, so that when it comes time to say, how much can I spend? How much can Mary spend? It's going to be a combination of all those sources. Here's the cool thing. You get complete control, well, mostly complete control over the timing of when that happens. Unlike your paycheck, that's maybe the first and the 15th or every other Friday. You get to decide when do you want your income in retirement. I have some clients, let's say they want 8,000 per month. They say, Send me that $8,000 per month on the first I want it. I'll allocate it. I'll spend it throughout the month, and then I automatically get another 8,000 on the first of the next month. I have others that like feeling like they're continuing to get a paycheck. They say, no, Continue on the 1st and 15th schedule. Send me $4,000 per month every single month on the 1st of the month, and $4,000 every single month on the 15th of the month. They then use that to recreate the paycheck that they had on an ongoing basis. Then finally, I'll have others who say, you know what, of that 8000 per month, 1500 of it, I'm putting into a vacation fund so that we can take a great vacation every four months, every six months, every eight months, whatever it is. So, you know what, James? Actually, of the 8000, send 1500 to the separate savings account and 6500 to my core checking account to be used for normal, everyday expenses. You have flexibility in your retirement to create the type of paycheck that supports your lifestyle. Then finally, something to note with Social Security is you don't actually have control over that. The thing that you don't fully have control over is the timing of when you receive Social Security. You have total control over when you file for benefits, but the actual monthly income, you can't tell Social Security you want that in the first month or the 15th of the month. If your birthday is between the 1st and the 10th of a month, you're going to receive your Social Security check on the second Wednesday of each month. If your birthday is between the 11th and the 20th of a month, you're going to receive your Social Security check on the third Wednesday of each month. And finally, if your birthday is between the 21st and the 31st of the month, then you're going to receive your Social Security check on the fourth Wednesday of the month. So you don't have control over that, but you do have control over the timing of when you pull your income from your portfolio. So those three simple steps will help you to create your own paycheck in retirement. And there are some nuances, things I'd be remiss not to mention here. A big one is, what about those other expenses? Whether that's a long term care event, whether that's a cost of a big renovation, whether that's the cost of supporting a family member temporarily or maybe, maybe doing a big family vacation every once in a while, your retirement paycheck is typically not just going to be consistent across the board. Along those lines, research actually shows you're going to spend a lot more money in the first several years of retirement, and that's going to start to dwindle over time. In your latter 70s and 80s, even, you're probably not spending as much as you were in your early and mid-60s. Now, towards the end of your life, you might be spending more due to enhanced or increased medical expenses, but there's something called the retirement spending smile where your spending starts higher, it starts to diminish in the latter, the medium parts of retirement, and then it increases again towards the later stages as you incur more medical expenses. And then finally you should also factor in things like home equity. To what extent are you going to stay in your home? Are you ever going to sell? Are you going to downsize? What other things might be unlocked, whether it's home equity, inheritance, things of that nature that could enhance or increase what you're able to do with your retirement portfolio. So I hope this helps. I hope this is something you're doing as you create your paycheck for your retirement. If you need help with this, this is what we do at Root Financial all day, every day for our clients. You can reach out to us. A link to our website is in the show notes and the resources below. If you need help with us, reach out, but at a minimum, make sure that you understand the process by which you can create that paycheck, which is understand what a sustainable withdrawal rate is for your portfolio, understand the impact of taxes on that, and then make sure you're coordinating your portfolio withdrawals with other income sources.