The Transition into Retirement: How to Shift from Paycheck to Portfolio Income

Most new retirees are excited to start the next chapter, but the transition can also bring some anxiety and uncertainty, especially when it comes to replacing a regular paycheck. In retirement, income may come from several different places, and you have more control over when and where you take it.

The goal is to create a retirement income plan that provides the cash flow you need while balancing investment risk, taxes, and long-term financial security.

1. Understand Your Retirement Spending Needs

One of the biggest question marks for clients approaching retirement is surprisingly simple: How much do you actually spend?

Some people have never needed to track their expenses closely because their paycheck has always comfortably covered them. Others find that spending varies significantly from month to month, making it difficult to come up with a realistic number.

Your retirement budget doesn't need to be perfect, but having a good idea of your expenses is an important starting point. We recommend separating spending into two broad categories:

• Fixed or recurring expenses: Mortgage or rent, utilities, insurance, property taxes, groceries, healthcare, and other regular bills.

• Discretionary or irregular expenses: Travel, home projects, gifts, entertainment, vehicle purchases, and other expenses that may change from year to year.

This gives us a better picture of not only how much income your portfolio needs to provide, but also how much flexibility you have if circumstances change.

2. Identify Your Retirement Income Sources

We like to compare retirement spending to filling a bucket with water. Your spending needs represent the bucket, and there may be several different faucets available to fill it.

Those faucets could include:

• Social Security

• Pension income

• Part-time or consulting work

• Cash savings

• IRA or 401(k) distributions

• Taxable investment accounts

• Roth accounts

The important question isn't simply which faucets you have. It's when and how much to draw from each one.

Social Security is a good example. Claiming earlier generally means receiving a smaller monthly benefit for a longer period, while delaying benefits increases your monthly payment up to age 70. The right decision depends on your financial resources, health, longevity expectations, marital situation, taxes, and other factors.

The first few months of retirement may also look different from later years. A final paycheck, bonus, accrued PTO payout, or other compensation may temporarily cover spending before regular portfolio distributions need to begin.

3. Create Your Own Retirement Paycheck

Once we know your spending needs and other sources of income, the portfolio can be used to fill the remaining gap. For example, if you need $8,000 per month and Social Security provides $5,000, your investment portfolio may need to provide the remaining $3,000.

We generally prefer establishing an automatic distribution that mimics a paycheck, creating a predictable direct deposit similar to what you were accustomed to while working.

We also stress to clients that retirement spending shouldn't depend on whether the market is up or down that month, nor should you feel that you can spend only the dividends and interest your investments generate.

This is one reason asset allocation matters so much in retirement. We want an investment strategy that you can stick with through both good and bad markets while continuing to support your income needs.

Maintaining an appropriate emergency reserve is also important so that an unexpected home repair, medical bill, or other large expense doesn't disrupt your retirement income strategy.

4. Understand the Tax Cost of Your Income

Most people spend their working years having taxes automatically withheld from their paycheck. In retirement, you may have to be more intentional about how those taxes get paid.

Taxes can often be withheld from Social Security, pension payments, and retirement account distributions. Depending on your situation, quarterly estimated tax payments may also be appropriate.

It's also important to understand that not all retirement dollars are taxed the same way.

Traditional IRA and 401(k) withdrawals are generally taxed as ordinary income. Qualified Roth withdrawals may be tax-free. With a taxable brokerage account, taxes generally apply when investments are sold for a gain, and the tax rate depends on factors such as how long the investment was held and your overall income.

It's common for retirees to spend down their bank savings or taxable accounts first simply because those dollars feel more accessible, while leaving their IRAs untouched for as long as possible. But that isn't always the most tax-efficient strategy.

In some years, it may make sense to intentionally take IRA distributions or complete Roth conversions while you're in a lower tax bracket. In others, drawing from a taxable account or Roth account may make more sense.

Rather than focusing solely on minimizing this year's tax bill, we look at how withdrawals from different accounts work together and what they may mean for taxes over the course of your retirement.

5. Prepare for the Mental Shift

The financial logistics of retirement are only part of the transition. We always tell clients approaching retirement that it may feel strange, sometimes much more than they expect, to go from saving throughout their entire career to actually spending those assets.

Many successful retirees got to where they are precisely because they were diligent savers, lived within their means, and were cautious about spending. Changing those habits and seeing money leave an investment account can be uncomfortable, even when their financial plan shows that they can afford to spend it.

It takes time to adjust, and a good retirement plan should have enough flexibility to adapt along the way. The money you've spent your career saving is there to help support the retirement you've been planning for.

Moving from a paycheck to portfolio income is both a financial and emotional transition. Understanding what you spend, where your income will come from, how withdrawals will be taxed, and how your portfolio fits into the picture can make that transition more manageable. And for many retirees, becoming comfortable spending the money they've spent decades saving is part of the transition, too.