Broker Check

How the Rules of Retirement Income Will Change

If you are saving for retirement in your 50s, you need to understand that there are two sets of retirement income rules you will follow in life. The first one will be present during your pre-retirement (income accumulation) phase of life, as you build your career and climb the proverbial mountain. The next set of rules happens during the subsequent retirement (income distribution) phase that begins once you stop working.

If you view the accumulation phase as a steep climb, you probably see the peak of the mountain – retirement – as the attainment of a major goal. And it is! But once you reach the top of the mountain, the rules of retirement income change drastically. The distribution phase is a very different game, thanks to factors that include:

Dollar cost averaging. If you are diligently saving for retirement in your 50s and investing in assets with the goal of augmenting your retirement account, dollar cost averaging is a technique you may be familiar with. It involves buying a fixed dollar amount of a specific investment on a routine schedule, irrespective of the price per share. When prices are low, you purchase more shares; when prices are high, you purchase fewer shares. You spend the same amount of money every time no matter what, treating your investment like you are getting it on “sale” when the cost per share is low.

From the viewpoint of many financial advisors, dollar cost averaging aims to reduce the risk associated with placing a large amount of money in a specific investment at the wrong time. And that is actually somewhat true during the accumulation phase – but during the distribution phase, you’re no longer dealing with dollar cost averaging. You’re actually dealing with reverse dollar cost averaging.

Here’s why: When the market is down and you’re in the accumulation phase, you can buy more of that investment at a reduced price. It’s great! But when the cost of your investment goes down during the distribution phase, that means you will have to sell more of it to meet your lifestyle demands. Not so great, right? If you are saving for retirement in your 50s, you need to understand that dollar cost averaging will change after you retire.

Inflation. As Americans, we spend a lot of time complaining about inflation – but in the accumulation phase when we are potentially growing and compounding investments, inflation is actually our friend. It’s what makes the value of our homes go up, and it’s what improves the value of our portfolios. But in the distribution phase, inflation starts working against us.

The role that inflation plays in our financial lives completely reverses after retirement. When inflation rises, the cost of consumer goods rises with it – and retired people suffer the most, because they are no longer accumulating wealth. This is one argument against minimum wage hikes; they fail to help people living on a fixed income, including the average retiree. Although inflation is your friend as you work hard to accumulate wealth – including when you are saving for retirement in your 50s – it becomes your enemy when your income is being distributed. The rules simply change.

Tax brackets. Many people find that their tax brackets also change during the distribution phase. When you are in the accumulation phase and your 401(k) and IRA accounts are being built up, you are more likely to be in a lower tax bracket than you will be during retirement.

Here’s why: During your working years, you are probably paying a mortgage. That equals a tax deduction. You have children at home: tax deduction. You may also be running a business, which is yet another tax deduction. And if you are maintaining a middle class income at your job, you are still benefiting from a variety of tax deductions as you continue to accumulate.

But in the distribution phase, you stop getting those tax deductions. The house is paid off, the children are grown and the business is sold; very quickly, your tax deductions disappear. This presents a problem for your IRA and 401(k) accounts. Those accounts were tax deferred during the accumulation phase, but now that you use those accounts as income, you are obligated to pay taxes on them – with no deductions to help soften the blow. Your tax bracket is another part of how the rules change when it comes to retirement income, and it’s important to consider while saving for retirement in your 50s.

No matter where you are in the accumulation phase, the rules of retirement income will change the moment you start the distribution phase. Start planning for it now, by speaking with a personal finance coach who can help you prepare. Call (888) 994-6424 to request your appointment!

Dollar cost averaging does not guarantee a profit or protect against a loss. Investors should consider the amount they are able to contribute according to their financial ability over an extended period of time.