The 'Pay Yourself' Rule of Retirement Spending

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You work to earn a paycheck, and one of the scariest things about retirement is that you stop collecting one. But you don’t have to with the ‘Pay Yourself’ rule of retirement spending, and it doesn’t mean buying a complicated annuity or relying on Social Security and a pension for that recurring biweekly or monthly income.

With this rule of retirement spending, you get paid automatically as if you’re working, so you can go about the business of enjoying your newfound freedom.

“Setting up a regular paycheck for yourself smooths the flow of income,” says Jennifer Scher, Certified Financial Planner at FBB Capital Partners. “It helps you create a budget and to keep a budget.”

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Intrigued? Read on to learn what the ‘Pay Yourself’ rule of retirement spending is all about.

The 'Pay Yourself' rule dials down retirement stress

A paycheck in retirement means one thing: stability. You know how much money is coming in, which makes it easier to plan how much is going out.

It helps align withdrawals in retirement with "the old mentality of 'I got a paycheck, here’s how much I can spend,'" says Daniele Beasley, a Wealth Advisor at Mission Wealth. It enables retirees to be proactive instead of reactive with their spending, she says.

For people who like consistency, it’s much better knowing they’ll get "paid" a fixed amount each month than to guesstimate.

Sure, spontaneity is exciting, but it can also be stressful if it means frequent withdrawals or having to remember to pay bills on time. That's not required with this approach.

How the ‘Pay Yourself’ rule works

The first step in implementing this rule is to create a realistic retirement budget, taking into account all your income and expenses.

After that, come up with your annual withdrawal rate based on your retirement savings, Social Security, pension, investment income and other recurring cash flow. Consider inflation, longevity (at least twenty years if not more in retirement), and market volatility, which is where financial advisers, trusted friends, family members, or online calculators can be helpful.

“It all starts with a plan,” says Beasley. “If you don’t have a financial adviser that you work with, look at the tech options, but you want to determine how much you can spend a year without being at risk of running out of money, and once you know the number, you can set recurring withdrawals.”

Set Boundaries
Regardless of the withdrawal rate, Beasley is an advocate of guardrails when creating a retirement paycheck. (We go into that more here with the ‘Go-Live Your Life’ rule of retirement spending.)

In general, the idea is that your spending rate is tied to the performance of your portfolio. If the market outperforms a set rate, you get to spend more. If it underperforms that rate, you rein in your spending.

Beasley says the rate should be reassessed annually to ensure it's aligned with your current reality.

Where does the money come from?

Once you know how much you need, you have to decide where to withdraw money from to create the recurring paychecks. For this, you may need the help of a financial adviser and/or a tax professional.

Each account has its own tax implications. With a traditional IRA, withdrawals are taxed as income; with Roth IRAs, they are not. With a brokerage account, there are capital gains to worry about. Meanwhile, traditional IRAs have Required Minimum Distributions (RMDs); Roth IRAs do not.

“I have some clients who take out what is equal to their RMDs every month, and I have other clients who have a combination of some coming out of their retirement and taxable accounts to meet their budgetary needs,” said Scher.

In other instances, if you have the choice to create a paycheck between an IRA and a Roth IRA, choosing to do it with the traditional IRA first and letting the Roth IRA grow tax-free may be the better option.

Why not just open an annutity?

You may wonder why go to all the trouble when you can just buy an annuity and have an insurance company pay you monthly, but Beasley and Scher aren't fans.

"There’s high expenses behind them, and you don’t get to participate in the upside," said Beasley. "Some people don’t care. They’ll give up the upside for guaranteed income." Additionally, Scher notes that you can create your own annuity with a solid budget and the "Pay Yourself" rule.

Tips when creating your 'paycheck'

Creating a paycheck in retirement is easier than you may think.

Sure, it requires a few steps, but once you've completed them, you’re good to go. Beasley and Scher both suggest having taxes automatically deducted from your “paycheck” just like you would if you were working. Your financial adviser or tax professional should be able to help you determine the percentage.

Here are the general steps to set up recurring payments from an IRA. It's a similar process to set up your monthly "check" from other investment accounts, such as 401(k)s.

Establish a withdrawal rate based on market performance and spending needs, as described above and in the "Go Live Your Life" rule.
Contact your IRA custodian and request the form to set up automatic withdrawals from your IRA.
Complete the form, including your IRA account number, the dollar amount to be transferred, and when you want the money transferred each month.
Provide the checking account information for where you would like the money deposited. Choose how much state and federal taxes you want withheld.
Revisit your withdrawal rate at least annually to account for changes in market performance.

It’s as easy as that!

One less thing to worry about with the ‘Pay Yourself’ rule

Retirement can be daunting enough without having to worry about managing money in a completely new way.

With the "Pay Yourself” rule of retirement, you don’t have to skip a beat. It lets you automate one part of your retirement life, so you can focus on everything else.

Donna Fuscaldo is the retirement writer at Kiplinger.com. A writer and editor focused on retirement savings, planning, travel and lifestyle, Donna brings over two decades of experience working with publications including AARP, The Wall Street Journal, Forbes, Investopedia and HerMoney.