You’ve dreamed of retirement for years. But nobody prepares you for the downsides. You know, those out-of-your-control things that creep up, whether it's loneliness or a big tax bill.
Downsides in retirement can happen to anyone, but they tend to occur more often to those without a plan, who haven’t thought through the what-ifs, says Matt Radgowski, CEO of Halo Investing. “They haven’t had conversations with their partners, heirs or financial adviser,” says Radgowski. “Those who have the biggest surprises, quite frankly, didn’t do the planning up front.”
You can’t prevent all the downsides in retirement, but you can prepare and implement strategies to mitigate their impact — and even benefit.
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From navigating the realities of living on a fixed income to dealing with the tax implications of retirement withdrawals and required minimum distributions (RMDs), here’s how to turn these downsides of retirement into upsides.
1. The Retirement Downside: You're on a fixed income
Rich or poor, retirement means the same thing to everyone: a fixed income. That can be jarring if you are accustomed to earning a paycheck regularly. It's the downside of retirement that is hard to get used to once it's a reality.
That fixed income, which typically comes from a combination of Social Security, savings and potentially a pension, may cause spending paralysis or may not be enough, which all requires action.
The Upside
Just because you are on a fixed income doesn’t mean you have to constantly worry about running out of money. There are ways to create recurring revenue streams that can give you peace of mind or permission to spend.
Annuities that guarantee income through your lifetime are one way. A bond ladder strategy that generates income each year as the bonds mature is another. Both can contribute to your monthly cash flow, but they are not without complexities. A trusted financial adviser can walk you through both.
2. The Retirement Downside: A big tax bill is on your horizon
Death and taxes are two of life’s guarantees. When it comes to the latter, if you have an IRA or 401(k), expect to pay more whenever you withdraw from it in retirement, especially after the age of 73. That’s when RMDs kick in, and you’re required to withdraw a portion of your 401(k) each year.
That money is treated as taxable income, and depending on how much you withdraw, it may push you into a higher income bracket, resulting in a sizable tax bill.
The Upside
If you want to avoid RMDs in the future and find yourself in a lower income bracket today, it may be worth it to consider a Roth conversion. This occurs when you move money out of a traditional IRA or 401(K), 403(b) or 457(b), pay taxes on the withdrawals and shift it into a Roth IRA to enjoy future tax-free growth.
Beyond the potential for tax-free gains, Roth IRAs have no required minimum distributions and allow tax-free withdrawals after five years and at the age of 59 1/2. Keep in mind that the conversion not only triggers immediate ordinary income taxes in the year of the conversion but also requires you to satisfy your RMD for the year before you can convert funds.
A Roth conversion also makes sense if you want to leave tax-free money to your heirs or avoid the Medicare Income-Related Monthly Adjustment Amount.
Another option is to use a Qualified Longevity Annuity Contract (QLAC), a type of annuity that is excluded from RMD calculations until the annuity payments begin, which can be as late as age 85. That means you could withdraw a reduced amount of RMDs between 73 and 85 and lower your tax hit.
If it's not about avoiding RMDs but rather dealing with taxes on withdrawals, Isabel Barrow, executive director of financial planning at Edelman Financial Engines, says the best way to handle it is to have the taxes taken out at the same time you take the withdrawal.
Alternatively, if you can’t have the taxes taken as a percentage of each withdrawal automatically, you might consider paying quarterly estimated taxes, said Barrow. “No one wants to end up with a huge unpaid tax bill in April, especially if you haven’t planned for it.”
3. The Retirement Downside: You lose your social connections, structure
Retiring can be hard to get used to. You dreamed about the day when you could stop working, but now that it's a reality, you may not know what to do with all your newfound free time.
For many people, their social connections, self-worth and daily structure are tied to their job, and when they lose that, they lose their sense of purpose. This can be detrimental to their well-being and state of mind. “So many people I have encountered in the industry have come back to the workforce not out of necessity but more for fulfillment," says Radgowski.
The Upside
The good news is that there are many options to build a social network and purpose into your retirement life. Barrow pointed to online groups, classes, community groups and charities as ways to connect with people and get out of the house. “Take a cooking class, join a walking group, take up pickleball, or volunteer for a charity. Be proactive about meeting people and creating a new network to help you transition into retirement,” said Barrow. Part-time jobs, consulting, or volunteering are other options to find a sense of purpose and make friends.
As for a lack of structure, Barrow suggests that while you don’t have to create a schedule like when you went to work every day, try to establish a routine and stick to it. The more structure and purpose you have in life, the happier you will be in retirement.
Plan to protect from the downsides
Retirement is a journey, and while there are downsides, they can easily be turned into upsides.
Whether it's taxes, a fixed income or loneliness, you can overcome retirement challenges by going into this next journey with a plan to tackle every and all potential downsides.
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