5 Key Decisions To Make In Your First Year Of Retirement

You spend most of your working life answering one retirement question: Am I saving enough?

Then you retire, and the questions change. Where will your monthly income come from, and which accounts should you tap first? How much should you set aside for taxes? When should you claim Social Security? What happens if the market drops right after you retire?

I've worked with plenty of people who spent years preparing financially for retirement but hadn't thought nearly as much about how they would manage their money once they got there.

Your first year of retirement is when you start getting some of those answers. Here are five decisions I'd focus on.

1. Decide where your retirement paycheck will come from

For most of your career, money showed up in your checking account every couple of weeks. In retirement, you're responsible for creating that paycheck yourself.

Start with how much you need to cover your regular expenses each month. Subtract Social Security and any other reliable sources of income, such as a pension. What's left is the amount you'll need to cover from savings and investments.

Then decide where that money should come from. You might have cash savings, a taxable brokerage account, a traditional IRA or 401(k) and Roth accounts. Withdrawing $50,000 from one of those accounts instead of another can have very different tax consequences.

Withdrawals from traditional retirement accounts are generally taxed as ordinary income. In a taxable brokerage account, you generally owe tax only on realized gains, not the entire amount you sell. Qualified Roth withdrawals are tax-free.

There's no withdrawal order that works for everyone. In some years, it might make sense to use more from a taxable account. In others, deliberately taking money from a traditional IRA could make sense.

If your income is lower in the years between retiring and claiming Social Security, for example, deliberately taking IRA withdrawals or carrying out Roth conversions could reduce future required minimum distributions (RMDs) and give you more control over taxable income later.

Boldin's retirement planning tool can help you compare different withdrawal strategies side by side and see how each one affects your taxes and how long your savings last. (Note: I'm head of support and a financial planning educator for Boldin.)

The important part is having a reason for where the money is coming from, rather than withdrawing from whichever account happens to be most convenient.

Once you've decided, you can set up regular transfers to your checking account. Many retirees like keeping the same rhythm they had while working, with a set amount arriving each month.

2. Figure out your new tax routine

Taxes can be one of the bigger adjustments during the first year of retirement.

While you're working, your employer withholds taxes from each paycheck. Once you retire, you may have several sources of income, each with different tax treatment and withholding options:

• Pension income and withdrawals from pretax retirement accounts are generally taxable
• Investment income and realized capital gains can add to your tax bill
• Depending on your other income, up to 85% of your Social Security benefits may be taxable at the federal level

You still need to pay taxes throughout the year. That might mean withholding from pension payments or IRA distributions, making estimated tax payments or using a combination of the two.

Pay particular attention if you retire partway through the year. Someone who retires in June might have six months of salary, a bonus or unused vacation payout, followed by retirement account withdrawals for the rest of the year. Add Social Security or investment income and that first tax year can look very different from the years that follow.

That higher income can also show up later. Medicare premiums are based on your income from two years earlier, so a big income year can mean IRMAA surcharges once you're on Medicare. Retirement or a reduction in work can qualify as a life-changing event, however, so you may be able to ask Social Security to base the surcharge on your more recent, lower income.

Estimate your tax liability before the end of the year. It's much easier to adjust your withholding or make an estimated payment than to find out the following April that you significantly underpaid. Taxes withheld from an IRA distribution are generally treated as paid evenly throughout the year, so a withdrawal late in the year can help cover a shortfall.

Once you've filed your first tax return as a retiree, review it. You'll have a much better picture of how your new sources of income are actually being taxed.

3. Decide when Social Security should start

Your retirement date doesn't have to be your Social Security claiming date, and treating them as the same decision can be expensive.

The difference in monthly income is significant. For anyone born in 1960 or later, full retirement age is 67. Someone with a $2,000 monthly benefit at 67 would receive about $1,400 by claiming at 62, or about $2,480 by waiting until 70. Because benefits are adjusted for inflation each year, that gap tends to widen in dollar terms over a long retirement.

If you retire before 70 and have enough savings to cover your expenses, you have a real choice. You could claim now and withdraw less from your portfolio. Or you could draw more from savings in the early years and let your benefit keep growing. Delaying can also create a window of lower-income years that works well for the Roth conversions and bracket planning covered earlier.

For married couples, this is a household decision. When one spouse dies, the survivor keeps the larger of the two benefits. That means the higher earner's claiming age affects not just their own income but how well the other spouse is protected later, potentially for decades.

A few first-year details are worth knowing:

• If you claim before full retirement age and retire partway through the year, a special monthly rule may let you receive full benefits for months you're no longer working, even if your earlier salary exceeded the annual earnings limit.
• If you claim and then change your mind, you can withdraw your application within 12 months. You'll have to repay what you received, and you can only do this once.
• If you've already reached full retirement age, you can voluntarily suspend your benefit to earn delayed retirement credits.

Health, longevity and cash flow all belong in this decision. What shouldn't drive it is timing alone. Claiming the month you retire shouldn't be an automatic decision. Run the numbers first.

4. Decide how you'll cover healthcare

For many people, health insurance is the biggest open question when they leave work. How you handle it depends largely on whether you retire before or after 65.

If you retire before 65, you'll need coverage to bridge the gap until Medicare. Common options include retiree coverage from a former employer, joining a working spouse's plan, continuing your employer plan through COBRA or buying a plan through the Affordable Care Act marketplace.

COBRA keeps your current coverage in place, but you'll generally pay the full premium yourself, which can come as a shock.

Marketplace coverage ties directly back to your withdrawal strategy because premium tax credits are based on your household income. Taxable traditional IRA withdrawals, Roth conversions and realized capital gains can all increase that income. The accounts you draw from in those early years can meaningfully change what you pay for health insurance.

If you're 65 or older, Medicare becomes the center of the decision. Your initial enrollment period runs for seven months around your 65th birthday. If you don't have qualifying coverage from current employment, missing it can lead to late enrollment penalties that last as long as you have Medicare.

This applies even if you've delayed Social Security, since enrollment in Medicare won't happen automatically in that case.

Ask yourself:

• What will my premiums, deductibles and out-of-pocket costs realistically add up to each year?
• If I'm choosing Medicare, do I want original Medicare with a Medigap and Part D plan, or a Medicare Advantage plan?
• Do I have health savings account (HSA) money I can use for qualified medical expenses?

Whichever route you take, ensure you're building healthcare into your budget as its own line item.

5. Decide what you'll do during a bad market

A market decline feels different when you're retired and withdrawing money from your portfolio.

Say you retire with $1 million and plan to withdraw $50,000 during your first year. Then a significant market decline occurs, and your portfolio is down to $850,000. You still need money to live on, but now you're taking withdrawals from a smaller portfolio. Selling investments after they've fallen also leaves less money invested to participate in a recovery.

Poor returns early in retirement can be particularly damaging when combined with ongoing withdrawals. This is known as sequence of returns risk, and it's worth planning for before it happens.

Ask yourself:

• How much of my near-term spending do I want in cash or other relatively stable investments?
• Which assets will I sell to fund withdrawals, and can those sales also help rebalance my portfolio?
• Which of my expenses are actually flexible?

Housing, utilities and groceries probably aren't going away because the market had a bad year. A major vacation, new car or large home project might be easier to delay.

You don't need to change your spending every time the market falls. Having some flexibility just gives you more options if a significant downturn happens early in retirement.

Replace assumptions with real numbers

A retirement plan you build while you're working is based largely on assumptions about a life you haven't lived yet. Your first year is when those assumptions start meeting reality.

After six months or a year, compare your actual spending with what you planned. Don't worry too much about individual months. Look for patterns.

If you planned to spend $80,000 a year and you're on pace to spend $95,000, figure out what's driving the difference. If you're consistently spending less than planned, you may have more room than you thought.

Look beyond spending, too:

• Are your taxes coming in where you expected?
• Are your withdrawals and cash reserves holding up?
• Are healthcare costs in line with your budget?
• If you delayed Social Security, does that decision still make sense?

Then update your plan with the real numbers and see whether you're still on track. If you're not, catching it after the first year gives you far more options than discovering it several years later.

Related Content

• 3 Options for Setting Up Your Retirement Paycheck: Choose the One That Suits You
• Five Mistakes to Avoid in Your First Year of Retirement
• 7 Money Habits of Retirees Who Never Stress About Spending
• Retirement Milestone Ages Most People Miss (And What to Do About Each One)
• I'm a Financial Planner: These 4 Spending Mistakes Can Derail Your Retirement Plan

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.