Businesses are complex, and fantastic, money making machines. At a high level I divide business skills into two paths:
The 'Keeping Money' aspect appeals to a wider a group, you might not think yourself in this group, but you likely are. In retirement, you effectively become self employed. Your retirement accounts is your business, and you are the employee. Knowing when to trigger taxable events, and what types of techniques are available to you make mammoth differences to net worth.
Most retirees will be moving from a pension system to a deferred compensation system. This change means that you, after many years of working, and having someone else do this for you, have to decide your 'salary'. Distributions in retirement from 401(k) plans is considered taxable income.
Throttle Up, and Throttle Down (Big and Small)
When working, income tax can be throttled up and down in a small manner, W2 income is somewhat static (since I come from the perspective where people should be fully funding 401(k) and HSA accounts where viable) and the only 'wiggle room' comes from positioning taxable income from interest or cap gains into advantaged locations.
The change in retirement is that you are able to, if desired, throttle up income. This is a new experience for a W2 worker, since asking your boss to boost your paycheck from $60K to $90K by 12/31 for tax reasons is usually met with a little resistance. The self employed individual is constantly wondering how to do exactly this, extracting money from the business (just like the 401(k)) in an efficient a manner as possible.
One big retirement goal, and one bigger caveat
Your goals in retirement (financially) should be to pay as little tax as possible, while not reducing your net worth. There is a tendency for people (perpetuated by the uniformed CPA) to seek deductions to tax at 'any' cost. If you asked a business person if they would like to reduce their expenses by 35 cents in exchange for $1 they would (hopefully) laugh you out of the door. But if you recommend that a person should donate to charity to reduce their tax bracket, they often gladly will.
Remember, spending $1 to get back anything less than $1 is bad business.
That's not to say that donating to charity isn't a great thing, it is simply to remember that the deduction (if itemizing taxes) is a bonus, not the goal.
This same logic failure occurs with mortgage interest. People (for personal gain) encourage homeowners to carry a mortgage in order to be able to deduct taxes. This is intended as arbitrage, where you'd earn money instead, but has two flaws. The first is that it is very hard, if not impossible, to find a better investment in terms of risk and reward than your mortgage right now (and much more so with higher interest loans). The second, hidden problem is your burn rate increases.
Remember, in retirement, you are suddenly 'self employed' you can control how much income to pay yourself, and when, in order to manipulate tax brackets. However, if you 'need' an extra $1900 per month to cover the mortgage, you have no choice other than to increase your income accordingly to cover that.
Burn Rate
This concept of burn rate (your annual expenses) is critical. It doesn't matter if you are a hot Silicon Valley firm with VC money, or if you are a mom and pop shop, or if you are a retiree. Controlling your need for income allows you to make more controlled and smarter decisions.
Next up.. the concept of 'Insulation'. When we look at 'earning and burning' both financially, and for our travel hobby, insulation is often overlooked.
- Making Money
- Keeping Money
The 'Keeping Money' aspect appeals to a wider a group, you might not think yourself in this group, but you likely are. In retirement, you effectively become self employed. Your retirement accounts is your business, and you are the employee. Knowing when to trigger taxable events, and what types of techniques are available to you make mammoth differences to net worth.
Most retirees will be moving from a pension system to a deferred compensation system. This change means that you, after many years of working, and having someone else do this for you, have to decide your 'salary'. Distributions in retirement from 401(k) plans is considered taxable income.
Throttle Up, and Throttle Down (Big and Small)
When working, income tax can be throttled up and down in a small manner, W2 income is somewhat static (since I come from the perspective where people should be fully funding 401(k) and HSA accounts where viable) and the only 'wiggle room' comes from positioning taxable income from interest or cap gains into advantaged locations.
The change in retirement is that you are able to, if desired, throttle up income. This is a new experience for a W2 worker, since asking your boss to boost your paycheck from $60K to $90K by 12/31 for tax reasons is usually met with a little resistance. The self employed individual is constantly wondering how to do exactly this, extracting money from the business (just like the 401(k)) in an efficient a manner as possible.
One big retirement goal, and one bigger caveat
Your goals in retirement (financially) should be to pay as little tax as possible, while not reducing your net worth. There is a tendency for people (perpetuated by the uniformed CPA) to seek deductions to tax at 'any' cost. If you asked a business person if they would like to reduce their expenses by 35 cents in exchange for $1 they would (hopefully) laugh you out of the door. But if you recommend that a person should donate to charity to reduce their tax bracket, they often gladly will.
Remember, spending $1 to get back anything less than $1 is bad business.
That's not to say that donating to charity isn't a great thing, it is simply to remember that the deduction (if itemizing taxes) is a bonus, not the goal.
This same logic failure occurs with mortgage interest. People (for personal gain) encourage homeowners to carry a mortgage in order to be able to deduct taxes. This is intended as arbitrage, where you'd earn money instead, but has two flaws. The first is that it is very hard, if not impossible, to find a better investment in terms of risk and reward than your mortgage right now (and much more so with higher interest loans). The second, hidden problem is your burn rate increases.
Remember, in retirement, you are suddenly 'self employed' you can control how much income to pay yourself, and when, in order to manipulate tax brackets. However, if you 'need' an extra $1900 per month to cover the mortgage, you have no choice other than to increase your income accordingly to cover that.
Burn Rate
This concept of burn rate (your annual expenses) is critical. It doesn't matter if you are a hot Silicon Valley firm with VC money, or if you are a mom and pop shop, or if you are a retiree. Controlling your need for income allows you to make more controlled and smarter decisions.
Next up.. the concept of 'Insulation'. When we look at 'earning and burning' both financially, and for our travel hobby, insulation is often overlooked.
