For 30 years it was automatic. Every two weeks a paycheck hit your bank account, and you lived on it. You didn’t have to think about it, worry about it or plan for it. The money showed up, you spent it, and two weeks later another direct deposit filled the account back up.
Next month, for the first time since you were fresh out of college, that deposit won’t come.
It’s time to build your own direct deposit, funded by the nest egg you’ve worked so hard to build. So how does a retirement paycheck actually work?
The short answer: Keep about three years of spending in short-term investments like cash and Treasury bills, and set up a monthly transfer into your checking account. The key is making sure the transfer runs on a schedule and comes from the right accounts, so you keep more of it after taxes. I’ll walk you through the details.
How much should you keep in cash?
Start with what you actually spend each month. Then subtract any income you’ll still have coming in, like a pension, Social Security or part-time work. What’s left is what your investment accounts need to cover.
We line that number up with short-term investments that come due when you’ll need the cash: this year’s spending in cash, next year’s in Treasury bills that mature in about 12 months, and the year after in short-term Treasuries that mature right behind them. Add a little extra as an emergency cushion.
Why three years? Markets will have bad years. With three years of spending set aside, a down market doesn’t force you to sell stocks at a low point to pay the bills. Everything beyond the reserve stays in a balanced, diversified portfolio built for the long run, because your retirement could last 30 years or more.
How does the monthly paycheck actually work?
We set up a recurring transfer from your Schwab account to your checking account on the same day each month. It looks and feels like the direct deposit you’re used to.
Taxes are the part people forget. If the money comes from a 401(k), most one-time withdrawals carry a mandatory 20% federal withholding. From an IRA, you choose how much to withhold, and a one-time IRA withdrawal defaults to 10% (IRS). Add state taxes where they apply. Setting withholding on the monthly transfer means no surprise bill in April.
As the short-term investments get used up, we refill them. Usually that means selling some long-term investments after a good stretch in the market, so you always have about three years ready for future paychecks.
Which accounts do you draw from first?
The order matters because each account is taxed differently. A common sequence for early retirees:
- Taxable brokerage account first, often during the gap years before Social Security. You pay tax only on the gains, which keeps your reported income lower. That can help with ACA marketplace premiums, which I covered in Retiring Early? No Health Insurance Is No Bueno.
- Tax-deferred accounts next, your 401(k) and traditional IRA. Those low-income gap years can also be a good time for Roth conversions while your tax bracket is lower. Required minimum distributions from these accounts start at 75 for anyone born in 1960 or later (CRS).
- Roth accounts last. They grow tax-free and have no required withdrawals during your lifetime.
If you’re between 55 and 59½, the 401(k) at the job you just left may be the account you can tap without a 10% penalty. I explained how in Retiring Before 59½? How to Access Your Retirement Accounts Without the 10% Penalty.
A worked example: Dave and Lisa’s paycheck
This example is hypothetical and simplified. It is not based on any client and does not assume any investment return.
You may remember Dave and Lisa from Can I Retire at 58 With $2.5 Million? They’re both 58, with $1.8 million in 401(k)s and IRAs, $500,000 in a taxable account and $200,000 in Roth IRAs. They need about $120,000 a year from savings until 65, including health insurance and taxes. That’s a $10,000 paycheck every month.
| Bucket | Amount | What it’s for |
|---|---|---|
| Cash | $120,000 | This year’s paychecks |
| Treasury bills maturing in about 12 months | $120,000 | Next year’s paychecks |
| Short-term Treasuries maturing in about 24 months | $120,000 | The year after |
| Emergency cushion | $50,000 | Roof, car, the unexpected |
| Long-term investments | About $2.1 million | Everything after that |
For the first few years, most of the $10,000 comes from their taxable account. That keeps their income low enough to manage marketplace premiums and leave room for some Roth conversions. Once the taxable account runs down, the monthly transfer switches to their IRA, with federal and state withholding set on it. Their Roth stays untouched.
Once or twice a year, we refill the reserve. After a good year in the market, we sell some long-term investments to top it back up to three years. After a bad year, we let the reserve do its job and leave the long-term investments alone.
5 mistakes that can shrink your retirement paycheck
- Taking one big withdrawal instead of monthly ones. A large 401(k) withdrawal can push you into a higher bracket for the year.
- Rolling your 401(k) to an IRA too soon. Before 59½, you may give up penalty-free access under the Rule of 55.
- Skipping withholding. No taxes withheld often means a big bill in April, and sometimes an underpayment penalty.
- Selling stocks in a down market to pay bills. That’s exactly what the cash reserve is for.
- Spending the Roth first. It’s usually the most valuable money you have to leave growing.
Retirement paycheck FAQs
How much cash should I keep in retirement? Many early retirees keep one to three years of withdrawals in cash and short-term bonds. More cash means less worry in a down market, but too much can lag inflation over a long retirement.
Can I change my monthly paycheck amount? Yes. A recurring transfer can be raised for a big trip or cut back in a lean year. That flexibility is one of the best tools you have.
Do I pay taxes on my retirement paycheck? It depends on the account. Withdrawals from a 401(k) or traditional IRA are taxed as income, a taxable account is taxed only on gains, and qualified Roth withdrawals are tax-free.
Build your own direct deposit
I’m living this one myself. When I left my W-2 job this spring, I built my own direct deposit the same way, and knowing a few years of spending is already set aside helps me sleep at night.
If you’re 55 or older and want to see what your own retirement paycheck could look like, schedule a conversation. We’ll map out your spending, your cash reserve and which accounts to draw from first.
You spent 30 years building the nest egg. Now it’s time to let it pay you. Are you ready to Own Your Monday?
Own Your Monday Wealth Management is an investment adviser registered with the Maryland Securities Division. Registration is not an endorsement by securities regulators and does not imply a certain level of skill or training. Advisory services are offered only to clients or prospective clients where the firm is properly registered or exempt from registration. This content is for educational and informational purposes only and is not personalized investment, tax, or legal advice. Information is believed to be accurate as of the date published but is not guaranteed. No strategy can guarantee a particular outcome, and all investments involve risk, including possible loss. Reading this post does not create an advisory relationship. The example above is hypothetical, does not represent any actual client, and does not assume any investment return. Tax withholding rules, required minimum distribution ages and plan rules change and vary by plan; consult a tax professional about your situation. Additional information about the firm is available in our Form ADV Part 2A and at adviserinfo.sec.gov.