Author: Tracy J. McCary
Gone are the days of defined income plans (pensions) that took care of us in retirement. In their place, we now have defined benefit plans (401(k)s, IRAs, etc.), which require determining how to convert our savings into a lifetime of retirement income. This is no easy task.
When you originally began saving for retirement, your goals were general: Save as much as you can, generate the highest returns possible (based on your risk tolerance), and start outlining where and how you want to spend your retirement. While this may be an effective strategy in your accumulation years, your distribution years will require more specific planning.
You see, saving for retirement is only half the battle. The second half involves making your savings last for the rest of your life. Keep in mind that the average retirement income is $19,884 per year, at $1,657 per month from Social Security benefits.
As a retirement planner in Norman, Oklahoma, here’s what I believe you should know about your retirement income plan.
A retirement income plan is a timeline broken down year by year that shows where your retirement income will come from, how much can be expected, and how you will choose to spend it. Your plan can be as simple or complex as you decide to make it – a sheet of paper or an Excel spreadsheet both work.
In your working years, your “income plan” was your salary. Based on your paycheck, you knew what you could afford to spend each month, how much was going towards savings and investments, and the overall lifestyle you could live.
Your retirement income plan does the same thing, except you’re living off of your investment portfolio. This means your income (generated from your portfolio value) may be subject to some degree of variability, depending on the plan from which you create and the type of assets you’re drawing.
What is a good monthly retirement income? A financial advisor in Norman, OK, will help you determine that.
Now let’s consider your retirement lifestyle:
- Travel the world?
- Garden and read?
- Spend more time with your grandkids?
- Remodel your home?
Whatever your dream, one thing is sure: you need income.
Spending down your nest egg is a tricky business. If you spend too much too early, you risk severely limiting yourself later on or running out of money entirely. Spend too little, and you miss out on the opportunities to enjoy precious experiences.
How do you know if you have enough to retire?
How do you know if you’re spending too much (or too little)?
Come on, say it with me: “My retirement income plan!”
Retirement income planning helps you find the middle ground.
You will know how much you can safely withdraw and spend each year while simultaneously setting aside enough money for the big splurges. You can afford to make those purchases (or take those trips or pay those tuitions) because you’ve planned for them.
Without getting into the weeds, these are some broad topics you need to be aware of regarding income in retirement.
A Few General Numbers
Every situation is different. But, for the sake of giving you ballpark figures to work with, here are a couple of principles people use to estimate retirement expenses and income:
- You can reasonably expect to need about 80% of your pre-retirement income to cover your cost of living in retirement. If you make $100,000 now, you can expect to need $80,000 per year (in today’s dollars) after you retire.
- You can reasonably expect to withdraw about 4% from your retirement portfolio each year. This withdrawal rate can keep a steady income stream while maintaining a good portfolio value for future years. If you need $80,000 per year and your portfolio is your only source of income, you would need a total account balance of $2,000,000.
**These figures are only to be used as estimates and are based on averages. They are not applicable to your specific situation. Please consult with a financial professional.**
There are two primary forms of income in retirement: Guaranteed and variable.
Examples of guaranteed income sources are Social Security benefits, an annuity, or a pension. Guaranteed income may be used to cover core living expenses.
Examples of variable income sources are 401(k) or 403(b), TSP, IRA, or other investment accounts. Other sources may include rental income, business income, or a part-time job. Variable income may be used to fill in the gap left by your guaranteed income and cover the fun stuff – travel, hobbies, and other bucket list items.
Your plan should involve a degree of flexibility and room to be refined over time. You want a plan that can adapt to the inevitable curveballs of life. Diversifying income streams and creating complementary income sources can reduce risks such as inflation, longevity, and market fluctuations.
For example, an annuity may provide guaranteed income but not offer flexibility or growth potential. On the other hand, exposure to equities may provide significant growth potential but does not guarantee income.
Also, keep in mind every income source is taxed differently. Be highly conscious of taxes’ role in your withdrawals – don’t let Uncle Sam take more than his fair share.
An efficient tax strategy can add years to your retirement savings (or allow you to retire that much earlier).
Everyone’s income strategy will look different because everyone’s risk tolerance, goals, needs, and temperament are different. No matter the asset allocation you choose, there will be inherent tradeoffs. The key is to find a plan that works for you, balancing your holistic portfolio with every facet of your situation.
A retirement income gap is a difference between your retirement income and your actual expenses (essential living expenses and bucket list expenses) annually. Many choose to use just their guaranteed income in calculating this figure.
- If your “gap” is a deficit, you would need to withdraw from your variable income sources to have your desired retirement lifestyle. Is that withdrawal rate sustainable? If not, you’ll need to lower your expenses or increase your income.
- Suppose your “gap” is a surplus, great work! You have enough fixed income to cover your desired retirement lifestyle and can use it to add to your savings (or spend more!).
When it comes down to it, your retirement income plan gap is the single figure that will determine if you’re ready to retire with the plan you currently have established.
As a general overview, here are some of the essential items to include in your retirement income plan:
- Determine timeline – You must plan for a long retirement, regardless of whether or not you’re retiring early.
- Identify expenses – How much will you need to spend each month in retirement on essential, nonnegotiable expenses (housing, food, utilities, taxes, healthcare)? How much “fun” money do you need each month (entertainment, travel, hobbies)? Once summed, multiply by 12 to find your annual expenses.
- Identify income – What is the amount of your guaranteed income? How much will you need to withdraw from your variable income sources? Will you have enough, based on your budgeted expenses and portfolio size?
- Budget one-time expenses – Plan the significant expenses (new home, new car, Mediterranean cruise) ahead of time, so you’ll have the money set aside to cover them as they arise.
- Asset allocation – A diversified portfolio that reflects your risk tolerance and meets your income and appreciation needs comes from all of the above. Don’t forget to rebalance back to your targeted mix every year.
The retirement income planning process entails so much more. If you’re overwhelmed, you’re not alone.
Find a Financial Service Expert
Financial advisors, retirement planners – this is what we do. We meet with people like you every day to understand where you are now and want to go, then develop a plan to connect the two.
Planning out retirement income is a complicated task and one you don’t want to mess up. Why go at it alone?
Create a Tax Strategy on Retirement Plan Withdrawals
Thinking critically about which account types to withdraw from first, which have RMDs and which don’t, where you should be selling short- and long-term gains and losses, rolling into a Roth IRA. All other tax-implicated decisions can have a massive impact on stretching every dollar.
You may have dozed off in that last sentence, but understand this: An efficient tax strategy can easily add tens of thousands of dollars to your annual income in retirement.
If you don’t have the patience to optimize it yourself, hire a financial professional – it will almost certainly pay for itself.
Minimize Taxes on Your Social Security Benefits
Once your income reaches a certain level, the IRS starts taxing your Social Security benefits. Cool, right?
If you can manage, delay collecting benefits until you reach age 70, opting for traditional IRA and/or 401(k) withdrawals in your 60s. This alone can significantly increase your Social Security income when you begin collecting.
To learn the best ways to optimize your Social Security, consult with your financial advisor or a tax professional.
Look into Annuities
In general, here’s how a fixed annuity works: You buy a financial contract through an insurance company with one lump-sum payment. Then, the insurance company pays you a minimum amount every month for the rest of your life. They’re a great way to diversify towards guaranteed income.
Annuities aren’t for everyone, and there are many different types – be sure you understand the details before purchasing.
Don’t Abandon Equities
Yes, stocks are volatile. But, they’re powerful tools for growing a portfolio, especially given enough time. For many financial advisors, they’ve become a staple in the portfolios of their retired clients.
For money you don’t plan on needing in the next 5-10+ years, consider some equity exposure to maintain (and potentially grow) your portfolio, even as you withdraw from it.
A Note on Retirement Strategies
These strategies just scratch the surface of everything available to you. If you feel ill-prepared for retirement, you may be closer than you think.
By working with a financial advisor who specializes in retirement planning and can deploy every strategy applicable to you, you will give yourself the best chance to reach all of the dreams you have for your golden years.
You’ve worked long and hard to grow your nest egg to what it is today. Now that you’ve retired, your global portfolio is your income generator. Now more than ever, you’ll need to protect it with extra vigilance as market volatility, taxes, inflation, and your propensity for losing golf balls threaten your retirement.
A proper retirement income plan will meet all of your financial needs and help you sleep at night, giving you confidence today of a secure tomorrow.
If you don’t feel that way now, book an appointment with us and let us demonstrate our value by bringing you tangible results and unparalleled peace of mind.
TRAC Advisor Group Inc. is a full-service, fee-based financial advisory firm in Norman, OK. We offer independent investment advice and help people withstand any type of market volatility with confidence.
As an independent investment advisor, we can offer alternative investments like numismatics and precious metals to diversify and hedge against uncertain times. With a straightforward and direct planning style, you can trust that we’ll keep you on track towards your financial goals.