Retirement Income Planning: Three Keys to Replacing Your PaycheckSubmitted by Reby Advisors | Certified Financial Planners | Danbury, CT on September 15th, 2017
Retirement is an exciting time. It also creates a lot of financial anxiety.
How can you know when you have enough money to retire? No one wants to retire, then un-retire and go back to work.
How much can you withdraw from your portfolio each year? No one wants to outlive their assets because they spent too much, too soon. You probably don't want to underspend either: retirement should be fun!
How can you keep pace with the rising cost of living? Most employers give annual pay raises to employees. That's on you now.
In the present day as guaranteed pensions are becoming extinct and Social Security simply isn't enough for most people to live on, you need to replace your paycheck with enough investment income to enjoy retirement.
This article addresses the three foundational keys to generating predictable streams of income that sustain your lifestyle through retirement.
You may also take advantage of the Free Retirement Income Plan offered at the end of the article.
How Much Money Do You Need to Retire?
You may have heard people ask questions like: Is a million dollars enough to retire? Or how much money is enough?
Rather than think about a lump sum, new retirees should change their mindset to income. Just as you received a paycheck or business profits during your working career, you'll be paying yourself in retirement.
To figure out how much money you need to generate that income, consider how much you'll spend on an annual basis. For most people, your current spending level is a good estimation. No one wants to take a step backwards, and few have the expectation of a lavish upgrade.
In addition, factor in whether any current expenses will go away, such as a mortgage or college debts that will be paid off. Also consider any major purchases. A second home, paying for the grandkids' college tuition, and leaving behind an inheritance should all be factored into your retirement budget.
Now that you know how much retirement will cost on an annual basis, find out how much you’ll receive in guaranteed annual income from Social Security benefits and pension payments. The difference between your lifestyle expenses and your guaranteed income is the amount you’ll want to earn in investment income.
Can you withdraw that much money from your investment accounts each year without running out of money? If not, you may need to delay retirement, find additional sources of income, or reduce your lifestyle expenses.
How Much Money Can You Spend in Retirement?
Many people who think they have enough money to retire end up slowly outliving their assets or reducing their lifestyle. To avoid this, it’s critical to know your “spending speed limit.”
Your speed limit is how much money can withdraw from your portfolio each year without putting yourself at risk to run out of money.
You may have heard of the rule of thumb where you can take 4% out of your portfolio and (supposedly) it will last forever. That’s great, but if you don’t know whose thumb it is, that’s a problem!
The reality is different for everyone, with “safe” withdrawal rates generally ranging from 3% to 6%.
How can that be? If you're 55 years old and want to start taking income, you may need that income to last 45 years or even more. A 75-year old may need take income for only 20 years. Additional factors to consider when assessing how much money you can afford to spend in retirement include:
- how much money you want to pass on to your loved ones (if any)
- guaranteed income streams like Social Security or pensions
- your tolerance for risk because it impacts your portfolio growth rate (see below)
- any outstanding debts like a mortgage balance
Focusing on Portfolio Growth
Many people approaching retirement will say, “I need a lot of interest bearing investments” or “I need high dividend stocks” to generate income. That’s the traditional way to get income.
Our approach is that it doesn’t matter whether your investment income comes from dividends or capital gains (or even from withdrawals of capital losses, which offset taxes), as long as your income will keep pace with rising prices and taxes.
Because the cost of living is always increasing, your portfolio will probably need to grow in order for you to sustain your standard of living through retirement.
Here’s a common mistake: investors move their 401(k) assets to all fixed income as retirement nears. Then when they visit a financial planner, the planner almost always advises them to get back into equities!
This is because almost every investor will need growth during retirement. Some of that growth will be withdrawn to fund your lifestyle, and some will be reinvested to keep pace with inflation.
This doesn't mean you're investing the same way a 30-year old would invest. Your shortened time horizon for when you need the money requires a more conservative strategy overall.
To fund short-term goals and lifestyle needs, you'll likely need some of your money in fixed income, guaranteed income products, or even cash. The money you need to live your lifestyle next month doesn't belong in the stock market!
Your risk tolerance also plays a factor. In order for a long-term investment strategy to work, you need to be able to stick with it. If you're invested outside the bounds of your personal risk tolerance and market volatility keeps you up at night, you probably won't be able to do that.
If you would like clarity on how much money you need to retire, how much you can afford to spend each year, and whether you're on track to live the retirement lifestyle you want, request a Free Retirement Income Plan from Reby Advisors.
Simply tell us a little bit about your goals and current situation in our interactive 5-minute quiz, and we'll prepare a custom plan for your family within three business days.