What Is Your Income Plan?

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This is the third part in a 5 part series. If you missed the first two parts, please start with The First Step In Your Journey To Retire Happy.

One of my favorite sayings is “People don’t plan to fail; they fail to plan”. It seems no matter what the subject is, this is true.

This is especially true when it comes to planning for your retirement finances.

This is because the focus for your assets in retirement is for income, where for most of your saving and investing life, the focus has been on wealth building.

Now you will use your assets to pay your bills, not your paycheck.

Questions To Ask While Building Retirement Income

When building your retirement income plan, you must include the answers to a couple of important questions.

• First, will your income last your lifetime? Given today’s longer lifespans, your retirement income will likely have to sustain for decades. After all, the fastest growing segment of our population is that of folks over 100! For many, that can mean 30, 40 or in some cases 50 years of income required. You do not want to be stressing over running out of money when you are in your 80’s or 90’s.

• Second, will your income keep up with inflation? One thing that has been apparent over the years is that, over time, things cost more. Inflation is part of our economic system. It is one of the primary objectives of our central bank, the Federal Reserve Bank, to keep inflation under control with a target of around 2% per year.

So, if your plan doesn’t allow for inflation, your ability to pay your bills and support your lifestyle will decline over time. Back in 1973 it cost 8 cents to send a first-class letter. Today, sending that same letter Costs 58 cents, more than a 700% increase! Same amount of work being done, but at a much higher cost. If the cost of your lifestyle goes up by 5%, then your income must go up by at least that or you will have to go without something in order to balance the budget.

• Third, how much income will you need to live how you want? This is the place I like to start as a target when designing the income plan. You may not have enough to create a reliable income that covers everything, but if you target an income, you will make better decisions on how to get there.

Methods That Can Be Used To Create An Income Plan

One of the most common questions I get from new clients the past few years, is “How do I take my portfolio and turn that into income so I can retire”?

I have gotten some form of this question from nearly all my referrals that are looking to retire or recently retired.

When you choose an income strategy, it is very different than the strategies we have used our entire life to build wealth, or at least it should be.

As we mentioned above, you want the income to increase over time, but not run out of funds. It should also be consistent and reliable.

When I am making a retirement income plan with a client, this is the cornerstone of securing their retirement and allowing them the confidence to retire and focus on enjoying their lives, not stressing out over running out of funds.

What’s Your Rate Of Return?

I recently had a review with a couple in my office. They kept asking about “rate of return” and I explained that “rate of return” was not what they had asked me for as an objective when we started working together.

Since they are 12 years apart in age, they wanted to be able to retire young enough so they could both enjoy retirement activities like travel and other elements of an active lifestyle. I prepared a “proposed retirement income plan” so that they could see how much income they would enjoy and how we have taken steps to insure that they don’t run out of income, regardless of the economy or market fluctuations or who is in the White House.

I also showed them how the income will increase over time, while still guaranteeing lifetime income, even for the younger spouse. I explained that now, we can concentrate on “rate of return” investing as the base of their plan is in place.

After going through their plan, they made some interesting comments.

When I reminded them that we wanted to remove the stress of worrying about running out of money from their plan they looked at each other and then said they knew several retired folks who were always worried about running out of money, even though they hadn’t and weren’t close to running out.

Just having that worry reduces your quality of life and the increased stress can even impact your health!

Income Strategies That Work

There are basically 3 different ways to strategically create a retirement income plan.

Interestingly, according to a recent article in the Wall Street Journal (Life and Work section “How to Make Sure Your Retirement Nest Egg Lasts, April 9, 2021), most folks avoid spending their nest egg and even continue to save during retirement.

This could shortchange your lifestyle, trying to conserve your principal.

Strategy 1: Systematic Withdrawal Method

The article I mentioned above referenced one of the more popular strategies, a straight withdrawal. Choose a percentage, usually 4% of the portfolio, and use that as a starting point, increasing the fixed dollar amount by inflation each year to maintain buying power.

The issue here is that when your investments drop in value and you are increasing the dollar value of your withdrawals, the chances of running out of money greatly increases. This is called “sequence of return risk”. I have a spreadsheet that models this and can “randomize” the order of S&P 500 historical returns while taking withdrawals, and the outcomes vary widely. Some sequences run out of money after 15 years, and other will go on for more than 30.

The updated thinking on this strategy is that you can increase your percentage of withdrawal to 5 or even 6%, as long as you keep the percentage of withdrawal constant. This means that if the value of your assets dropped your income would also drop for that year.

Reducing income can be tough as that is a real pay cut, and in another year like 2008, it would mean you would take about 50% less income than in the prior year. That could be a hard adjustment to someone’s lifestyle.

This method requires consistent monitoring and adjustments due to fluctuations in values from year to year. Skipping the monitoring responsibility under this approach can lead to some nasty surprises.

Strategy 2: The Bucket Approach

In this approach, you allocate some of your assets to cash. Usually 3-5 years’ worth of expenses. This is the bucket you draw your income from. This way, if the market drops, you don’t have to sell anything to pay your bills.

You then have one or two additional buckets that are invested so that you can get a higher potential return than cash is paying. Some folks will use a moderate risk and an aggressive strategy if using 2 buckets, or you can just manage them as one bucket.

When the markets are up, you liquidate some positions and take those profits to replenish the cash bucket to maintain the 3–5-year cushion that you have been taking your income from.

If using 2 buckets for investing, if there are profits in the more aggressive bucket, you move it to the less volatile bucket, eventually harvesting gains from that bucket to replenish the cash bucket as needed.

This approach is “rules based” and the rules must be followed, or you could end up drawing down your balances too fast and increase your probability of running out of money. You create your strategy statement at the outset and must monitor market volatility and performance, taking profits and maintaining cash as per the rules you establish.

This method allows you to avoid “forced selling” when your investment values are down. One of the challenges can be that keeping that much cash liquid, given today’s low interest rates, can be a significant drag on portfolio returns.

Strategy 3: The “Flooring” Approach

In this method, you create a base guaranteed lifetime income stream that meets your basic lifestyle needs. This is the amount of income to keep food in the fridge, the lights on and a roof over your head.

These income streams must last at least as long as you live and have to include a way to increase income over time to maintain purchasing power. It can be as simple as an “income ladder” that new income streams turn on every couple of years, or to have some type of indexing to the income so that it can increase over time.

The types of things we use are generally protected in some way from market losses. Things like pensions, social security, investment grade bonds, and annuities are all examples of income tools that will provide lifetime income on a guaranteed basis.

Getting the most from each of these tools requires a different strategy.

• Claiming social security can make the difference of hundreds of thousands over your retirement. I wrote about this in detail here.
• Pension maximization is something that needs to be done in advance of taking your pension benefit. Once claimed, you can’t change and might leave a significant amount on the table for a benefit you will never get to use.
• Bonds must be from a quality issuer (investment grade) and held to maturity. Bond funds do not mature, so they will not provide the required reliable income.
• Annuities need to be understood and the right ones selected based on your overall situation. They can create a steady source of income as well as income that will increase over time. Some annuities will do this better than others, so work with an adviser who understands the different options and how to evaluate the features offered and their cost. Annuities are offered by insurance companies that are uniquely qualified to hedge the longevity risk, so you won’t outlive the income benefit, even if you live past 100.

Some of you might be thinking that investment real estate could provide that income source. Well, it could, but the guarantee of income is only as strong as your tenant.

If they lose their job, get sick or the business goes under, there goes the income stream, so we usually want to make sure there is a back up in case one of those things happens.

Once you have set up the “floor” of guaranteed lifetime income that covers your basics, then you can invest the rest for growth and to provide additional capital for emergencies, opportunities or luxuries that aren’t part of your floor.

A Low Stress Retirement Is Possible

This is a very important topic to understand if you want to enjoy your Happy Retirement and live a low stress enjoyable retirement. After all, you earned it, but you don’t want to lose it.

If you want to take the first step and figure out your income target, call the office at 415-331-9030, or contact us through the website and we will provide you with a tool we call the “Spending Plan Analyzer” which will help you figure out how much income you want to live on.

The contents herein are the opinion of the speaker and should not be considered as tax or legal advice. This podcast should not be considered a solicitation for investing or advisory services. Strategies mentioned are not a recommendation to implement or purchase those products or strategies. You should contact your own advisers as to the appropriateness for your specific situation.
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