Retirement Income 101: Top 5 Planning Strategies

by Rob Phillips, CPA

In the aftermath of recent market turmoil, investors are getting back to the basics as far their retirement planning goes. Although the stock market has recovered, pre-retirees have lost a lot of ground in the retirement accounts, and many who had been counting on the equity in their homes are facing a new reality, which is that retirement may not be what they had originally envisioned.

Belts will have to be tightened, retirement dates delayed, leisure plans scaled back, but, with some retirement income basics, most people should be able to get their financial situation back on track.

Start with Realistic Assumptions

To determine your income requirement, you have to be able to make some basic assumptions about your future. The most significant assumption is how long you plan to live. With life expectancies increasing, most people who reach the age of 65 can expect to live beyond the age of 80. If you’re married, there is a reasonable chance that one of you will live much longer! That’s a range of 20 to 37 years of life in retirement.

A lot of people assume that upon retirement their expenses will go down, they won’t need the sort of money they were earning while working. There have been several rules of thumb tossed about, such as 70% of earned income as retirement income need. That probably won’t cut if you need to plan for an income that is to last 30 years or more.

Your retirement lifestyle will have a price tag. If you have been driven towards a more austere existence, you still should carefully plan your retirement budget. Expenses that a lot of people fail to account for are increased medical costs (including insurance premiums), and long term care expenses. Healthcare costs are increasing faster than most other costs and are expected to reach an average annual cost of $15,000 per retiree. These days, many retirees can expect to still be paying their mortgages unless they swap out their home for a smaller one in a less expensive location.

The Inflation Factor

As a country, we have been lulled into complacency by a long period of low or no inflation. That appears to be changing, and we could be in for normal inflation cycles with possible spikes. The impact of inflation for income that has to last 30 years can be substantial. Essentially, a 3.5% inflation rate would reduce the purchasing power of your savings in half in 20 years. All basic assumptions and future income requirements should include a realistic forecast for inflation or your income or you are likely to find that your income comes up short.

Determine Your Savings Need

Using your own assumptions, you must determine the money you will need at your target retirement age that is able to generate an income flow for 20 or more years. The old rule of thumb was that required funds was based on a drawdown rate of 7% per year to make it last. Recent studies revealed that, at that current rate, retirees are exhausting their savings much too soon. Experts often say that the amount should be based on an annual drawdown of 4%, adjusted annually for inflation.

Should You Plan for Social Security?

It used to be that people, especially the Gen X and Y groups, would not consider Social Security in their retirement planning because they didn’t’ feel it would be around. These days, more people are counting on it to fill some of shortfalls that developed from declining portfolios and home equity. On average, Social Security will pay out about $1,100 a month per retiree. So, while it is becoming increasingly difficult to plan without Social Security, it is important to build an additional safety net as your retirement income foundation.

The Need for Growth

The old rule of the thumb was that, as the time horizon for retirement shortens, your investment allocation should become more conservative with an increasing emphasis on income investments and a decreasing emphasis on stock or growth investments. One such rule used your age as a guide to investment allocation advising that your income investments should equal your age. So, for instance, at age 60 your income investments should be 60% of your portfolio.

As more people reach retirement target dates with diminished 401(k) accounts, and with increasing prospects for inflation resurgence, pre-retirees will need to rethink that strategy and maintain some growth orientation in their portfolio even after retirement.

The key to achieving long term growth, while maintaining portfolio stability and flexibility, is to create a well-rounded and fully diversified investment portfolio. Large, dividend-paying blue chip stock funds, gold exchange traded funds, and income real estate investment trusts are ways to add growth and stability to a portfolio that includes income investments such as government and corporate bond funds.

Build a Safety Net

While it is crucially important to invest for growth and increasing income, it is made easier when it is done on top of an income foundation that becomes your ultimate safety net. By creating an income source that is invulnerable to market conditions and guaranteed to last as long as you do, you will feel more comfortable taking some moderate risk on a portion of your portfolio.

A lifetime annuity may be purchased with a portion of your assets and, essentially, provide the same guaranteed income stream that company pension plans used to provide retired employees. Pension plans are simply a thing of the past, but annuities are becoming increasingly popular as a way for individuals to create an income safety net that can’t be outlived.

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