Welcome to this workshop, Retirement Income Planning.
We think of your financial life as unfolding in three stages. The first is Financial Safety focused on building a good foundation. Next is Wealth Accumulation where we gather resources for the final stage, Financial Freedom is having the money resources you need to do the things that bring joy and fulfillment to life. For more on the money stages, check out our Money Milestones course.
This session, Stage 3, Financial Freedom course.
What exactly is retirement income planning? Well, we think of it as getting to a point where you have enough income to maintain your standard of living for the rest of your life, regardless of how long you live. Sounds good, right?
Here are the four steps of retirement income planning. Step 1 figure out how much you will need. What expenses will be new in retirement and which ones will be reduced or eliminated? Next estimate how long you will live by considering how long your parents and grandparents lived. Third, think about where you will draw retirement paychecks from. The most common sources are social security, savings, investments, and part-time work. Finally, and most importantly, you will need to make sure your plan will work. That requires you to test and adjust your plan as you get closer to retirement.
The sooner you start retirement income planning, the better. That’s because you can fine-tune your estimate of how much income you will need to maintain your lifestyle when your working days are behind you. Consider your gross pre-retirement income then subtract payroll taxes and contributions to accounts like 401ks, IRAs, etc. That leaves your estimated retirement income need.
A general rule of thumb is to plan to replace 70-80% of your pre-retirement income to fund a similar retirement lifestyle.
Next, think about how long you might live. According to the Society of Actuaries, assuming excellent health, one-third of today’s 65-year-old women and about one in four men are expected to be alive to celebrate their 95th birthday.
While living a long, healthy life is an aspiration of most folks, living several decades without a paycheck presents its own set of challenges. With one of the most significant being inflation.
Inflation is the rate of change in prices. Rising inflation means you must pay more for the same goods and services from one year to the next. This has a significant effect on our cost of living including... higher food costs, higher gas costs, higher utility costs, and higher interest rates on loans and mortgages. These rising costs mean your dollar doesn’t stretch as far.
In 1916, 9 cents would buy a quart of milk. By 1966, your 9 cents got you just a small glass of milk and by 2017 9 cents bought a mere seven tablespoons of milk. Imagine how far 9 cents will stretch when you retire? This is the reality of inflation.
As you approach retirement, your appetite for investment risk will likely decrease. You may even want to move your money to “safe” investments like cash and bank instruments like CDs. But
Is cash safe? Sure, your balance won’t drop from one statement to the next but is that what “safe” means when it comes to retirement income planning?
This chart shows the 1-year bank CD interest rate minus annual inflation. You’ll notice that since 2018, CD investments have been losing. Granted, it’s not dollars they are losing but since those dollars aren’t earning enough to outpace inflation, they are losing purchasing power.
So, if most investors aim to reduce risk as they approach their golden years, and cash isn’t going to cut it, what can retirees do?
The short answer… stay invested. This chart from JPMorgan shows the average annual returns for different investments from 2002 to 2021. Inflation has averaged 2.2% annually while cash has earned an average of 1.2%. Stocks and Bonds have faired better.
If the goal is to reduce risk but stay ahead of inflation, a good strategy is to build a balanced portfolio that contains a variety of investments. Portfolios with 60% stocks and 40% bonds as well as those that were less aggressive with 40% stocks and 60% bonds faired well relative to inflation and much better than cash.
Over this same period, the average mutual fund investor outpaced inflation but fell short of the returns offered up by other investments and balanced portfolios. One reason is that investors often sell investments strategy when markets go down, in essence buying high and selling low which is not the road to wealth.
The name of the game is still “stay the course” which is easier said than done. Check out our Beware the Media workshop and be sure to schedule time to meet with a coach to build a retirement investment portfolio you’ll be able to stick with.
Okay. Let’s shift from inflation and investing to spending, which is more fun to talk about. Step three in retirement income planning is to determine where your paycheck will come from when your working days are over. The obvious one is social security which accounts for 40% of the typical retiree’s income. Some may still have a traditional pension benefit which usually represents 10%. Others may have a part-time job or some other source of income. But, a significant contributor to your retirement lifestyle will be the choices you make when it comes to saving and investing.
When it comes to investing for retirement income success, you have to stay invested. When you rely on savings and investments for your lifetime paycheck, you will also need to stick to a safe withdrawal rate. That’s because spending too much too soon can deplete your investments. Next, create and stick to a spending plan. Unexpected things will still happen in retirement so monitoring day-to-day spending is really important. Check out our Start Smart workshop which focuses on building a spending plan. Finally, as we say in nearly every workshop, a key to retirement income success is having adequate emergency savings.
Let’s talk about a “safe” withdrawal rate. As you are putting money into your retirement savings, you naturally want to maximize your growth. That means taking more risks with investments. But as you enter retirement, you reduce risk. Which also means reducing the potential growth of your savings.
Let’s say that your pre-retirement growth portfolio earns an average of 7% per year. But, as you adjust that growth portfolio to a 40% stock:60% bond portfolio, like the one we saw in the JPMorgan chart, you might expect earnings of about 5-6% per year.
If you want your savings to continue to grow in order to keep ahead of inflation, you will need to withdraw no more than 5% of your account annually. If your withdrawal rate exceeds the earning power of your account, you might find yourself running OUT of savings.
Okay. We have completed steps 1 through 3. Now it’s time for the last step – testing the plan. Assume your current income is $85,000 annually. You expect to need 75% or $63,750 per year of retirement income. Your income will come from Social Security and your personal savings and investments. Finally, let’s assume you have a family history of average life expectancy.
There are basically three dials we can turn in order to get this employee’s retirement income plan on track. First, they can save more. They could also reduce their retirement income or plan to work longer.
Let’s first try to get the employee on track by saving more. If we increased their savings rate from 8% to 31%, the analysis suggests the employee would have some money remaining at the end of their life expectancy.
Next, we could test reducing the employee’s retirement income. If we reduce from a 75% income replacement to a 60% income replacement, the calculation shows a little bit remaining at the end of the plan.
Finally, let’s consider working longer. If they work until age 67 instead of retiring at 62, the calculator estimates they will have some funds remaining at the end of their plan.
In our other scenarios, when the employee planned to retire at 62, their employee’s anticipated social security income was about $32,000. Notice that delaying retirement to age 67 gives them time to save more but also gives them a sizeable raise in their social security check. We will come back to that in a minute.
There is one final option. That is adjusting all three dials. Retirement income planning can be complex and figuring out which option has the best impact on your situation is critical.
In our “work longer” scenario, we saw the benefit of delaying Social Security. Our workshop, Social Security Overview, takes a deep dive, but I’ll mention a few key aspects of our national retirement system here.
You can start receiving benefits as early as age 62 or you wait until as late as age 70. Depending on when you were born, your full retirement age ranges between 66 and 67. Each year you wait, you get an 8% pay raise. That means taking your benefit before full retirement age can leave a big dent in your social security paycheck.
In fact, the difference between your check at age 62 and your check at age 70 can be as much as 76%. That’s why you tend to get the biggest impact on your retirement success when you turn the “work longer” dial.
Okay. We are on the home stretch now. Let’s highlight things you can do to get your retirement plans on track. You can delay retirement, save more in your 401k, and think about downsizing your home which helps by cutting expenses and perhaps realizing some additional dollars to invest. Also, be sure you complete a cash flow analysis so you can fine-tune your retirement income estimate. Also, check your investment portfolio allocation and consider rebalancing to reduce risk as you head toward the retirement finish line. Remember the benefits of delaying your application for social security and striving for good health. That helps your quality of life and reduces money spent on healthcare.
Be sure to consider any additional income sources you may have overlooked including working part-time or selling some personal assets. Some folks might also have rental income. Then there are things like reverse mortgages and inheritance. Although, we generally do not suggest depending on these two income sources when preparing your plan. These are “last resort” or “icing on the cake” situations.
Okay. We made it. In our time today, we covered the components of retirement income planning. First, evaluate your current situation and, wherever possible, live below your means. This helps you practice retirement by living on less. Another way to practice retirement is to reduce your take-home pay by saving more in your retirement accounts and paying down debt. Also, don’t forget the importance of building that emergency savings account ideally for 12 months or more of your living expenses. Finally, do no harm! Avoid raiding retirement savings or taking loans from your 401k. In this last lap of your working days, it’s hard to rebuild savings.
Retirement income planning isn’t about being rich. It’s about having enough money to buy time.
And you can get there by taking just the best next step. Google is full of advice. So are family and friends. But not all advice matches your situation.
Schedule right from your MyMoneyNav dashboard or email yourfinancialcoach@moneynav.com.
A great next step is to complete the MoneyNav assessment. Your responses will be used to build a personalized set of best next steps or MoneyMoves to get you on track and moving forward. Email yourfinancialcoach@moneynav.com for a link to your company’s assessment.
And finally… Be sure to keep joining us for MoneyMondays. To view upcoming sessions and to sign up, visit www.moneynav.com/moneymonday. On behalf of the entire MoneyNav team, thanks for joining me today! If you have questions on this topic or another, please reach out. We look forward to connecting with you.