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Let’s face it; the changing social security, healthcare and investment landscapes make retirement planning more challenging than ever. Here is a walk-through of some of the more common issues, along with a few ideas to guide your retirement income strategies.
Do you really need a retirement income strategy?
The simple answer is, yes. Things are too complicated now to leave this issue to chance. A retirement income strategy is needed so you can cover living expenses, accommodate longer lifespans, protect against inflation, and maintain enough flexibility to adapt to changing circumstances. For most, social security benefits and withdrawals from IRAs will cover the majority of their retirement income. But there is always the risk of a shortfall.
The first thing to realize is that “income” isn’t the magic word. “Cashflow” is. We’ve written about this before, but by way of a quick summary, you can only meet your living expenses and accomplish your financial dreams through cashflow. Ultimately, all “income” needs to be translated into “cashflow.
So, you need to determine how much cashflow you’ll need to live comfortably. You must have an idea of your retirement goals and what the financial requirements are. In addition, psychology teaches us that there is a hierarchy of needs, wants, and dreams, and we should approach retirement in the same way.
How much retirement income will you need for necessary expenses?
How much will you want for discretionary expenses that can be reduced if necessary. If you can cover most of your basic needs through super-safe sources of cashflow, you have more flexibility to adapt your retirement portfolio to changing investment markets.
Many retirees worry that they must replace their entire paycheck when they retire. Research says that’s usually not true. On average, most high-earning retirees only need to replace between 65% to 75% of their pre-retirement income. Of course, this may not be valid for everyone. You’ll have to look carefully at this issue, but don’t just assume that you need to replace 100% of what you used to make.
Lastly, what are your dreams?
It should be easy enough to figure out what you need, and then what you want. But don’t be afraid to consider the big dreams. These are the items that go beyond just getting a new car or painting the house. Those are wants, and they come and go over time. The dreams are the big – usually one time – events; they’re the ones that you’ve always hoped you could do, but probably secretly assumed you wouldn’t do. That trip to Europe, or the second home at the beach or in the mountains come to mind.
All of these combined – your needs, wants and dreams – are important enough to nail down that you might consider working with a professional who can create an in-depth analysis of what your retirement needs to be and what it can be.
Where will you generate your retirement income?
This will come from a mix of super-safe sources like Social Security or pensions, and then withdrawals from your retirement savings. These sometimes are supplemented with cashflow from rental properties, business interest, or even second careers.
One size does not fit all. Every retiree is unique. Social security and pension benefits, rental units, businesses and careers all run the gamut. Most of the time, they are still not enough. The vast majority of affluent retirees rely on their retirement portfolio to supplement everything else they automatically receive or can generate with extra work.
How much cash can you withdraw from your portfolio without running out during your lifetime?
While you may have heard about the “5 percent” rule, we would strongly advise that you cannot rely on a simple yardstick like that for something as complex as retirement, which lasts an average of 20+ years.
To answer the withdrawal question, you will have to assess what reasonable rates of return can be earned, what your risk tolerance actually is, what the inflation rate is likely to be, and how long you may live. It’s easy to say, “oh, the average mortality is 85 years, so that’s what I’ll plan on”. But if your family has a history of relatives living into their 90s, you better plan on surpassing that. Medical science has made longer life more probable, not less probable, than what previous generations experienced.
The longer you live, the greater the flexibility you’ll need. With time comes many benefits – more time to pursue dreams, more time with the kids, etc. But time also brings more time for investment markets to go crazy. If you’ve locked yourself into one strategy (say, buying a bunch of “laddered” bonds, which is a popular but potentially dangerous choice), you run the risk that the strategy you pick is wrong for your specific experience. It’s great to plan, but all “plan A”s need to have a backup “plan B”, and many times a “plan C” needs to be waiting in the wings.
Is Social Security still one of the safe retirement income sources?
We’d answer, yes, but with a huge caveat. Taking your benefit and what Congress ultimately does to shore up social security will have a tremendous impact on all retirees.
We’ve all been led to believe that social security benefits are guaranteed for life. That is not technically true. Social security benefits are super-safe in the sense that an agency of the US government stands behind them. The truth is that in an emergency, the Congress can change social security law. They can add options, withdraw options, change payout formulas and CPI calculations; and they can phase out benefits based on income levels.
The very sad reality is that Social Security, as presently defined, is bankrupt. The benefits promised cannot be paid from any reasonable estimation of future collections and contributions from working Americans. Something needs to change.
We believe that the needed changes are relatively easy mathematically, but very difficult politically. We therefore believe that Congress will wait until the problem has reached “emergency” status before it acts. Trying to reform the system now gives too much material for any politician’s enemies to claim they want to cheat the elderly. Right now, nobody is going to touch this third rail.
Most likely – when that emergency arrives – some combination of changing retirement age, adjusting the inflation factor, and phasing out benefits based on income levels will be adopted, and the system will become solvent and healthy again.
Current formulas strongly suggest that retirees wait until they can receive their maximum benefit before they trigger social security. For most, that probably remains a good strategy. But for the ones who may earn more than whatever becomes the income cut-off for phase outs, it might be wise to trigger benefits earlier. The thought being that it will be harder for Congress to reduce or eliminate payments to people who are already collecting their benefit. The ones to see the greatest reduction would therefore be the wealthier retirees who are not yet receiving a benefit.
When should you retire?
Putting aside for a moment whether you hate or love your job, pre-retirees should consider the benefits they receive from their employer. If you’ve got a sweetheart deal in the form of health insurance, you might want to consider delaying retirement a few years. Or you might consider, switching to a less stressful job which might offer good benefits even if it offers less pay. Delaying retirement for even a few years can substantially increase your retirement savings and improve your entire retirement picture.
Saving and investing for retirement is just the first step. Developing a reasonable strategy with confidence it can be maintained over time is very different challenge.
If you feel uneasy about your situation, don’t worry; just start to take steps today to identify and improve your retirement picture. Less than one fourth of retirement-age Americans feel “very confident” that they will have enough money to enjoy their retirement. When you approach retirement with a good plan, both your odds of success and your confidence in success improve dramatically. We’re here to help, and it costs nothing to have an initial discussion and consultation.