David J. Perrotto
The Four Walls of Retirement Income
With people living longer then ever, and now the average life expectancy moved up to 87 years, many people ask themselves Will they outlive their money? It might seem impossible to answer. Who really knows how long they will live, never mind the roller coaster of the investing world? This answer seemed so much easier, back in the day. Yet you can know some things, such as how much income you are likely to need in retirement, and how much you will likely generate when you actually retire. But income is the first step. After you stop working, how much money you have coming in each month will determine not only your lifestyle but the likelihood of that money lasting as long as you need it to last.
1. Social Security
It's much easier to figure out your income from Social Security contributions now than it ever has been. The government has long mailed out annual estimates, but now you can go online and look up your current retirement income analysis any time you like. Go to My Social Security and create an account. It will take a few steps to identify, but it's well worth it. From there, you can easily see what the Social Security Administration currently believes you will receive at early retirement (age 62), full retirement (67) and at age 70, the latest age at which you can file for income benefits. This should make up roughly 43% of your retirement income on average.
2. Pensions and annuities
This is increasingly rare for American retirees, but if you work or worked in the past for a government agency or a large corporation, you might have a pension plan waiting for you. This is also known as non-contributory deferred retirement plan. Likewise, you may have purchased an annuity inside an IRA as well. You can learn the ultimate monthly and annual income values of such plans by directly contacting the plan administrators. You should be getting a quarterly statement. If not, make sure they know where you live and how to contact you. This should make up roughly 25% of your retirement income on average.
3. Portfolio holdings
Income from investments can be difficult. I like to suggest that 4% is good percent of money to withdraw from a conservatively invested portfolio, a majority of that withdrawal coming from dividends. However, like investing itself, income from investments is a moving target, and can change at any given time. The important point is to make sure that your calculations include income from the other three walls here, and that you stay smart about income taxes in retirement as well. On average this makes roughly 12% of your retirement income.
It's easy to give up and say, "I'll just work forever!" But if you know what to expect from the previous three income sources, it might change your attitude toward what work you choose to continue doing and for how long. For instance, rather than seeking part-time work year-round, your income from Social Security, a pension and investments might create an opportunity to work seasonally and perhaps travel off-season. Balancing work and play is no less important in retirement as it was during your full-time working life. On average this makes up roughly 11% of retirement income.
In the end, a good retirement must be managed, much like a good career. Once you add up all of the potential income sources, things often start to look better, and if coordinated correctly, your foundation, and 4 walls will hold your financial house up well through retirement.
Putting The Four Walls of Retirement Cash Flows Together
Ultimately, these components of interest, dividends, capital gains, and principal form the four walls of your retirement income house. In some years, the biggest drivers to total return are from interest and dividends, which can be taken and spent. In other years, a bull market means ample capital gains that can be liquidated for retirement spending instead, especially in times of low yields from interest and dividends. In down years, it may be preferable to tap principal, in order to leave the rest of the portfolio invested for a hopeful future rebound. In fact, diversification across the four walls of retirement income can be a highly effective way to protect against the potential stressors that can adversely impact a retirement plan.
It's crucial to recognize that not all retirement income is actually taxable income. In fact, the process to optimize the tax-efficient liquidation of retirement accounts is entirely separate, including determining when to tap taxable vs pre-tax vs tax-free vs tax-exempt accounts, proper asset location of available investment assets across the different types of retirement accounts, as well as ongoing tax-efficiency strategies like the timing of harvesting capital gains and losses and converting your tax deferred account to tax free. One goal is to make the same amount of money stretch as much as possible, and tactfully managing your tax bracket is going to build the roof of the house.
But again, that’s actually the whole point of relying on all four walls for your retirement income. You don’t necessarily know which one will produce the desired results from year to year, but diversification gives you the best shot to get it from somewhere, without taking on excessive risk or portfolio concentration in stretching for yield along the way.
With you as the foundation, the four walls holding up your financial roof, you can make it through retirement, and not outlive your money.