If you missed it, Part 1 talks about what a retirement plan is and finding your expenses in retirement. Read it here.
Fitting Income to Expenses
Once we have a clear picture of what our needs and wants are in retirement we can start to match up income and expenses. When building out a retirement income plan there are three different categories of income that we evaluate.
1. Guaranteed Lifetime Income
Social Security - While there have been entire books written about maximizing your social security benefits, I will spare you the details here and simply say that getting this decision wrong can cost you in excess of $100,000 and the normal coffee shop wisdom on this is typically wrong.
Pensions – Pensions are becoming less prevalent, but there are a handful still floating around, particularly if you are a civil servant employed by the local, state, or federal government. Much like your social security claiming strategy, making your decision on when to claim and, if married, which option to claim can have an outsized impact on your retirement. It is certainly worth it to engage with a financial professional prior to making any elections on your pension because often times pairing your pension election with other financial products can lead to an increase in retirement income.
Annuities – Specifically we are talking about lifetime income annuities when discussing guaranteed lifetime income. Annuities have gotten a bad reputation at times and somehow have found a way to simultaneously be undersold and oversold. Without getting into too big of debate on the pros and cons of annuities, I will simply state here that they are the only financial product that exists that can take your savings and produce a stream of guaranteed lifetime income. For the right person and situation, they can provide the safety and security needed to reduce stress in retirement.
2. Semi-Guaranteed Lifetime Income
Rental Real Estate – Rental income in retirement can provide a steady (and inflation protected) stream of income that should stand the test of time. It is certainly worth evaluating the pitfalls particularly if you are going to manage the rentals yourself. While this form of income has certainly stood the test of time, you must recognize the risks associated with keeping the property maintained as well as the risk of vacancies and build in appropriate margins to address these risks when they inevitably come about. A subset of rental real estate is the rent of farm ground. A question that comes up quite frequently is whether to cash rent or crop share. Being on the planning side, I like the predictability of cash rent, but I am sympathetic towards those who gravitate towards crop sharing. It is important to note that this is not an either-or decision and I know of landowners who have successfully done a portion in each, and this has given them a portion of very predictable income while still maintaining the upside potential inherent with shares.
3. Portfolio Income
Portfolio income refers to the income received from your investment portfolio. While we do have some ways to turn portfolio income into guaranteed lifetime income via a lifetime income annuity, that is not what we are discussing in this section.
The 4% Rule – The 4% rule is the rule of thumb that states that you take 4% of your portfolio’s value as the basis for your withdrawals. You are then able to adjust it for inflation in each of the subsequent years of retirement. This rule was based on Bill Bengen’s research in the mid-1990s based on historical data of the stock market. While I think this makes for an excellent rule of thumb, in practice it is an over-simplification and does not account for the behavioral economics that allow for the higher withdrawal rate discussed below.
Retirement Income Guardrails Strategy– What sets apart the retirement income guardrails strategy from the above 4% rule is its inherent dynamic nature. While the 4% rule is generally easier to understand and thus the more discussed withdrawal strategy, retirement income guardrails allow you to start with a much higher withdrawal rate to begin with. Based on financial advisor Jonathan Guyton’s and professor William Klinger’s research, the retirement income guardrails strategy allows you to increase your withdrawals when the market does well, but requires you to decrease or tighten your belt if your portfolio falls below a specified metric. This is the method most often used in our office as it is my belief that it more closely resembles our work history with our spending expanding during the good times and contracting during the poor times.
Learn more about Retirement Income Guardrails here: Guardrails Approach: A Flexible Retirement Withdrawal Strategy (cnbc.com)
The Dangers of a Just in Case Retirement
Decisions made around retirement are among the most impactful decisions of our entire lives, and it is our mission here at QED Wealth Solutions to ensure that you avoid the “just in case retirement.” You know, that retirement that keeps the mattress stuffed full of cash “just in case”. The retirement that leads you to never checking off the items on your bucket list because of the “what ifs” that are inherent to life. It is our goal to help you live the retirement of your dreams by utilizing the wisdom of the research to craft a plan that allows you to spend your money without fear of outliving it. Retirement planning is our passion. If you are searching for peace of mind surrounding your retirement, contact us today to get started on your personalized retirement plan.
This post is for educational and entertainment purposes only. Nothing should be construed as investment, tax, or legal advice.