For many families, the entire point of saving for retirement is to create an “income engine” that produces income to pay for life in retirement after the wages stop. But creating that engine can be tricky because of how hard it is to answer the following questions:
- How long will you need the money?
- How much do you worry about needing chunks at different times during retirement?
- How sure are you about how much you need each year?
- How important is it that you have money for your heirs at the end?
All of us have at least some of these five potential income sources available:
Social Security
Every worker with at least 10 years of earnings can get a Social Security income benefit, which includes a cost-of-living increase and lasts for your entire lifetime (which is great because a lot of retirees live longer than they expect). You get the:
- Max monthly benefit if you start at age 70.
- Standard benefit if you start at age 67.
- Reduce benefit if you start early at age 62.
Guaranteed Products
Some workers have company-sponsored pension programs. Other people choose to purchase insurance contracts that will guarantee annuity income. These products:
- Can include income for life at a cost.
- Can include cost-of-living increases at a cost.
- Generally do not allow spending the principle in lumps” if you need to.
Employer-Defined Contribution Retirement Accounts
Many companies offer retirement accounts for workers such as 401(k), 401(b), and 457. When you contribute to these accounts, the employer is the legal trustee of the account, but you own it. Your earnings grow tax protected. The employer plan document controls when and how much you remove. Generally, after age 59½ you can get access to your savings without penalty. With these:
- There’s no guarantee they will last.
- Distributions prior to age 59½ are generally not permitted expect under specific circumstances.
- Distributions before age 59½ may incur a 10 percent IRS penalty.
Individual Retirement Accounts
Every worker with earned income has the option to save money into an Individual Retirement Account, such as a Traditional IRA or a Roth IRA. You own the account. Your earnings grow tax protected. You control when and how much you remove. With these:
- They can be used at any time and in any amount.
- There’s no guarantee they will last.
- Distributions prior to age 59½ incur a 10 percent IRS penalty.
Taxable Savings
Some people use generic savings for retirement income. This money is very accessible but does not have any tax advantages as it grows. With these:
- They can be used at any time and in any amount.
- There’s no guarantee they will last.
Income Factors to Consider
To build a reliable income engine, you need to balance a few factors that tend to compete with each other, including:
- Size of the monthly check. The bigger the check, the harder it is for the checks to last for a lifetime.
- How long the income will last.
- Often you must reduce the size of the monthly checks to be sure the money lasts.
- If you want to guarantee the money will last, you will need to buy a contract that can lock up your money.
- How much the income can vary from year to year.
- You can buy a contract to get a stable check year after year. This locks up your money.
- Usually, a stable payout will mean a lower payout over time.
- How easy it is to access principle. Easier access usually means lower return and more variation in account value.
- How much money will be left when you die. The more you want to spend each month, the harder it is to preserve some for the end.
As you can see, all these moving parts create a few questions:
- How do you decide what accounts to use for your income?
- How do you decide when to tap into each account?
- How can you be sure your projections are realistic and accurate?
- How do you decide when to adjust if necessary?
Some general strategic ideas:
- Keep earning as long as possible. It reduces the amount of income needed dramatically.
- Count on Social Security at age 70 as a baseline income to cover basic living expenses.
- If you retire before age 70, at retirement, buy a guaranteed income contract to cover your basic expenses up to age 70. Then once Social Security kicks in,
- At retirement, buy a deferred longevity annuity to begin paying at age 70 and last for a lifetime with a cost of living increase.
- Invest the remainder of your savings for maximum growth until it’s needed for income.
Of course, deciding exactly how to do all this can be pretty tricky. It might make sense to get the help of a CERTIFIED FINANCIAL PLANNER™ professional.
To find a CFP® professional near you, start your search here.
As you visit with financial planners, I suggest a couple things to check:
- Is the advisor always the client’s advocate – a fiduciary advisor?
- Is the advisor only paid by clients, not any financial product manufacturer or distribution network? That would be a fee-only advisor.
These two points help assure that you are working with a professional who is committed to your best interest at all times. It seems sort of obvious to me that a professional would work in this way, but it’s not automatic.
A fiduciary, fee-only, CFP® professional can help you make great retirement income choices and develop a comprehensive financial plan that is driven by your goals and priorities and addresses all aspects of your financial life. With a big-picture approach, you will be better prepared to understand your options at every step along the way.
Yes, I am a CFP® professional. I’m always a fiduciary and I only work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice.
If this article has you thinking about your own circumstances, contact my office at rdunn@dunncreekadvisors.com. I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.