Early on in my career I envisioned a sound Retirement Plan as an overflowing vault. I’d think of a childhood cartoon, Duck Tales, and Scrooge McDuck backstroking through his version of Fort Knox. Save more money than you could possibly spend. Of course, this was the brilliance of my 21 year old self - An infant in the world of Financial Planning, wondering why no one wanted to hand over their life savings for me to manage.
I was referred to the Father of an existing client and had a plan for him all laid out. A solution to all his retirement concerns: a large lump sum waiting for him in retirement.
I was WAY off.
For this client opportunity was important to him, but lifetime income mattered more. Ultimately, he decided to split his assets between an annuity at another firm and a traditional brokerage account with me. I inquired as to the thought process on his decision to place assets into an annuity as the opportunity for growth did not rival a traditional brokerage account.
I remember the conversation like it was yesterday. “I can sleep well knowing that if it all hits the fan, I’ll still have my beer and burger money” [actual quote a bit more colorful].
I use this edited quote on a weekly basis. It makes perfect sense. Create a worst case scenario for yourself during retirement to cover the essentials. For this client, beer and burgers were just that.
For Retirement, Income Matters as Much as Savings
Steady income or a lump sum? Last year, financial services firm TIAA asked working Americans: if you could choose between a lump sum of $500,000 or a monthly income of $2,700 at retirement, which choice would you make?1
Sixty-two percent said that they would take the $2,700 per month. Figuring on a 20-year retirement for today’s 65-year-olds, $2,700 per month comes to $648,000 by age 85. So, why did nearly 40% of the survey respondents pick the lump sum over the stable monthly income?1
Maybe the instant gratification psychology common to lottery winners played a part. Maybe they ran some numbers and figured that the $500,000 lump sum would grow to exceed $648,000 in twenty years if invested – but there is certainly no guarantee of that. They may have taken inflation into account and deduced that $648,000 in retirement income would purchase less across the next 20 years than it currently does. Perhaps they felt their retirements would last less than 20 years, as was the case with many of their parents, making the lump sum a “better deal.”
The reality is that once you retire, income should be the primary concern. The state of your accumulated retirement savings matters, yes – but retirement is when you start to convert those savings to fund your everyday life.
Could you retire with income equivalent to 80% of your final salary? If you have saved and invested consistently through the years, that objective may be achievable.
Social Security replaces about 40% of income for the average wage earner. (For those at higher income levels, the percentage may be less.) So where will you get the rest of your retirement income? It could come from as many as six sources.2
Systematic withdrawals from retirement savings and investment accounts. You may start taking distributions from these accounts at an initial withdrawal rate of 4% (or less). If these accounts are quite large, the income taken could even match or exceed your Social Security benefits.3
Private income contracts. Some retirees opt for these, though the income they receive may not be immediate.
Pensions. The health of some pension funds notwithstanding, here is another prime source of income.
Your home. Selling an expensive residence and buying a cheaper one can free up equity and reduce future expenses, thereby leaving more money for you to live off in the future.
Passive income streams. Examples include business income produced without material participation in the business, rental income, dividends, and royalties.
Work. Part-time work also lessens the pressure to draw down balances in your retirement and investment accounts.
Work longer, and you may indirectly give your retirement income a boost. One recent analysis from the National Bureau of Economic Research concluded that by delaying your retirement even three to six months, you could give yourself the potential to raise your standard of living in retirement as much as you would if you save 1% more of your pay over 30 years.3,4
Remember that earning too much in retirement can impact your Social Security benefits. Part of them can be taxed if your “provisional income” surpasses a certain threshold.
Social Security calculates your provisional income with the following formula: provisional income = your modified adjusted gross income + 50% of your yearly Social Security benefits + 100% of tax-exempt interest that your investments generate. (Since pension payments and retirement account withdrawals are considered ordinary income by the federal government, they both count in this formula.)3,5
If you are a married taxpayer who files a joint income tax return, as much as 50% of your Social Security benefits can be taxed if your provisional income tops $32,000, and as much as 85% if it exceeds $44,000. For single filers, the 50%/85% taxation thresholds are set at $25,000 and $34,000.5
Although your retirement benefits may be taxed, more retirement income is decidedly better than less – and a key part of retirement planning is estimating both your retirement income need and your retirement income potential. Talk to a financial professional about that matter before you retire.
This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
Securities offered through LPL Financial, Member FINRA & SIPC. Investment advice offered through IFG Advisory, LLC, a registered investment advisor. IFG Advisory, LLC and Magnolia Financial Group are separate entities from LPL Financial.
Citations.
1 - fool.com/retirement/2018/01/02/lifetime-income-retirees-need-it-and-heres-how-to.aspx [1/2/18]
2 - ssa.gov/planners/retire/r&m6.html [1/25/18]
3 - cbsnews.com/news/the-top-retirement-decisions-facing-older-workers/ [1/25/18]
4 - nber.org/papers/w24226.pdf [1/18]
5 - ssa.gov/planners/taxes.html [1/25/18]
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