If you're within five or six years of retirement, or if you're already retired, you need to have a written retirement income plan so you know three things:
- What sources your money is coming from
- When it’s coming in
- The tax implications of that income each month and each year during your retirement
These days, having a precise plan is paramount because retirement is harder for many people than it was 30-plus years ago.
Strong legs to stand on
I think back to my grandfather and his retirement. He passed away in 1991. After serving in World War II as an Army pilot, he came home to work in the insurance industry. When he retired, he had a pension, along with his Social Security and retirement savings that he and my grandma put away.
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That was in the days of the “three-legged retirement income stool.” For the most part, most people were able to cover their basic bills with Social Security and their pension — guaranteed forms of income that arrived every month. Most of the time, that income increased with inflation. Because he had a pension and Social Security, my grandfather viewed their personal savings as fun money — what he used to spoil the grandkids, like me.
But here’s the problem: Now, we have a retirement income stool that, for most people, has lost a leg. It’s really like 1½ legs. Pensions are largely gone. Because of that, much of the pressure is on you to create your own retirement income.
Sure, companies have done some nice things, such as offering 401(k)s with a company match. But, meanwhile, there are questions about the solvency of the Social Security program. Benefits could be significantly reduced in a few years, effectively shortening one of the other legs of the retirement income stool.
Or the government could extend the full retirement age. Think about it: Now, if you wanted to retire at 65, you could probably live off your personal savings for a couple of years and then turn on Social Security at 67, the full retirement age range for many people. But let’s say the full retirement age for Social Security is extended to 69, and you wanted to retire at 65. In that case, you would need to depend on your personal savings for four years of income before drawing Social Security.
When it comes to your retirement income plan, your personal savings leg of that stool is taking on a huge burden it didn’t have in the past. Now, we have to think about a different concept: How do you structure personal savings to provide the income you need over the long term in retirement?
Simple math to avoid retirement complications
It’s prudent to talk about retirement income planning in two cycles:
- What is your base income? What do you need on a monthly basis to pay your bills?
- What’s your ideal income? What do you want to do in retirement? What do you want to spend every year on your retirement goals?
You have to have a written income plan that accounts for how much you are going to spend monthly on bills and fun things. Then you subtract how much is coming in from your guaranteed income streams (Social Security, pensions, annuities). There’s often a gap, and that gap has to be filled by your savings. Here’s where the kicker comes: If 90% of your personal savings is invested in equities, you're taking on a huge risk. That’s because if the stock market dips significantly, your over-allocation in it can be a problem.
The bottom line: You do not want to have your everyday expenses tied up in Wall Street performance. What you should do to safeguard much of that money is take your personal savings and slice off the amount you need to fill that monthly gap. That needs to be your “safe money” — money that can withstand all the different seasons of the market.
With the rest of your personal savings, you can take your risks. You can try to catch lightning in a bottle with high returns in a particular year because, if your base budget is covered with monthly guaranteed income streams and the part of your personal savings you designated to cover the gap, then the rest of it is icing on the cake.
It all comes down to an income plan
I ask people all the time: What is your written income plan? They slide an income statement across the table to me. I say, “This is nice, but it’s a portfolio, not a plan. What's your written income plan?” They say, “When we need money, we just call our broker, and they sell some stuff, and it shows up in my checking account.” I ask them, “Is there a method to the madness of what they’re selling? And are you taking into account the tax consequences of the sale of those positions?”
Drawing a dependable monthly income and making sure the legs on your income stool are strong enough to stand on are the keys to a happy retirement. A written plan that includes reducing your market risk will give you more confidence about your financial future.
Dan Dunkin contributed to this article.
The appearances in Kiplinger were obtained through a public relations program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
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