Maybe you’re a little like me.
In the “home stretch” of your career.
You’ve worked hard for decades. Climbed the corporate or business ladder, or simply found a decent job and showed up every morning ready to work. Day in, day out. Week after week. Month after month. Year after year. Decade after decade.
Now, you’re in your late 50s or early 60s, and it’s starting to dawn on you.
It’s almost time.
If you’ve been fortunate, privileged, frugal, or some combination of those, in a few years, you’ll be able to retire.
And that’s when it hits you.
No more paychecks. No more client payments. Instead, you’ll have to establish your own paychecks, funded by your portfolio and other retirement income sources.
Are you getting a bit queasy at the thought of having to start drawing down your portfolio to generate retirement income, when you’ve spent decades building it up?
No worries. That’s what we’re here for today.
Below, we discuss retirement income planning and share ideas to help you create your own forever retirement paychecks from multiple sources of income to ensure you can enjoy a comfortable retirement.
While your personal circumstances will differ from mine, the concepts in this article offer an approach to turn the sources of income available to you into a sustainable stream of paychecks in retirement. As you begin to prepare your own retirement income strategy, you may want to consider hiring a financial advisor experienced in retirement planning who can help you develop a personalized plan tailored to your needs.
With this article as a guide, and as you begin to consider how these concepts apply to your own situation, you’ll be on a clear path to create your own retirement income plan with forever retirement paychecks that will last a lifetime.
Where Can You Find Sources of Retirement Income?
Here are 21 different potential sources of retirement income. Depending on your personal circumstances, how much (if any) money comes from each of these will vary. In fact, even in your personal case, it will likely vary over time.
First, let’s start with “regular” retirement income. These are sources that will generate recurring retirement income each month, like your regular paycheck. The advantage here is that you bear next to zero risk or responsibility for coming up with this money. For example:
- Your Social Security retirement benefits, once you claim them between age 62 and 70
- Your spouse’s Social Security retirement benefits, once s/he claim them between age 62 and 70
- Defined-benefit pensions and/or cash-balance plans
- Annuitized 401(k) – some plans let you convert your 401(k) balance into a plan that pays you a set amount just like an annuity
- Immediate and/or deferred annuities
- Reverse mortgage
- Part-time paychecks
Next, there’s what I’ll call “semi-regular” retirement income. These sources are pretty reliable, but not as much so as the above regular sources. They don’t guarantee a payment of a specific sum and/or continued payments. You may need to periodically roll over from one vehicle to another or find a replacement of some other sort. For example:
- Payments from variable annuities – what you get depends on how well the underlying investment does, but they typically have a set minimum and a set maximum
- Interest from savings accounts, certificates of deposit (CDs), bonds, money market funds and/or accounts, etc.
- Stock dividends
- Profit distributions from shares in a private business
- Rent payments from residential and/or commercial rental real estate
- Premiums from selling covered options
- Credit card rewards
- Monetized hobbies including, e.g., Medium Partner Program payments
- Required Minimum Distributions (RMDs) from your retirement accounts once you turn 72 – equal to the balance of those plans divided by your approximate remaining life expectancy (failing to take RMDs on time incurs massive penalties equal to half the amount you failed to take!)
Finally, there’s the least predictable source of retirement income – your investment returns. These can be large, small, non-existent, or even negative. For example:
- Stock portfolio returns (even if these are negative, you can take out money, but it means selling shares at a loss)
- Bond price appreciation
- Real estate price appreciation
- Cryptocurrency appreciation
In extreme cases, an investment may go down to zero. If you’re especially incautious (e.g., selling uncovered call options or short-selling a stock) your losses can even be far worse than losing 100% of your investment.
Streamline & Simplify Your Retirement Income Sources
One thing I’m already thinking of for myself is the importance of simplicity.
If you have multiple 401(k) plans, 403(b) plans, individual retirement accounts (e.g. SEP IRA, Roth IRA, traditional IRA), taxable investment accounts, annuities, etc., staying on top of everything is a challenge in the best of times. As we get older (and I’m talking 80s, 90s, or beyond older), I can only imagine how much more challenging this will be.
As a first step, consider simplifying your financial life by e.g.:
- Merging similar accounts (make sure the amounts there don’t exceed the limits of FDIC insurance)
- Moving most or all of your accounts to a single bank (again, consider FDIC limits)
- Rolling 401(k) and 403(b) retirement plans into an individual retirement account (though note that IRA money may be less protected against creditors than 401(k) assets)
- Rolling over IRAs to one or two entities (making sure those entities get high governance marks)
Next, figure out the logistics of how your retirement income will flow into your checking account, establishing that “forever retirement paycheck.” This is needed unless all your retirement income will come from the “regular income” category above.
One example might be to set up a “cash bucket” (see more about this below) in a high-interest checking account or a money market fund, with at least enough money for 2 years (I myself plan to make it 4 years’ worth of our expenses), and set up an automatic transfer to your checking account for the 1st of each month.
That will be your forever paycheck.
How Much Income Will I Need in Retirement?
Knowing your retirement income needs and living expenses is critical.
Knowing these numbers with extreme accuracy is less so.
Depending on how many years you still have before retiring, you could use as crude an estimate as a fraction of your current income, or as detailed and precise an estimate as a complete budget projected 10 or more years out.
At the cruder end, you can start from your current adjusted gross income (AGI) as reported in your recent tax return. Then, reduce that number by the amount you typically save for retirement. Next, reduce it by the amount you estimate you have to spend for work-related activities. This could include commuting costs, meal costs at work, dry cleaning work clothes, payroll taxes, etc. Finally, consider how much extra you’ll likely spend for healthcare (including Medicare premiums and dental care), leisure activities (you may want to travel more), gifts (for kids, grandkids, great grandkids…), etc.
You can improve the accuracy of your retirement budget significantly by using a retirement calculator. One example is from the Wall Street Journal, which I’ve reviewed and suggested improvements you can implement yourself.
Finally, at the more extreme end, you can create a detailed budget projection that starts from your current spending levels across all budget items, and projects (at least 5 but better 10+) years into the future. This long-term projection lets you address occasional large expenses that don’t come up every month or even every year, such as replacing a roof; repairing or replacing your central air conditioning, major appliances, etc.; or a hospital stay. Since, by definition, you don't know when to expect such expenses, consider adding a line item for unspecified and unexpected expenses.
You can do all this old-school on paper, or high-tech using financial software. Personally, I use Excel because it’s much more convenient and easy to update than paper, and much more flexible than using e.g. Quicken (which I use to track our actual finances).
Now that you have a spending timeline, you need to create your income timeline…
Your income timeline is essentially the same as what you did above for your expenses (and can be added to the same tool you used for that), just that it accounts for all your sources of retirement income. For each source, figure out when it will start, and what is the expected monthly amount.
For example, if you plan to claim Social Security benefits at age 67, the month following your 67th birthday is your start date for this income stream. The Social Security Administration provides a nifty website that provides you with your estimated benefits depending on when you’ll claim them.
Next, you can do the same for your spouse’s Social Security benefits.
If you have a deferred annuity, you can put in its start date and promised payment amounts.
The above-mentioned RMDs also have a start date – April 1 of the year after the calendar year in which you turn 72, and December 31 of each year thereafter. However, you can take monthly distributions so long as you take the full RMD by each due date.
Continue like that for each and every expected source of retirement income.
Will it be enough?
***Cue in suspenseful music***
For each month of the years you’ve projected forward, subtract the total of your monthly expenses from your total retirement income.
Is the number equal to or greater than zero for every month?
Unless you’re extraordinarily fortunate and privileged, the answer is almost certainly no.
Strategies for Generating Sufficient Retirement Income to Cover Your Expenses
Let’s talk about your floor, buckets… Perhaps we need a mop?
Seriously though, these are critical parts of my strategy, and I hope they’ll serve me (and you) well.
What’s Your Floor?
Remember the expense timeline/budget we talked about before?
Go back to it, and pull together all your non-discretionary expenses. This will likely include:
- Home maintenance & repairs
- Homeowners/renters insurance
- Property taxes
- Auto loan
- Car maintenance & repairs
- Auto insurance
- Health insurance premiums (including Medicare)
- Medical expenses (doctor visits, prescriptions, etc.)
The total for all these is what we’ll call your spending “floor.”
If you want to be safer, I suggest you add some margin to cover discretionary expenses at the level you’d drop them to if you hit a financial emergency.
Ideally, you want to have enough regular retirement income to cover this expense floor.
Unless you’re fortunate enough to have a generous pension, this will be difficult to achieve. One option to consider is buying an immediate annuity with a portion of your retirement nest egg. The great advantages of annuities are that (a) they’re guaranteed (assuming you pick a highly rated provider), and (b) payouts should be higher, and possibly much higher, than the 3.5-4% you might be able to safely draw from a balanced stocks/bonds portfolio.
However, keep in mind that this strategy has drawbacks.
Depending on the specific annuity you buy, payments may only continue until you pass away, leaving your spouse up the proverbial creek. Consider buying a “joint and survivor” annuity to prevent that, but know this will reduce your monthly annuity payout.
Another annuity option to consider is an inflation rider. This too will reduce your monthly payout. However, if you don’t do it, even at the historic average inflation of ~3.5%, after 20 years your inflation-adjusted benefit will be cut in half. If inflation continues at its current 7.5% rate, that cut could happen in less than 10 years.
One major drawback of annuities is that you lose control over the money you pay into it. If you have a sudden large expense, you won’t be able to access that money. Depending on how long you survive, and the provisions you choose, your eventual heirs will likely not see much if anything from what you paid into the annuity. And lets not forget that annuities are notorious for high fees, so if you choose this path, pay special attention to those fees and how they'll affect your income.
Annuities become even more interesting if purchased when interest rates are historically high, because that will likely drive up your monthly payouts. Then, if and when interest rates drop back to a more average level, your payments should still be high.
What Buckets Do You Want?
One piece of advice from Wade Pfau, Professor of Retirement Income, with which I agree whole-heartedly is to create a cash buffer so you’re not forced to sell stock investments at a loss to cover your retirement spending when, not if, the market crashes.
That’s my first bucket – enough cash to cover 3-4 years’ worth of retirement spending, at least at the difference between my spending “floor” and my regular retirement income (e.g., Social Security, etc.).
At the other extreme, there’s my long-term investment bucket. Both my parents lived to age 91, so I’m hoping to survive at least a couple of decades in retirement. That’s long enough to stay invested in the stock market.
Another possible bucket you may want to consider is an intermediate one, for discretionary expenses and especially for large expenses planned a few years out. You can invest this bucket in lower-risk assets such as bonds or bond funds, floating rate funds, and possibly good balanced-asset mutual funds (I like T. Rowe Price’s Capital Appreciation Fund, but it’s been closed to new investors since 2014, so you’d need to find a different option in that space).
A Range of Retirement Income Strategies
The challenge here is to be able to withdraw money from your retirement plans in a disciplined way that ensures your retirement income will outlast you. You’ll have few good options if your portfolio goes to zero, leaving you in poverty in your old age.
A famous “safe withdrawal” guideline is the so-called 4% rule, created in the 1990s by financial advisor Bill Bengen, based on the worst-case results for a 50/50 portfolio of stocks and bonds for the period from 1926 to 1976.
The rule would have you withdraw 4% of your portfolio in your first year of retirement, and then adjust the dollar amount each year thereafter by the level of inflation of the prior year (e.g., your Year 2 draw will be higher than your Year 1 draw by the inflation rate of Year 1).
For example, if you had a $1 million portfolio, here’s how your withdrawals would change over the initial 5 years of retirement, based on hypothetical inflation numbers.
|Retirement Year||Annual Withdrawal||Inflation Rate (Hypothetical)|
Bengen has since complained that given how his research showed a 4% initial withdrawal guaranteed your portfolio would have survived the absolute worst 30-year period in the time frame he researched, a 5% initial withdrawal would be more reasonable.
Others have argued in the opposite direction, saying that with the more muted returns expected in the coming years and decades than we saw from 1926 to 1976, we should reduce initial withdrawals to 3.5% or even 3%.
Research does show that if most of your retirement spending is non-discretionary, you’d be well-advised to err on the side of lower withdrawals. On the flip side, if much of your spending is discretionary, allowing you to significantly cut spending during market downturns, you might be safe with an initial withdrawal as high as 7%.
The 4% rule, or any variant (e.g., a 3% or 5% rule), assumes you’d increase your annual draws by the level of inflation.
However, research also shows retirees tend to reduce their spending by about 1%/year on average. If you believe this will be true for you too, you could add 1% to your favorite initial withdrawal percentage, and increase your withdrawal amounts each year by 1% less than the prior year's inflation.
Using the same assumed $1 million portfolio, a 5% starting point (that's due to the extra 1%), and the same hypothetical inflation numbers as above, you could do something like what’s shown in the next table.
|Retirement Year||Annual Withdrawal||Inflation Rate (Hypothetical)|
As you can see, this gives you higher annual draws, with that extra gradually decreasing over the years, as your presumed 1%/year spending decrease comes into play.
Another option is to increase your annual draw by 2%/year, which is the Federal Reserve’s inflation target, instead of the actual inflation number. However, if you were currently retired and trying to follow that strategy through a relatively high inflation period like we’re experiencing now, your buying power would decrease dramatically. For example, if inflation stays at 7%/year for 5 years while you only increase your draws by 2%/year, you’d have to cut your budget by over 20%! After 10 years, that cut would become an impossible 38%!
Yet another option is mostly limited to people fortunate enough to have enough regular retirement income to cover their floor. Here, you’d draw a fixed percentage of your portfolio each year. In years where the market is kind, this would give you a nice raise so you could afford fancy vacations, etc. In years when Mr. Market frowns at you, you might need to forgo vacations, trim gifting, etc. to fit your discretionary spending into the resulting smaller draw.
The big benefit of such a strategy is that by definition you can never run your portfolio down to zero. The problem is that if the market hits a prolonged stretch of losses, your standard of living may become far less comfortable than you planned.
Interest and Dividends Only
Some people, especially those who don’t have much appetite for financial risk, choose to “invest” solely in income-producing assets such as bonds, bond funds, money market funds, CDs, savings accounts, etc.
This strategy has a relatively low risk of losing principal.
However, you take on a high level of the following risks:
- Interest rate increases will cause your bond values to drop (unless you hold them to maturity, which you can’t do with a bond mutual fund)
- Interest rate decreases will reduce your income anytime you have to, e.g., roll over a matured CD into a new CD
- Dividend-paying stocks may have their dividends cut or stopped
- Since you give up almost all growth, inflation will eat away at your buying power over time
On the other extreme, if your risk tolerance is as high as mine, you may invest nearly all of your nest egg in stocks, stock funds, real estate, and other high-growth/return assets, aiming for high total returns.
Here, you don’t care if your returns come from dividends or from share price appreciation. You simply draw the amount you decided to draw, selling shares if and as needed.
The benefit is obvious – your portfolio will on average return double or triple the inflation-adjusted return of bonds.
However, it will suffer far higher volatility, potentially losing 50% or more in a single year! That’s called market risk.
If you take such a hit early in retirement and can’t reduce your spending to avoid selling shares when prices are depressed, it could eviscerate your retirement plan. That’s known as sequence-of-returns risk.
Another possible drawback is that you may need to manage your portfolio more actively than in the Interest and Dividend Only strategy. However, if and when you decide you’re not comfortable picking winning actively managed mutual funds, let alone individual stocks, you can invest in low-cost index funds.
Total-Return Plus Guaranteed Income
The third option is taking the middle road.
Here, you do what you can to bring in enough guaranteed income (from regular retirement income sources as listed above) to cover your spending floor.
Then, you keep a cash bucket to cover 3-4 years of spending you can’t cover from guaranteed sources.
Finally, you invest the rest for total return, potentially close to 100% in stocks and other higher-risk, higher-return assets.
As I detail elsewhere, this is my personal plan for our retirement.
Delaying Social Security Benefits
If your nest egg is large enough, you may be able to delay claiming Social Security benefits until you turn 70. This would increase your monthly benefits by 8% for every year you delay claiming from your full retirement age (67 if you were born in 1960 or later).
Doing this will require you to spend more from your 401(k), 403(b), IRAs, etc. until you turn 70. However, the guaranteed 8% increase in benefits may be higher than your (not guaranteed) market returns, making this an attractive option.
Sequencing Accounts for Tax Efficiency
Depending on your specific situation, you’ll be able to optimize your tax liability over the years by drawing from some types of accounts before others.
For example, most people would get the most tax benefit by financing their retirement spending first from taxable accounts, to benefit from much lower tax rates on capital gains. Next, drawing from tax-free accounts (e.g., Roth IRAs, Roth 401(k)s, HSAs), which would not be taxable at all. Finally, drawing from tax-deferred accounts (e.g., traditional IRAs and traditional 401(k)s), that get taxed as regular income.
If you expect your marginal tax bracket to be much higher later in retirement (e.g., due to high expected RMDs), you might do better swapping the order of tax-deferred and tax-free accounts.
“Filling” tax brackets, i.e., increasing your taxable income up to the breakpoint of the next higher tax bracket may also be advisable, e.g., if you want to consider converting tax-deferred accounts into tax-free Roth accounts.
As you can tell, this is a complicated puzzle, with lots of pieces. Talk to your tax advisor to figure out the optimal solution for your personal tax situation.
If you’ve always been an employee without significant income beyond your salary, it would be understandable if you didn’t realize that once your paychecks (and their tax withholding) stop, you'll likely need to pay estimated quarterly taxes. However, understandable does not mean you won’t have to pay interest and penalties if you don’t do it right.
Use tax preparation software, or preferably ask your CPA to figure out how much you need to pay each quarter (usually April 15, June 15, September 15, and January 15 of the following year).
To avoid sticker shock, set aside a portion of the estimated payments in a separate savings account each month so you can more easily cover the large quarterly payments without too much stress.
RMD Tips and Tricks
Coming back to your RMDs, if you work past age 72, you may not need to take any RMDs for the balance in your 401(k) at the specific employer where you still work. However, if you own 5% or more of that company, you don’t get to use this particular “get out of jail free” card.
If you own 100% of your business, it would seem you’re out of luck (for RMDs at least), right?
Not so fast!
If you find someone interested in buying your business, here’s an idea to run by your CPA. Work into your sales agreement a clause that lets you continue working part time at the company for as long as you want. If possible, retain ownership of 1-4% of the company to make it harder to kick you out.
In this scenario, you may be able to legally postpone RMDs for a significant portion of your retirement portfolio for a very long time. In fact, if your 401(k) plan allows it, you could potentially roll other retirement plan balances into that 401(k), protecting an even larger fraction of your nest egg from forced-selling taxes.
For whatever RMDs you do have to take and that are beyond what you need to cover your expenses, you can reinvest that excess in tax-efficient assets in a taxable account.
The Bottom Line
Retirement income planning has two big pieces: first, accumulating as large a nest egg as possible; second, establishing a forever retirement paycheck for your drawdown stage. In this article, I cover that second stage in detail with guidance to create sustainable retirement income throughout your golden years.
Everyone’s personal situation is unique, and planning for your own retirement may require addressing factors not covered in this article. A financial advisor who specializes in retirement planning can work with you to develop a personalized plan tailored to your unique circumstances. Even if you prefer to manage your finances on your own, a one-time consultation with a financial professional offering a second set of eyes can increase your confidence that your retirement income will last as long as you do.
As a final suggestion, if you do decide to work with a financial advisor, interview several, asking them specifically (1) if they're fiduciaries (i.e., they have a duty to place your interests above their own, advising you to buy investments that are best for you, rather than ones that are simply reasonable), and related to that (2) how they're compensated for advising you.
My personal bias is toward "fee-only" fiduciary financial planners. This ensures the advice you get isn't tainted by potential conflict of interest that exists if the advisor is paid through commissions (whether instead of or in addition to a fee). In commission-based scenarios, the advisor's interest is to sell you investments that pay them higher commissions rather than others that may be a better fit for you but that pay them less.
This article is intended for informational purposes only, and should not be considered financial, investment, business, or legal advice. You should consult a relevant professional before making any major decisions.
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