Many retirees don’t set up a retirement income plan, and that oversight often comes back to hurt them. Fortunately, you can get a good handle on this by answering two questions and taking six steps.
Discussed here is a very simple approach to retirement income for a simple retirement roadmap for allocating retirement savings for a 30-year income.
Question 1 – Have I Saved Enough?
Whether you have enough to retire depends almost entirely on how much you expect to spend in retirement.
Step 1 – Figure out how much you expect to spend in the first year of retirement by itemizing your expenses. Take care to be accurate as possible with respect to your expected retirement lifestyle. Break down your expenses into two categories: basic expenses and desired expenses. Generally, basic expenses are between 60% and 80% of total expenses.
Step 2 – Take stock of guaranteed income sources. Add up the annual expected income from pensions, Social Security, and any annuities. Do not include income from stocks, bonds, or real estate since none of this is guaranteed. The total is your annual guaranteed income in the first year of retirement.
Step 3 – Find the gap with a little more math. Subtract your annual guaranteed income from your total expenses (basic plus desired). This is your annual expense gap. Multiply your gap by 28. This is your required retirement portfolio value.
Step 4 – Now that you know what you need, go ahead and identify all investments and assets that you intend to use for retirement income. Leave out your emergency fund, any health care assets, long-term care or an inheritance, as well as any assets you wouldn’t liquidate for additional retirement income. The total is your expected retirement portfolio value.
To be retirement-ready, your expected retirement portfolio must be greater than your required retirement portfolio. If you don’t have enough in your portfolio, you need to take another look at your plan and assets.
But assuming you’re happy with your portfolio, what’s next?
Question 2 – How Should I Allocate My Retirement Portfolio Assets?
Step 5 – Cover your basics. Your basic expenses should be completely covered by guaranteed income. If your basic expenses are more than your guaranteed income in the first year of retirement, consider delaying the start of these income streams or use some of your portfolio assets to purchase an annuity to increase your guaranteed income to at least match these expenses.
Step 6 – This step assumes all basic expenses are covered in the first year of retirement by guaranteed income. With your remaining investable assets, you can implement this three-bucket strategy I personally like to use to provide income while keeping pace with inflation over the coming decades. Each year, you will withdraw funds from one or more of your buckets to meet these expenses, which is known as your annual withdrawal amount (AWA).
Bucket 1: (Three Times Your AWA)
This bucket is for short-term savings and where you will withdraw funds from each year. This bucket is intended to keep up with inflation utilizing CD laddering, online savings accounts, or other cash equivalent options. The balance in Bucket 1 should always be between one to four times your AWA. If the balance strays out of this range, pull from Bucket 2 or push funds into Bucket 2.
Bucket 2: (20 Times Your AWA)
This bucket is invested for stable income. This is typically a 60/40 equity/fixed-income mix with high-dividend and high-interest investments. All earnings (interest and dividends) should flow into Bucket 1. You should not expect this bucket to produce enough income to meet all your desired expenses. Because of this, you should plan to shift one-third of your AWA into Bucket 1 each year. This will keep Bucket 1 healthy. The balance in Bucket 2 should stay between three and 25 times your AWA and should naturally decrease as you proceed through retirement. If the balance strays out of this range, move the extra (or shortage) to (or from) Bucket 3.
Bucket 3: (Remainder >5x AWA)
Bucket 3 is for growth investments and should be invested aggressively. Typically, this means a 90/10 equity/fixed-income mix. This is the remainder of your retirement assets and starts at least five times your AWA. Any interest or dividends should be paid into Bucket 1. If the total return in any year exceeds 10%, transfer the excess return into Bucket 2.
Going through this exercise should give you a better perspective on how to approach your retirement income needs. It is common to go through this process multiple times before it feels comfortable.
There are many other more complex withdrawal strategies that may produce more income with fewer assets, but this simple retirement income plan is designed to give you a realistic amount to work with and a clear method for investing your retirement assets.
Before making any changes to your retirement plan, consult with a financial professional who focuses in retirement planning. This could help you take your retirement plan to the next level and allow you to sidestep potential landmines you may not be focused on.
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