Looking back at my father, I see someone who was entitled to two pensions and Social Security. As he put it, he “just got money in the mail.” Fast forwarding to present day, I work with folks who are or will be solely dependent on the money they have saved and their Social Security to drive their retirement income. So the question is, “How do you not outlive your money?”
We work on average 40 years. During that time we buy homes, perhaps raise and educate children, and assist in the caregiving of our aging parents. Then, we stop working. All of the things you have done—or not done—through the years will determine the quality of your retirement lifestyle. Also, the quality of lifestyle will influence how long those dollars saved will last. Folks look at their accumulated pool of money and ask me, “Can I retire?” That question is very hard to answer. I think a prudent approach should be to ask two questions: “How much do I need to pay the basic needs,” and “how long will I need to sustain those needs (i.e., life expectancy)?”
Determining the Cost of Your Lifestyle
If you are still accumulating for retirement, I highly recommend you start to calculate the cost of your lifestyle and discover the cost moving forward. The first step is knowing what you want out of retirement. Most folks either haven’t really thought about retirement income or how much they need to save for retirement. Not to mention the surrounding questions, such as: How much does it cost for you to live in your current home? What are your medical insurance and health care costs? How much are your other fixed costs, such as auto and life insurance and food costs? These and other questions help you start to understand what it will cost to retire. Then ask yourself if your budget allows for the fun stuff (i.e., trips, spoiling the grandchildren, hobbies that require money, replacing that aging automobile, etc.). Most planners look at the pool of money you have accumulated and then make an assumption as to how long you are expected to live. They apply an expected rate of return to that pool of money and start to draw off of that pool of money based on what you say you need to maintain your standard of living. We can run simulations against that basic measurement to illustrate the impact of portfolio losses and gains to your savings and the longevity of your money. We do this because investment returns are not level, but returns have volatility both to the upside and to the downside. So again, “How long will my money last at this rate of consumption?” is a key question in determining a happy and positive outcome.
Stabilizing Income Streams
How can you add some stability to your income stream that is not determined by market volatility? One great item is a retirement income stream that is not determined by how much you have saved or on market performance. Examples of stable income streams would be Social Security, annuities, or a pension because, if handled correctly, these items will pay as long as you live. When you get consistent streams of income and have no risk of investment loss, then that brings some stability to your cash flow. Otherwise, cash flow would have to be solely dependent on the money you had saved and the market. Planning retirement income is entirely different than saving for retirement. The design of the income flows must be calculated to protect against losing that cash flow. Think about it, when you were going into the beginning of 2008 did you have any foresight that your investment account could lose in excess of 25%? So, if you had been drawing 4% off your savings and the value of that portfolio dropped by 25%, then what is your true new rate of consumption? It is more like 5.3%, which may not be sustainable and could require you to rethink how much you can withdraw going forward. It’s just math, but these figures impact how you will live for 25 years or more.
You have determined the cost of the lifestyle you want in retirement., and how long you think you will be around to enjoy that lifestyle. Now you are one step closer to answering the hard question: “Will I outlive my money?” If you think you will fall short or cut it too close, how do you fix the situation? If you have some time on your side, you can do something about it. Save more, spend less, pay off debt while you are working, and prepare for the day you do not generate a paycheck. If you are running out of time, you have fewer choices, and you will be forced into some hard decisions. You might have to continue to work beyond the day you envisioned retiring, live a diminished lifestyle, or, worst case, consume your savings long before the expected timeframe. If you want to avoid this fate, remember time and money. By accounting for both time and money, you can build a plan that helps you to avoid a retirement disaster.
Creating Your Income Streams
Back to the income streams for a moment, if you do not have a company pension, how can you create a consistent cash flow that will last your lifetime? There are products called fixed index annuities (FIAs) that can satisfy a few of your lifestyle requirements. You can have investments that have minimal downside and participate in investment expansions when the market goes up. Additionally, through riders, you and your spouse have the ability to receive FIA payments over the course of a lifetime. These payments help to ease the fear of running out of money too early. With the rising cost of living, you need to consider dedicating a portion of your retirement savings into an FIA plan. To help with income guarantees, you will need to work within the guidelines of the particular FIA product to ensure you can continue the cash flow for life. Also, since annuities are long-term investment programs, you will need to leave the funds in the annuity, which, to an extent, reduces short-term liquidity. The trade-off is liquidity for cash flow. We need money for both lifestyle and unexpected expenditures, as well as that steady “paycheck” for longevity.
At the end of the day, planning is the heart of the issue. Take the time to work with a professional who can build various retirement scenarios to help you in determining where you are today versus where you want to be. Once you understand the numbers, you can better decide the personal cost of your retirement lifestyle. After you get the “number,” measure annually to see if you are on track to accomplish your goal. Annual measurement is critical during retirement, as market declines inherently cause the static rate of consumption to increase. This increase may not be sustainable, but, when caught early, it may be easier to correct with minimal change to your lifestyle. There are many other variables to consider in “doing it right,” but this should get you thinking in the right direction. Lastly, be discerning from whom you take advice. I encourage you to have all your trusted advisors (CPA, estate planning attorney, insurance and investment professional) on board to ensure that their advice lines up and YOUR plan integrates properly.
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