For decades, the primary focus of retirement planning has been on the accumulation phase, and building up one's nest egg. But in recent years, it's become all too clear that having a solid strategy in place during the spend-down phase is equally, if not more, important.
In fact, you really can't talk about the finances of retirement today without discussing retirement income. This is becoming a highly popular -- sometimes even overwhelming -- topic with many of my pre-retiree clients. The reality is that once an employer paycheck stops arriving, that monetary gap must be filled with one's own retirement assets. Adding to this challenge is the fact that people are living much longer and face the growing risk of outliving their savings. As a financial advisor, one of my goals is to address this "longevity risk" and put a plan in place that converts a client's nest egg into a reliable income source.
When I talk about retirement income with clients, first and foremost, we discuss their needs, wants and wishes. Most people don't have enough money to cover all three of these retirement visions, so we prioritize what is most important. To prioritize and get a clear picture, we run the numbers for retirement, breaking down the budget into monthly inflow and outflow. Inflow is retirement income, while outflow entails expenses. Quite simply, inflow needs to meet or exceed outflow. However, it's something that many retirees overlook. Even those with great wealth struggle with their personal balance sheet. Managing the flow of funds and ensuring they last a lifetime is at the core of a successful retirement income strategy. It also helps to lay out retirement goals and expectations.
Along these lines, ING U.S. conducted a study to understand how pre-retirees want to spend their time in retirement compared to how retirees actually spend their time. Interestingly, expectations did not meet reality in certain categories. One area of disconnect involved travel. According to the findings, those who were polled expected to travel much more than they actually did in retirement. While there might be a number of reasons for this, one might conclude that pre-retirees are not fully prepared to fund some of their aspirational activities. This, in turn, results in financial dreams giving way to financial reality. It's best to go into retirement with a clear sense of how you will spend your time and money so you won't be unpleasantly surprised.
Another important part of my conversation with clients involves discussing the different retirement income financial levers and when to pull them. For most people approaching retirement today, typical retirement income sources will include social security, employer pensions (this will be less common for future generations), annuities and other income such as rental properties or divorce settlements. Understanding payout amounts and options, optimal timing, spousal benefits, death benefits, taxes and eligibility is essential. For example, waiting a few additional years before tapping an income source can yield a significantly higher monthly income, while setting up a spousal benefit can help ensure that your spouse's income is not cut significantly at your death. These are important decisions that require forethought and strategic planning ahead of retirement.
In planning for retirement income, it's helpful to break down retirement into three distinct stages. The first stage I call the "go-go" years, where you first embrace retirement, undertake new or re-discovered activities and check items off your bucket list. In the next phase - the "slow-go" years - you are still active, but easing back on the throttle.. Discretionary spending may be declining, while medical spending may be rising. Finally, the "no-go" stage is more sedentary during which you may have physical impediments that keep you close to home. At this stage, medical expenses could be the biggest expense. Before retirement, walk through the finances of all three of these retirement stages.
Ideally, the principle balance of your retirement assets should be fully intact when reaching the "no-go" stage, so you enough resources to last your lifetime and, if fortunate, something to pass on to your heirs. With the right investment strategy and, as a rule of thumb, tapping around four or five percent of your total savings each year in retirement, the goal is to keep your principle intact when you reach that final stage of life. Note that the percentage for annual draw-down will vary depending on each individual's personal situation.
When determining your investment strategy, don't forget to account for the impact of inflation on your nest egg. With inflation and the potential for 20-plus years in retirement, what would cost you $5,000 today could cost you $10,000 in 10 years. To maintain the same purchasing power in future years, your investments need to deliver returns that can help beat the rate of inflation.
To get started in mapping out your retirement income picture, I encourage you to use an online income needs calculator. These self-help tools can offer a quick way to think about your personal scenario. They also lay the groundwork for a more comprehensive discussion with a financial advisor, who can play a valuable role in helping with your retirement financial plan.
ING Retirement Coach Jacob Gold is a third generation financial advisor. He is a published author of "Financial Intelligence; Getting Back to Basics after an Economic Meltdown", which was published in August 2009. Gold is a CERTIFIED FINANCIAL PLANNER™ practitioner and FINRA Series 7, 24 and 66 securities registered.
Securities and Investment advisory services offered through ING Financial Partners, Member SIPC. Neither ING Financial Partners nor its representatives offer tax advice.
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