Retirement Income 101

In the aftermath of the housing market crash and the ensuing financial meltdown that led to the stock market crash of 2008, investors are getting back to the basics as far their retirement planning goes. Although the stock market has recovered, pre-retirees have lost a lot of ground in the retirement accounts, and many who had been counting on the equity in their homes are facing a new reality, which is that retirement may not be what they had originally envisioned. Belts will have to be tightened, retirement dates delayed, leisure plans scaled back, but, with some retirement income 101 basics, most people should be able to get back on track.

Start with Realistic Assumptions

To determine your retirement income need, you have to be able to makes some realistic assumptions about the future. The most important assumption is how long you will live. With life expectancies expanding, most people who reach the age of 65 can expect to live beyond the age of 85. If you’re married, there is a good chance that one of you will live beyond the age of 97! That’s a range of 20 to 37 years of life in retirement.

A lot of people assume that, when they retire, their expenses will decrease so, they won’t need the kind of income they were earning while working. There have been several rules of thumb tossed about, such as 70% of earned income as retirement income need. That probably won’t cut if you need to plan for an income that is to last 30 years or more.
Your retirement lifestyle will have a price tag. If you have been driven towards a more austere existence, you still should carefully plan your retirement budget. Expenses that a lot of people fail to account for are increased medical costs (including insurance premiums), and long term care expenses. Healthcare costs are rising faster than most other costs and are expected to reach an average annual cost of $15,000 per retiree. These days, many retirees can expect to still be paying their mortgages unless they swap out their home for a smaller one in a less expensive location.

The Inflation Factor

As a country, we have been lulled into complacency by a long period of low or no inflation. That appears to be changing, and we could be in for normal inflation cycles with possible spikes. The impact of inflation on an income that has to last for 30 years can be devastating. Essentially, a 3.5% inflation rate would cut the purchasing power of your money in half in 20 years. All assumptions and future income needs should include a realistic forecast for inflation or your income or you are likely to find that your income sources come up short.

Determine Your Savings Need

Using your assumptions, you need to determine the amount of money you will need at your target retirement age that can generate an income flow for 20 or more years. The old rule of thumb was the amount of money needed was based on a drawdown of 7% per year to make it last. Recent studies revealed that, at that rate, retirees were exhausting their savings much too soon. Experts now say that the amount should be based on an annual drawdown of 4%, adjusted annually for inflation.

Should You Plan for Social Security?

It used to be that people, especially the Gen X and Y groups, would not consider Social Security in their retirement planning because they didn’t’ feel it would be around. These days, more people are counting on it to fill some of shortfalls that developed from declining portfolios and home equity. On average, Social Security will pay out about $1,100 a month per retiree. So, while it is becoming increasingly difficult to plan without Social Security, it is important to build an additional safety net as your retirement income foundation.

The Need for Growth

The old rule of the thumb was that, as the time horizon for retirement shortens, your investment allocation should become more conservative with an increasing emphasis on income investments and a decreasing emphasis on stock or growth investments. One such rule used your age as a guide to investment allocation advising that your income investments should equal your age. So, for instance, at age 60 your income investments should be 60% of your portfolio.

As more people approach their retirement target dates with diminished 401(k) accounts, and with increasing prospects for inflation resurgence, pre-retirees will need to rethink that strategy and maintain a growth orientation in their portfolio even after they retire.
The key to achieving long term growth, while maintaining relative portfolio stability, is to create a well-rounded and fully diversified investment portfolio. Large, dividend-paying blue chip stock funds, gold exchange traded funds, and income real estate investment trusts are ways to add growth and stability to a portfolio that includes income investments such as government and corporate bond funds.

Build a Safety Net

While it is crucially important to invest for growth and increasing income, it is made easier when it is done on top of an income foundation that becomes your ultimate safety net. By creating an income source that is invulnerable to market conditions and guaranteed to last as long as you do, you will feel more comfortable taking some moderate risk on a portion of your portfolio.

A lifetime annuity can be purchased with a portion of your assets and, essentially, provide the same guaranteed income stream that company pension plans used to provide retired employees. Pension plans are largely a thing of the past, but annuities are becoming increasingly popular as a way for individuals to create an income safety net that can’t be outlived.