Today we are going to take a look at the Steps for Retirement Income Planning.
Let’s dive right into the different steps in the retirement planning process.
Step 1: Estimate Retirement Income Needs
This step in the retirement planning process is to determine the amount of income that will be needed annually to support your expected standard of living during retirement. This amount will, of course, vary among retirees, and will depend upon the projected retirement age, life expectancy, inflation, and a variety of other family and economic factors.
There are two methods typically used to determine the amount of income needed: the replacement ratio method and the projected expense method.
The replacement ratio method simply applies a percentage of a person’s preretirement income, to estimate how much he or she will need during retirement. This ratio typically ranges from 60 to 80 percent of your income before retirement.
The projected expense approach is a more detailed and precise method of projecting income needs than the replacement ratio method.
With this approach, future living expenses are estimated by comparing them directly to current living expenses which may include housing, utilities, transportation, food, clothing, vacations, and other expenses.
The projected expense method provides a more precise estimate of future income needs because it is based on your actual household expenses.
Step 2: Consider Your Sources of Retirement Income
Traditionally, people have relied on three primary sources for their retirement income:
· Social Security
· an employer-sponsored pension or retirement plan, and
· personal savings and investments
These 3 sources are considered the cornerstones of a person’s retirement income.
Retirees can use the image of a 3-legged stool to refer to these combined income sources.
A senior’s retirement security rests firmly on this stool when all three sources are in place. If one leg of the stool is missing or weak, you may not have adequate income, unless steps are taken to strengthen the other legs. The income that is generated by these three sources will, in large part, determine how comfortable a person’s golden years will be.
Generally speaking, an individual has the most control, only over the last component, their personal savings, and investments.
Social Security is currently being strained financially and future income increases and the amount of income a retiree receives could change.
And, few employees have access to pension benefits, as most employees no longer offer such plans.
For these reasons, the 3-legged stool looks quite different today for many retirees, as the personal saving component has become the most important indicator of future financial stability.
Any income shortfall that is not covered by Social Security and/or a retirement plan must be made up by personal savings and investments, or through income derived from other sources such as continued employment after retirement.
Step 3: Determine the Annual Amount you will Withdraw.
Once you have determined a realistic income need, the next step is to calculate what percentage of assets can be withdrawn each year.
The goal is to determine how much money you can withdraw to support your standard of living, without prematurely exhausting your funds.
Once an initial withdrawal rate is determined, it is also necessary to determine how long the assets are likely to last, if withdrawals continue at the same rate each year.
In other words, if a retiree withdraws funds at a certain rate, will his or her accumulated savings be able to sustain an income flow for a lifetime?
The concern is that too high of a withdrawal rate will deplete assets too soon, while too small of a withdrawal rate may cause the retiree to have a lower standard of living than necessary.
What’s the Recommended Withdrawal Rate? Well, It depends on your unique circumstances.
Most advisors agree that choosing a conservative withdrawal rate—typically 3 or 4 percent—minimizes the risk of emptying a nest egg prematurely.
Of course, the withdrawal rate may need to be periodically adjusted, depending on changing circumstances.
Step 4: Create a Systematic Arrangement for Income Distribution
After determining a realistic income withdrawal rate and making sure that the funds are properly diversified, the next step is to determine which resources should be tapped first to provide that income.
Generally, there are three basic sources of retirement income:
· Currently taxable investments, like savings accounts or mutual funds.
· Tax-deferred investments, like 401k plans and Traditional IRA’s.
· Tax-free investments, like municipal bonds or perhaps Roth IRA’s.
Among these types of assets, different taxation rules will apply.
The question then becomes: How can clients tap their nest eggs, and in what order, to minimize taxes, meet expenses, and extend the life of their savings for as long as possible?
To answer the question, regarding the correct order of withdrawing funds, many financial practitioners favor a withdrawal approach known as the bucket strategy.
Under this approach, a retiree divides his or her nest egg into several accounts, or “buckets,” each with a different level of risk. Withdrawals are then taken from the various buckets, depending on financial returns and market conditions, rather than from the portfolio as a whole.
Step 5: Determine a preferable withdrawal cycle.
Which of the various buckets should be siphoned first—or last?
Seniors will not only need to gauge market conditions when deciding which assets to sell and buy, but they will also need to pay attention to withdrawing funds in a way that minimizes taxes.
Clients are typically advised to:
· withdraw taxable assets first.
· draw down tax-deferred accounts next.
· withdraw funds from tax-free accounts, like Roth IRAs and municipal bonds, last.
Each retiree’s financial situation must be looked at individually, and the optimal withdrawal strategy for each individual will be different. There are literally hundreds of different strategies that can be used.
Developing a distribution strategy in retirement may therefore be considerably more complex than simply following one standard rule of thumb, and decisions may need to be reevaluated annually as changes occur to state and federal tax laws and a retiree’s income needs and investments.
Step 6: Monitor the Flow of Income and performance of investments and review the plan.
Retirement income planning is not a one-time event.
As circumstances change, your financial needs will change as well.
The death of a spouse, a long economic downturn, or a move to a retirement community may increase the need for income.
As people progress through retirement, their short- and long-term goals may shift, often requiring a change in the income strategy.
An annual review is a good opportunity to reevaluate the chosen strategy and make any necessary changes, to keep the plan on track.
Hopefully this information provides you with some food-for-thought as you consider your retirement income plan pf action.
Thank you for your time and reach out to me if you have any questions.
Blessings to you and your family.