Creating a "paycheck" in retirement
A few thoughts on retirement income planning
Happy Wednesday,
Let’s assume you’ve just retired.
Now what?
Whether you’ve left a tenured teaching position or are hanging it up after years on the road as a commission-earning salesperson, your paycheck – whether it was consistent or not – is going away.
Hopefully, you’ve done a good job planning and saving for this day and the years that follow, but it’s still an uncomfortable feeling.
You’re walking away from a stream of income, and even though you had to work in exchange for that income, now that the income is gone, how will you make your finances and your life work?
I have some good news for you.
You can create a paycheck for yourself in retirement.
However, instead of your paycheck coming from [insert name of former employer here], it will now come from your savings and investments.
Many people plan to retire and live on the dividends and interest from their portfolios. They consider their portfolio principal to reside behind a sheet of glass with the words “break glass only in case of emergency” written in bold red letters.
For some, this approach might work.
But there is more than one way to address your “retirement income” needs.
Let’s say you have a portfolio worth $2 million that you’ve accumulated over a 40+ year career.
Treasuries?
If you retire and put your entire $2 million into 10-year US government bonds, you could, based on today’s interest rates, generate approximately $99,200 per year in interest income. As I write this in March, 2024, the yield on the 10-year Treasury is at 4.096%.
Even if you’d be happy with this level of income, your principal is losing purchasing power every year as inflation slowly (but surely) erodes just how far those principal dollars will go in the future.
Also, since this example is based on 10-year Treasury bonds, what happens after 10 years?
Who knows where rates (and your income from Treasuries) could be then?
Not recommended.
How about the 4% rule?
There is a widely accepted and research-supported rule of thumb that indicates you can take 4% from your portfolio each year to create a sustainable income stream that will withstand whatever the markets may throw at us in the future.
Of course, the research supporting this “4% rule” is based on the fact that it would’ve worked in the past. And the past isn’t an indication of future results, blah, blah, blah…
This “4% approach” will conceptually leave enough potential growth in your portfolio to keep up with - and ahead of - inflation over time.
It will - according to the research - grow your income and your portfolio to help battle inflation and the erosion of your purchasing power.
Compared to buying Treasury bonds in the example above, you just went from a 4.096% yield (based on 10-year Treasuries) to 4% portfolio yield.
In dollar terms, that’s a “pay cut” from $99,200 per year to $80,000 per year (4% of $2 million).
However, the 4% rule better insulates your portfolio and your lifestyle from the destruction of inflation over time than Treasury bonds would.
Having said all this, I’m not a fan of rules of thumb, and I wouldn’t recommend them to you either.
The 4% rule ignores how much investment risk you’d have to expose yourself (and your money) to in order to make the numbers work.
And this particular rule of thumb doesn’t account for the fact that you may want to spend more in your earlier retirement years and less in your later retirement years when you might be less mobile and less active.
Besides, your life is dynamic with its own ups and downs. And surprises.
Applying a fixed, but supposedly growing, income stream seems - to me, at least - a little too simplistic.
And this coming from someone who’s a BIG fan of simple.
Annuities?
At this point, your friendly broker or insurance agent has the solution you’ve been looking for.
Sure, 4% sounds great, they say, but what happens when the market goes down?
If your portfolio drops by 25%, your 4% (now on a portfolio worth $1.5 million) is only $60,000 per year. You’ve just taken a 25% pay cut based solely on the whims of a fickle market.
And what happens if:
the other candidate gets elected?
your portfolio goes down by more than 25%?
interest rates and inflation go higher from here?
income taxes move higher?
the sky is falling?
That last one is a bit hyperbolic, but in my experience many of these annuity peddlers are professional doom and gloomers.
But all hope is not lost…
What if, they ask you, there was a product that gives you market returns when the market is going up, but offers complete protection when the market goes down?
No, it’s not too good to be true, they say. Just put your money in an equity indexed annuity contract.
What they often fail to mention is that your money is locked up under sizable withdrawal penalties for 6-10 (or more) years, your annuity’s market performance doesn’t include dividends (which is a BIG part of market returns over time), and in the years the market is doing well your participation in the upside of the market is often capped which means you don’t get all of it.
I’m not a fan.
Your Personal Pension
Here’s what I suggest . . . think of your retirement income and your portfolio like a pension.
As you may know, pensions can be over- or under-funded.
And so can your financial plan.
It can be too hot or too cold as I mentioned in this recent column:
Goldilocks and the 3 financial plans
Happy Wednesday! After writing last week’s article on the potential cost of being “conservative” I’d planned to follow it up this week with another alliteratively titled piece on being “aggressive.” Maybe something like the “artificial allure of an aggressive approach.”
In plain English, why couldn’t you create and manage a flexible retirement income plan that reflects your personal situation, preferences, and priorities along with changing personal, professional and economic circumstances?
In this scenario, you can literally have a dollar amount transferred to your checking account once a month (much like a paycheck) and when the market does better, you could potentially:
Give yourself a pay raise,
Reduce your investment risk (sell some stocks while they’re high) and keep your “pay” the same,
Add or increase other goals, or
Some combination of the above.
Conversely, when the market goes through a bear market cycle, as it inevitably will, you would:
Take a temporary pay cut,
Increase your investment risk (buy more stocks when they’re low) and keep your “pay” the same,
Reduce or delay other goals, or
Some combination of the above.
Sorta makes sense, doesn’t it?
And by the way, over time, this approach can likely create greater average income from your portfolio than even the 4% rule of thumb.
For example, here’s one of my client’s estimated percentage withdrawal rates over time:
But as you may suspect, this only works if your personal plan is the centerpiece of your financial planning and decision-making process. Creating a plan once, and only looking at it every 2 or 3 (or more) years won’t cut it.
In fact, you don’t need or want “a plan” at all.
You want “planning.”
You want the verb, not the noun.
It’s an ongoing process where you DO NOT rely on forecasts or yesterday’s news. You simply update your plan on a consistent basis and incorporate new information as you get it. Then you stress-test your plan against what might happen in the future based on what you know today.
This isn’t a forecast.
This is an exploration of all the potential outcomes you may experience giving you the context to establish the right combination of your goals (based on your priorities) that gives your plan sufficient comfort and confidence of working in all types of future environments.
As long as you continue to make small adjustments along the way. This is the “planning” part.
It’s an important concept and is counter to most financial advice that is dispensed today.
If this personalized, flexible approach sounds interesting to you, I’m pleased to let you know that it’s a fundamental premise that’s baked right into my financial advice process.
If you’d like to learn more or discuss how it might impact your situation, get in touch.
And you can learn more about our Retirement Planning services if you’re interested.
Let me know what you think… how are you planning to handle your retirement income?
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And as always, thanks for reading.
Until next Wednesday,
Russ
"You want the verb, not the noun."
Love that.