By Jon L. Ten Haagen
During your working years you took home a regular paycheck (weekly, bi-monthly or monthly), and you paid for everything with its proceeds, rent, mortgage, auto, food, utilities, clothes, vacation, entertainment, the kids and inverted for your retirement.
Now, you are retiring and your paychecks will stop. You will switch from receiving a steady income to paying your ongoing bills.
You will have to establish a financial plan that provides for the income you’ll need to live on. Specifically, you will need to consider:
What sources of income are you confident you can count on? How much income will they provide each year? How and when will the income be paid? How will you coordinate payments from different sources to create a steady stream of income so there’s money in the bank when you need it?
Your sources of cash flow to choose from are: Social Security, Defined Benefit Pension(s), IRAs, ROTH IRAs, Annuities, Personal investments and a possible job. When your monies arrive, unlike a paycheck, which arrives regularly, retirement income arrives on different schedules. Social Security checks and annuity and pension payments usually come monthly. Others like stock dividends arrive quarterly. Interest on many bonds is paid semi-annually. Few if any payments, are weekly or biweekly. That means you have to think about balancing the amount coming in to meet your expenses.
Let’s concentrate on annuities today. There are various types of annuities: fixed, variable, immediate, deferred, single premium, incremental, qualified and non-qualified. There are many sub-categories of these types also.
There has been an annuity debate going on for years and it will continue: Annuities, variable annuities in particular, have advocates and critics. The advocates feel that the insurance protection and contracts offer, the potential for growth, and promise of lifetime income make them valuable retirement planning products critics argue that annuity fees are too high for the investment and insurance benefits these contracts provide. We will not solve this discussion today!
Annuities are insurance company contracts. The premiums you pay and tax-deferred earnings on those premiums are designed to be a source of retirement income, either in the future if you chose a deferred annuity or right away with an immediate annuity.
With a deferred annuity, the principle earnings accumulate in the build-up period. Eventually you can annuitize, which means you convert your account value to a stream of lifetime income, or you can take the money some other way. With an immediate annuity, the lifetime income you receive is based on several factors including the amount of your purchase, your age, and the interest rate available at the time of purchase.
Now the big picture: The regular income you can expect from Social Security and a defined benefit pension depends on your work history. In general, the longer you work and the higher your salary, the more income you can anticipate, up to the annual ceilings.
Realistically, though, neither of these sources is likely to be as important a source of retirement income in the future as they have in the past. Social Security faces the imbalance of more beneficiaries and fewer workers contributing, and fewer employers offering defined benefit plans.
The retirement income you can expect from other potential sources depends on three things: How much is invested, where it’s invested, and the long- term return those investments provide. You have much greater control over these choices, and so much greater responsibility for the outcome than you may realize. That’s why it is critical to put basic investment principles to work, including asset allocation and diversification, across your tax-deferred as well as your taxable portfolios. It’s also why you want to start thinking seriously about retirement income before you start thinking seriously about retiring. Does this sound like a familiar theme in this column? Start early and be consistent!
Near retirement you want to think about turning some of your investments into income. Remember, when you retire you should consider that you may well live for another 20-30 years, and some of your monies have to continue to seek growth.
One of the challenges you face in managing retirement income is that net worth doesn’t translate directly into income that you can use to pay your bills or make new investments. Stocks may pay dividends, but much of their value is the price per share you could realize only if you sold. You can spend bond interest, but if you liquidate the bond when it matures rather than reinvesting that amount, you won’t earn interest in the future.
On the other hand, you must take regular cash distributions from your tax-deferred retirement accounts once you reach 70.5 years of age. To meet that requirement, and create a cash flow, you might establish a systematic withdrawal schedule, or in the case of an annuity contract, choose annuitization. That is when you convert your account value to a steady lifetime income stream. These annuity contracts come in many ‘flavors’ so shop carefully and work with a knowledgeable insurance/investment expert.
One approach is to spread your retirement savings around among a number of products, each designed to fill a different role for your needs. That might mean putting some money in stocks, bonds, mutual funds, real estate investment trusts (REITs), professional money management and fixed or variable annuities (or both).
Thank you for reading our article this week. If you have any questions or ideas about this article, or one you would like to see written, please reach out and give us your thoughts. As always the very best of fortune with your journey to a comfortable retirement. Start early, invest on a consistent basis and work with a Certified Financial Planner. See you in two weeks.