How Do You Convert Savings into Retirement Income?
How to turn retirement savings accounts into a steady income stream is one of the most crucial questions most people will want answered for their retirement planning. While they want to enjoy the lifestyle they've earned, they fear depleting their retirement accounts and outliving their money.
For decades you've been saving and told not to touch those retirement accounts. Suddenly you find yourself amongst the retired with a sizable nest egg; this is what you've been preparing for, and you finally hold the golden key. Oddly, having this large sum of money at your fingertips does the opposite you planned for; it gives you anxiety about the best way to use it instead of the peace of mind you've earned.
Now that you are no longer receiving a regular paycheck, you realize the importance of knowing your nest egg will provide for you and your family for the rest of your lifetime. Sure, it's a nice sum of money, but how long will it last? What happens if the market drops or inflation shoots up? What if you are reliant on income from this account while the market is dropping? What about healthcare costs and taxes? How much of your money can you really enjoy, and will there be anything left for your family?
Without answers to all these questions, you might wonder if you can treat your retirement account like an ATM and spend it, however, and whenever you want. However, knowing you only get one shot at this, it's probably a good idea to develop a plan for receiving a sustainable income from your retirement accounts. What if you had an overall strategy that would allow you to feel confident and will help provide for you and your family throughout this stage of your life? A solid financial plan will be your guide for accessing retirement savings to provide monthly income, and often it can be guaranteed.
Planning for Income Distribution from Retirement Accounts
As a comprehensive financial planner, a vital element of every plan is understanding cashflow. Before we ever look at the retirement accounts, we first need to get a grasp on your current and future expenses. Only then can we analyze your cash flow to understand your current or future needs. It's common to hear you can get by with 70% of your pre-retirement income. However, it's my experience most recent retirees are busy and want to enjoy the life they've earned. It's better to expect the same monthly expenses as before retirement as a starting point. If we find an income deficit or a low probability of success during the planning process, we can address the budget and adjust the plan.
With monthly expenses accounted for, we can look at all of your income sources to determine your monthly income need. About 30% of Americans today still have a pension, and for those lucky ones, that income will be taken into account first. Occasionally I find there are other sources of income, such as a spouse's income, farm rents, property rentals, etc.
Social Security will also supplement income, but it only covers about 33 percent of a retiree's basic needs for most people. When building a comprehensive financial plan, we utilize advanced software to provide a personalized Social Security filing strategy. Our approach is NOT to just enhance the benefits of social security but to find the best overall benefit from an income, investment, and tax perspective. This Social Security filing plan will advise the optimal age to begin receiving benefits.
After adding up pensions, Social Security, and any other income sources we will be able to determine if there is a gap. If there is a gap, this is when distributions from retirement accounts come into play.
People, Not Products
As a fiduciary, when creating a financial plan, I'm bound to putting my clients' interests first; this is why my solutions aren't focused on financial products; instead I focus on solutions. Non-fiduciaries only requirement is to sell a product that will be suitable for their customer's needs, regardless of if it is the best solution for the client. This may be why ‘in-house' branded mutual funds or insurance products are common offerings. There have been countless times a planning client has sat down in my office and asked me to explain how their annuity works. I often ask them why they purchased that annuity and how it benefits them. Often, they can't answer those questions.
A successful income plan is tailor-made for the individual first and foremost. It's critical to understand the customer's overall risk tolerance, goals, and feelings regarding their money. Other factors that will direct a cashflow plan include expected longevity, healthcare considerations, the importance of legacy planning, and surviving spouse income safeguards. Since each individual's situation is unique, the financial products used to build the income plans can vary significantly from person to person.
Strategies for Converting Savings into Monthly Cashflow
There are many ways to convert retirement accounts into a regular withdrawal strategy to provide for living expenses. Which investment vehicle is used depends upon the individual needs, and often we create a plan that utilizes more than one vehicle to achieve the goals; I like to call this bucket planning. Creating an income plan is a balancing act based upon immediate vs. long-term needs. The more immediate your needs are, the more conservative our approach likely is. Assets that will be used for future income can then focus on growth. Because we have to consider inflation, taxes, market fluctuations, potential long-term healthcare, changes to income after a spouse passes away, and other unknowns, it's important to choose the right balance of financial vehicles.
In most cases, the bulk of your retirement savings will be in an IRA or 401k, which can be withdrawn from on a regular basis, subject to some rules. Typically most employer retirement accounts will have a mixture of equities and bonds that align with risk and growth goals. These stocks and bonds are usually held within the mutual fund choices offered by the employer's retirement plan. My recommendations are usually to convert mutual funds to Exchange Traded Funds (ETFs). ETFs offer the diversity of mutual funds and are usually based upon equity markets, but typically have lower fees and are more tax-efficient.
I'll often offset some of the risks of market-based investments with insurance-based vehicles, such as Fixed Indexed Annuities (FIA). The FIA has characteristics of both the Fixed Annuity and Variable Annuity which allows a balance of the risks and rewards. With a lower risk than the variable annuity and higher income potential than fixed annuities, FIA's can help hedge against the stock market's volatility. We also gain the option of having a predictable income stream by using the FIA. Once your predictable income plan is in place, you might feel more comfortable focusing on a growth strategy with the remainder of your portfolio assets.
Lastly, I'll mention an Indexed Universal Life as a source of retirement income. I feel this is most suitable within an overall retirement and tax strategy for high net worth individuals. Since the product's cash value is most often tied to an external index, such as the S&P 500, it can have strong growth potential. While many may discount the use of a life insurance policy for tax-advantaged income and wealth transfer, the illustrations speak for themselves. The National Associate of Insurance Commissioners (NAIC) adopted regulations that prohibit insurance companies from illustrating unreasonable growth assumptions; most companies will use an assumption lower than the historical average.
Regardless of which strategy you choose, it's imperative to understand whether your income will be guaranteed for your lifetime or whether you run the risk of depleting your assets due to outliving your money. You also must factor in reasonable safeguards against inflation and market fluctuations.
How Much Income Can I Safely Take?
I know from working with retires that there is a huge difference between seeing your retirement accounts fluctuate while still working and contributing compared to watching the balance drop while in retirement and taking distributions. While a retirement income plan built around guaranteed withdrawals from annuities and pensions may not have depletions risks, it's important to control the withdrawal rate when deriving income from market-based accounts. Market drops and large distributions earlier in retirement would be especially hazardous to plans dependent upon portfolio growth.
One widely accepted principle is the 4% rule, which states that you can safely withdraw 4% of the asset's principle every year without risk of running out of money in retirement. Considering the S&P 500 has returned an average annual rate of over 11% over the last 30 years, a heavily weighted equities portfolio most likely wouldn't touch the principle.
However, I don't adhere to the 4% rule as a good plan for a withdrawal strategy. Here's what could happen by relying on this surefire ‘4%' rule: First, historical averages do not guarantee future results. There are no guarantees in the equity markets. Furthermore, the ups and downs of the market from year to year can cause a ‘sequence of returns' risk, lowering individual returns. Finally, for some people, a 4% withdrawal may provide insufficient funds for the lifestyle they desire.
So what happens if you need more than a 4% distribution to cover the gap between your income and expenses? In many cases, calculations at a 7% withdrawal still project high rates of success. However, if there are limited retirement funds available, coupled with longevity, the real risk is outliving your money. Does it now make sense to pursue a higher return? Maybe, but that doesn't come without risks. Either way, retirement planning software should be used to stress-test the likely success rate of either plan, weighing longevity risks, inflation, and market fluctuations.
Which Account Do I Access for Income First?
Establishing a plan for taking withdrawals is an integral part of the strategy, often with multiple accounts set up to access at different periods of retirement. Which account to draw from first depends on your individual situation. For example, for some, taking social security at 62 makes the most sense, and for others, delaying until full retirement age or 70 is better. Sometimes, spending down the retirement accounts first provides the greatest tax savings over your lifetime.
The truth is, there's no one ‘perfect' strategy that can meet the needs of everyone. Usually, spouses are different ages with different retirement dates, each holding a variety of 401ks and other investments. It's a precise balancing act to provide a path for the best strategy suited for them. Without a proper plan, there may be tax implications, unwarranted risk and hindered growth factors resulting from tapping the wrong investment accounts.
How Can a Financial Planner Help?
Nobody wants to run out of money in retirement, but did you know there's another real risk in retirement that even more people face? Not living the life you could be because you're afraid of running out of money. One of the most important things a financial planner can provide is peace of mind. You've spent years saving for retirement, so wouldn't you want a plan for how to spend it?
A financial planner has experience and advanced software tools to create your customized plan. A good financial plan will also tie in other important components such as access to emergency funds, tax strategies, probate avoidance, a legacy plan, and much more. The goal isn't just to skimp by, but to bring you the joy, peace, and satisfaction to enjoy the retirement you've earned!
Krista McBeath is an Investment Advisor, Chartered Financial Consultant, a Licensed Insurance Advisor, a Fiduciary, and an experienced tax advisor who specializes in financial planning, investments, and insurance.
She utilizes advanced tools for in-depth calculations that analyze tax and retirement scenarios to help their clients avoid a future tax time-bomb. Whether this means enjoying more of your hard-earned money in retirement or passing along assets to loved ones, with less tax burden, planning makes the difference.
