I would like to lay out 2 opposite strategies when it comes to retirement income planning. Neither strategy is necessarily right or wrong in all cases.
As usual when it comes to opposite thought processes, they will fall on 2 different ends of the spectrum.
And that means that there will be numerous options in between the 2 opposite positions. Where you fall on the spectrum will depend on a number of different factors, which we will discuss.
And after you read this you should have a clearer idea of what type of retirement income planning strategy is going to be more suitable for you.
And it’s not going to be the same for everyone.
In fact, if you choose a retirement income planning strategy that does not fit your goals, you could end up sabotaging the success of that plan. And if a financial adviser is pushing you into an investment strategy that does not line up with your goals, you need to understand what’s about to happen to you, and then avoid this adviser’s recommended strategy.
The Need For Retirement Income Planning
Before we talk about 2 different strategies for generating retirement income, let’s talk about how important it is to have a good plan.
When you retire you will have a pot of money. A lot of it may be in your 401(k) that you are about to rollover into an IRA. You may have other sources of savings that are outside of an IRA. These would be called “Non-Qualified” sources of savings.
When you quit working you no longer receive a paycheck. I think this is obvious to all.
That means you will need to have other sources of lifetime income. The 2 primary sources of income for retirees are Social Security and pension. Not everyone will have a pension.
In most cases, these lifetime income sources will not be enough to cover the expenses for the lifestyle you want to live.
That means you must use your savings to cover the remainder. And when you start using your savings the thought will cross your mind, “What if I run out of money?”
That’s where Retirement Income Planning comes in. It is the practice of looking at your situation and determining the most efficient, low-cost, and low-risk way to fill in the gap between your income and your expenses.
And to do so in such a way to minimize the risk of you running out of money before the last day of your retirement.
So, obviously, there is a lot at stake here.
If you don’t plan properly you could risk running out of money. And what that really means is that as you see your money dwindle down, you will begin drastically cutting back on expenses and sacrificing things that you thought you would be able to enjoy in retirement.
You may even have to consider going back into the workforce.
In other words, to keep your money from running out you will sacrifice the lifestyle you thought you were going to enjoy in retirement.
So let me repeat myself: “There is a lot at stake here.”
Two Schools of Thought on Retirement Income Planning
Seeing that retirement income planning is so important to retirees, let’s talk about 2 opposite ways to plan for income in retirement. And keep in mind, there are options in between these 2 extremes, more moderate options. Like much of life happiness is found in moderation.
The first way is to invest all your money in the market. The thinking behind this strategy is to use a balanced portfolio that is in line with your risk tolerance.
You would then have a plan where you would take systematic withdrawals from this portfolio. You may even base your withdrawals off something like the “4% withdrawal” guideline.
Using this strategy you would need to be committed long-term. Even when the market is down and your portfolio is down with it, you would need the fortitude to “hang in there” under the faith that markets will eventually go up.
Some people can do this. Some people cannot. Ask yourself, “Which type of person am I?”
The second strategy is to guarantee everything. This means using financial products that cannot lose value.
This would include CD’s at the bank or fixed annuities. No matter what happens in the stock market, these are not going to go down.
You could use fixed annuities to generate income that would cover your expenses. Once you know your expenses are covered you could use additional fixed annuities or CD’s for the rest of your savings as a way to protect them and get conservative growth.
Using this strategy you would not have to worry about the stock market’s performance, but you would also not expect aggressive growth from your savings.
Some people like 100% guarantees on principal safety. Some people do not because they want more growth potential. Ask yourself, “Which type of person am I?”
The Middle Ways
In between these 2 polar opposites are numerous other options for planning for income.
Instead of putting all of your money in the market, you may choose to 1) put some of your portfolio in the market, 2) another portion in annuities that will guarantee you a certain level of income, and 3) still another portion in simple cash at the bank for emergencies.
This is a more balanced approach.
The actual percentages you allocate to these 3 options will depend on some other factors. Let’s look at those factors.
How Should I Allocate My Retirement Savings?
I am speaking in generalizations here. But it should help you when determining how to allocate your assets in a retirement income plan.
First, if you have a lot of lifetime income (perhaps from Social Security, pension, other sources) and it is sufficient to cover your expenses in retirement, it may make more sense for you to be invested more in the market.
The reason is because your basic expenses are covered through the lifetime income sources. So you are not dependent on how the market performs to pay for your lifestyle in retirement.
Second, if you have a strong appetite for risk and can handle a high degree of volatility in the market, it may make sense for you to have more exposure to it.
The fact is some people cannot handle a high degree of volatility in the market. Especially retirees. And I understand. I would be the same way if I were retired and needing to protect my savings.
But some people can handle it. And those people may be perfectly fine picking a balanced portfolio in line with their risk tolerance and withdrawing a certain amount from it each month or year. Even when it is down due to a market correction.
Third, if you like the idea of having some of your retirement expenses covered through additional lifetime income, an annuity may make sense as a portion of your portfolio.
It would provide you additional income (added on top of Social Security, pensions, etc.) to meet your needs.
Knowing that those needs are mostly (perhaps entirely) met, you may then be perfectly comfortable investing another portion of your money in the market to get some higher growth potential.
What Retirement Income Planning Strategy Should You Use?
To know which retirement income planning strategy is right for you, you must “Know thyself.”
I can’t overstate that enough. If you have a retirement plan that would work but you can’t stick with it (think about bailing out after a market crash and locking in your losses), then that’s not the right strategy for you.
It’s one thing to have a plan that works. It’s another thing to have a plan that works… that you can stick to.
So ask yourself the following questions:
- Are income guarantees that important to me?
- Is higher growth potential (with the potential for losses) more important to me?
- How much lifetime income guarantees would I feel comfortable with?
- Do I have the fortitude to stick with a steady withdrawal strategy from my stock market investments… even when my portfolio is down?
The way you answer these questions will determine a lot about which way of planning is right for you.
Since there is no “one-size-fits-all” plan for everybody, you need to be aware of these different factors. You need to be aware of this so if a financial adviser tries to push you into a plan that doesn’t match up with your goals, you will know not to go along with that plan.
In the end you need to know what is important to you. You can ask yourself some simple questions to help you determine this. And if you work with a financial adviser (or are considering working with one) make sure they take time to understand your situation, needs, risk tolerance, and goals.
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