When you retire, you shift from working for a paycheck to drawing a retirement paycheck. A solid income distribution strategy is essential as you move into this new chapter of life. By gaining an understanding of how much you'll need and what resources are available, you'll be able to pursue the lifestyle you want during retirement.
If you follow the three retirement income planning strategies below, you'll be well on your way to creating a sound financial path for your future.
1. Determine Your Need
More often than you might think, people transition into retirement without a clear idea of how much money they need to have saved. If you don't have a savings goal, you risk falling short on the necessary expenses and fun purchases that contribute to a fulfilling retirement. There are different approaches to managing expenses in retirement, but two best practices include:
Determining an income replacement ratio: A traditional rule of thumb is to estimate how much you'll need based on your pre-retirement income. You might assume that you'll only need a portion of your current income in retirement because you're no longer paying payroll taxes and saving for your future, but a more detailed estimate is ideal. Experts believe that replacing at least 70 percent of gross pre-retirement income is adequate for most people, but your specific ratio depends on a lot of factors, including taxation, so speaking to a financial professional can help.
Following a detailed spending plan: If you track your spending (or calculate what you spend over a typical year), you can develop a detailed budget and project your retirement expenses with those numbers. This approach allows for fine-tuning, enabling you to account for factors such as your mortgage payoff date and spending patterns that may change through retirement.
2. Make the Most of Social Security
Social Security makes up about 33% of household income for the elderly in the U.S. That's a significant piece of your retirement income strategy, so it's critical to get this right.
Most people can take retirement benefits at age 62, but according to the Social Security Administration (SSA), your benefits are reduced at that age, and if a spouse takes over your payments after your death, those survivor benefits may be permanently reduced if you claim early. Waiting until your full retirement age allows you to dodge those benefit reductions, and delaying benefits until age 70 provides the highest monthly benefit. Compare your lifetime income (and survivor benefits) at different ages before you make a decision.
Planning to retire by age 62? It could still be best to wait to apply for Social Security. Consider other sources of income as well as different asset types when weighing the benefits of collecting against tax liability. To get by without Social Security income, you may have to rely on your savings, leverage an income annuity or employ other strategies to bridge the gap.
3. Evaluate Your Withdrawal Strategies
Guaranteed income sources such as Social Security, annuities and pensions can provide a base of income, and if you need more than that, you can spend from your savings. Two popular strategies for planning withdrawals are the 4% rule and a bucketing strategy.
The 4% rule assumes that you can withdraw 4% of your account balance and adjust for inflation over a typical 25-year retirement. For example, if you have $1,000,000 in assets, you start with $40,000 (or 4% of $1,000,000) of income in the first year of retirement. If inflation is 2% that year, you increase your withdrawal during the following year to adjust, resulting in a $40,800 withdrawal. This retirement income strategy is an attempt to make your money last for the rest of your life, but there's no guarantee.
A bucketing strategy divides your retirement savings into several different risk "buckets." For example, you might keep the money you need for your first 1 to 3 years in safe investments such as cash, and for the money for the next several years, you might use relatively low-risk investments and hope to earn a modest return. For money you won't need for more than 10 years, you might invest at a somewhat higher risk level, depending on your needs and risk tolerance. As you spend cash from the first bucket, you gradually replenish those funds by drawing from subsequent buckets.
Start Your Retirement Income Planning Today
There are several ways to approach your retirement goals, so you can easily find a method that work best for you. By defining your goals, maximizing your resources and planning your withdrawals, you'll be able to feel secure that you're ready for the next stage of your life.
For 16 years, Tony Alvarez has lead a team of financial professionals in southeastern Florida for Bankers Life specializing in comprehensive retirement planning for the pre-retiree and senior markets. He holds a Business Administration degree from Florida Atlantic University, FINRA licenses for Series 7, 63, 66, FL-215 Insurance licensing, as well as a variety of other expert level certifications from the American College of Financial Planning, and AHIP. His expertise lies in the training and development of reps throughout the financial services industry providing guidance and advice for Healthcare planning, Estate planning, and tax-advantaged retirement income distribution planning.