What does your retirement look like? Traveling to and from your beach house along the coast? Uninterrupted time with friends and family? Working part-time to keep busy? However you picture yourself, it’s important to consider your expectations carefully, because your retirement income plan will be designed to support the retirement lifestyle that you envision.
What Can Impact My Overall Retirement Income?
Americans are living longer. With life expectancy likely to increase, this stimulates a longer period of time you’ll need your retirement income to last. There are many factors that can have enormous impact on your overall retirement situation.
Here are a few things to consider before choosing when to retire:
- If you're planning to retire early, you'll have fewer years to accumulate and earn money. Retiring early will mean a longer distribution period and the potential to outlive your income. Additionally, retiring earlier than most could mean a lack of health care due to eligibility requirements.
- If you're delaying retirement, you'll have more years to contribute and save and a shorter distribution could enhance your savings potential. You could take advantage of health care through your job while working and delayed Social Security potentially increases annual benefit.
- If you plan to work during retirement, you'll have the ability to stretch your personal savings. You'll potentially have access to healthcare through your employer and while you may see an increase in Social Security benefits in the future, they will be reduced while working.
Three Main Goals to Balance your Retirement Income Plan
The process of Retirement Income Planning begins with knowing: when your retirement will start, how long it may last, and the type of lifestyle you want. There is a process to balancing your retirement income plan, and that process begins with understanding and planning for three main components of retirement:
- Maximize your ability to enjoy retirement to make sure you have the financial ability to do the things that you want to do.
- Manage the risk of outliving your income to minimize the chance that you will outlive your money.
- Manage the risk of unexpected life events.
Once your goals are set, the image below depicts the process to help reach them. Now let’s dive in as to what each step means:
How Much Annual Income Will I Need?
When trying to figure out how much annual income you’ll need in retirement, its tempting to rely on general guidelines. You may hear that you should plan on needing somewhere between 60% and 90% of your pre-retirement income when you retire. General guidelines like this are easy, but not helpful in effectively tailoring into your unique circumstances, expectations, and goals.
Instead of basing an estimate of your annual income needs on a percentage of your current income, focus instead on your actual expenses today, and whether those will stay the same, increase, decrease, or vanish by the time you retire. A mortgage or costs for transportation to and from work may disappear, but maybe you anticipate yard care service, snow removal, or home maintenance expenditures as you age that would result in an increase. Think through all possible scenarios.
How Much Annual Income Will I Need: Accounting for Health Care Costs
A major retirement expense to keep in consideration is the cost of health care. With the likelihood you will focus more on health in retirement, and the greater chance that your health will decline, it’s important to budget for the coverage elections such as Part B coverage for medical care, a prescription drug plan, or a Medigap policy.
How Much Annual Income Will I Need: Account for the Cost of Long-Term Care
Long-Term Care refers to the ongoing services and support needed by people suffering from chronic health conditions or disabilities. While it’s difficult to face the fact that our health might decline, statistics suggest that most of us will need long-term care during our lifetimes at some point after we reach age 65. The national average annual cost of a nursing home, according to Genworth 2019 Cost of Care survey, is $90,155. So, how do you pay for it? Many assume Medicaid will pay for long-term care costs, and you may be able to rely on Medicaid, but there’s a catch. To qualify, your assets and income must be low enough to allow you to qualify. And paying out-of-pocket is a gamble unless you’re wealthy. An alternative is long-term care insurance, which may provide a source of funds for long-term care expenses but doesn’t ensure that you won’t have to pay for some of the long-term care costs out-of-pocket. And you will need to be sure to factor in the premium for this insurance to your retirement income needs.
What Else You Should Consider
Many factors are overlooked yet important in helping to determine your income needs in retirement. Below are a few things to consider:
Inflation is basically a general increase in the cost of goods over time, and accounting for inflation is difficult. Unless you accurately account for inflation, you’ll likely underestimate the amount of annual income that you’ll need in retirement. Keep in mind that inflation doesn’t affect all goods and services equally. If fact, retirees can be affected by the disproportionate increase in the cost of some things, for example, health care. All-in-all, with other things being equal, inflation means that you’ll need more retirement income each year just to keep pace.
Impact of Taxes
Taxes can eat into your income, significantly reducing the amount you have available to spend in retirement, and it often overlooked. You’ll want to make sure that you understand whether income that you’re counting on is, or is not, subject to tax. Depending upon your filing status and total annual income, many are surprised to learn that a portion of Social Security retirement benefits may be subject to federal income tax. You’ll also want to understand how your income is taxed:
- Ordinary income tax (e.g., interest)
- Special tax rates for long-term capital gains and qualifying dividends
- Tax-free income (e.g., certain municipal bonds)
- Special rules for tax-advantaged accounts
Different types of investments carry different risks. Sound retirement income planning involves understanding these risks and how they can influence your available income in retirement. Risks that need to be accounted for include:
- Investment or market risk
- Reinvestment risk
- Interest rate risk
Sources of Income
After you’ve estimated the amount of annual income you’re going to need in retirement, it’s time to determine how much annual income you can already count on. Traditionally, retirement income has been described as a “three-legged stool” comprised of: Social Security retirement benefits, traditional employer pension income, and individual savings and investments. Social security and employer pensions produce a steady of relatively “fixed” stream on annual income you can depend on. The amount of social security you’ll receive is based on the number of years you’ve been working and the amount you’ve earned.
Social Security basics:
- You can determine estimate annual income using a benefit calculator
- Earliest you are eligible to take Social Security is age 62
- Working in retirement can affect your Social Security benefits as mentioned previously
- The federal government periodically adjusts Social Security benefits for inflation
- For most people, Social Security alone isn’t going to provide enough income in retirement
Unless you have a generous employer pension and high Social Security earnings, you’re going to have a gap of additional income needed. This is going to be made up of personal savings and investments.
When we’re talking about personal savings, we’re talking about the funds that you have in tax-advantaged accounts like IRAs, 401(k) plans, 457(b) plans, and 403(b) plans, as well as any investments you hold outside of tax-advantaged accounts.
When it comes to putting together a plan to convert your personal savings into a source of retirement income that fits your needs, there are several factors to consider:
- Investment / asset allocation strategy
- Specific investment and product choice
- Withdrawal rate
- Order of withdrawals
- Required minimum distributions (RMDs)
During your accumulation years, your asset allocation decisions may have focused primarily on long-term growth. But in retirement, the demands on your portfolio are likely to be very different.
An effective asset allocation plan:
- Provides ongoing income
- Minimizes asset volatility
- Maximizes likelihood that savings will last as long as needed
- Keeps pace with inflation
There are many different investment options, however here are a few choices that might have a place in the income-producing portion of your overall investment strategy:
- Bonds, bond funds
- Dividend-paying stock
- Certificates of deposit (CDs)
- Treasury Inflation-Protected Securities (TIPS)
- Distribution funds
All investing involves risk, including the possible loss of principal. You should not invest in any of these options without a full understanding of the advantages and disadvantages the investment offers, as well as an understanding of how any earnings are taxed.
Before investing in a mutual fund, carefully consider the investment objectives, risks, charges, and expenses of the fund. This information is available in the prospectus, which can be obtained from the fund. Read it carefully before investing.
An annuity is a contract between you and an annuity issuer (an insurance company). You pay premiums in exchange for the issuer’s promise to make payments to you for a fixed period of time or for the rest of your life.
An annuity can offer:
- Guaranteed income stream for life (guarantees subject to claims-paying ability of the annuity issuer)
- Fixed income means less flexibility
- Relative return on investment
- Can be a full or partial solution
Personal Withdrawal Rate
Your retirement income plan depends not only on your asset allocation and investment choices, but also how quickly you draw down your personal savings. Things to keep in mind:
- Current vs. future income needs
- “Sustainable withdrawal rate”
- Calculation methods
- 4% to 5% typical withdrawal rate
- Particularly important in early years of retirement
Given a choice, what type of account should you withdrawal first?
- Consider withdrawing from taxable accounts first, then tax-deferred accounts, and lastly, any tax-free accounts.
- Income concerns vs. estate planning concerns
- Your individual circumstances
As you’ve learned, there are many factors that contribute to your overall retirement income. For a further in-depth analysis from CFS* Financial Services Representative, Erik Waldron, view our on-demand webinar, Setting Yourself Up for Success: Retirement Income Planning on our CU Events page.
Ready to begin planning but not sure where to start? Contact Investment Services, provided by CUSO Financial Services, L.P. (CFS),* today at 513.243.6510 or email Todd Blessing at: firstname.lastname@example.org or Erik Waldron at: email@example.com.
- Learn More About Investment Services
- Closing a Retirement Income Gap
- Planning for Retirement
- Pros and Cons of a Health Savings Account
- Coping with Market Volatility
*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. ("CFS"), a Registered Broker-dealer (Member FINRA/SIPC) and SEC-registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. General Electric Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.