Today, fewer retirees are covered by traditional pension plans, which places a big burden on retirees to fund their retirement with income from personal savings and investments. Only one in four Baby Boomers expect significant income from an employer provided pension.[i] When it comes to generating income from your savings and investments, there are several challenges. And, if you’re not prepared, they have the potential to derail your whole retirement income plan.
One such challenge is underestimating the number of years your retirement will last. You may live longer than you expect. Retirement could last 30 years or more. For a couple both age 65, there is a 25% chance that one spouse will live to age 97.[ii] That makes it a real challenge for many retirees to determine how much income they can safely withdraw from their savings and investments without running out of money before they die.
Another challenge is determining what today’s “safe” withdraw rate is. Generating reliable income in retirement can be more challenging when interest rates are low (like they are today in 2018). You may not be able to count on traditional approaches to generating retirement income, such as the “4% Rule” in today’s environment of low interest rates and a volatile stock market.
Are you or your clients comfortable rolling the dice when it comes to retirement income?
If your withdrawal rate is too high while generating income from your investment portfolio, it lowers the “confidence” level of income lasting over a 30-year retirement. Assuming an inflation-adjusted withdrawal rate of 4% at retirement and a portfolio allocated 60% to stocks and 40% to bonds; there would be a 30-40% chance that your portfolio would fail to provide income over a 30-year retirement.[iii]
There are certainly several different strategies that can be used to turn your savings into reliable income.
Income Floor Approach
One approach to consider is the Income Floor Approach. This method may help provide you with a solid foundation for addressing your retirement needs. With this strategy, a minimum level of income (the “income floor”) is established to cover essential income needs. The income floor may be funded from guaranteed income sources like Social Security, pensions, and annuities.
Discretionary lifestyle expenses and legacy planning may be more flexible in nature and may be addressed by investing the balance of your assets in a broad range of investments and insurance products based on your time horizon, risk tolerance and investment goals.
The first step in this process is to consider your retirement income needs. Determine how much money you’re going to need annually during your retirement, or your “income number”.
This will be the sum of your essential expenses, plus your discretionary expenses.
What’s essential and what’s considered discretionary is up to each individual. For example, some people may consider golf as an essential income need, while others take a bit more traditional approach.
Here are some examples of what most people would consider essential expenses:
- Basic transportation
- Healthcare expenses
- Insurance costs
- Income taxes
- Other personal expenses like clothing, haircuts, etc.
Traditional examples of discretionary expenses would be things like:
- Travel and recreation
- Memberships (golf clubs, racquet clubs, etc.)
- Gifts to family
- Donations to charities
So, now you have your annual essential expenses and your annual discretionary expenses and the two added together give you your total annual expenses. This is your income number.
Total Annual Guaranteed Income
Next, you need to identify what guaranteed income sources you have. These income sources would typically be income from things like Social Security, pensions, and existing annuity payments. If you have yet to begin drawing your Social Security benefits, this is a great opportunity to explore various Social Security claiming strategies that fit your needs so that you can maximize your future benefits.
Once you have obtained the annual income amounts you expect to receive from your guaranteed income sources, add them up to determine your total annual guaranteed income.
Now…Do You Have an Income Gap?
It’s now time to check if you’re facing an income gap.
Determine if you have enough guaranteed income to cover your annual essential expenses. This is a priority for many retirees.
Simply subtract your annual essential expenses from your existing annual guaranteed income to determine your essential income gap.
If your essential expenses are greater than your existing guaranteed income, then this is your essential income gap and filling this gap with another source of guaranteed income is how we can create your income floor.
In addition to guaranteeing all your essential income needs, many retirees choose to cover all – or part of – their discretionary expenses as well. This comes down to your personal risk tolerance.
So far, you’ve assessed your income needs, identified your guaranteed income sources, and determined if you’re facing an income gap.
Now that you’ve identified your income gap, work with your sales consultant here at Financial Independence Group to determine the indexed annuity and income rider combination that will be best suited to fill the income gap for you or your client.
The information within this article is for informational purposes only and does not constitute legal or tax advice. Customers should consult their legal or tax professional regarding their own unique situation. Annuity products and their related features, benefits and guarantees are backed by the claims paying ability of an insurance company.