Whether you have already retired or you’re nearing retirement, one of the biggest questions that you likely want answered is: “How much income can I enjoy from my assets?” You have saved and invested all of these years, you’ve accrued this nest egg, and now you want to know how much of it you can spend.
Retirement Planning Today
Well, before we dive into that question, let’s talk about the primary approach to retirement planning today and some of the issues that might exist within that approach.
Probability-Based Retirement Income Planning
Many retirement plans are built around a probability-based investment approach, meaning the majority of the nest egg remains in investments, albeit may be a lower-risk investment profile than you had in your younger years. Nonetheless, the majority of the assets are still in the stock market and this probability-based approach to retirement income planning is going to use a number of different assumptions about you in your retirement to generate probabilities.
Assumptions in Probability-Based Retirement Income Planning
Some of these assumptions are the investment approach that you take on your savings throughout retirement – having a certain investment allocation throughout retirement is one assumption in the probability-based strategy. Another assumption involved is how much of your retirement assets you intend to spend in retirement. Lastly, a probability-based model will use the length of time you expect to live.
The Results of Probability-Based Retirement Income Planning
These different assumptions are built into a model and then run through a multitude of simulations – hundreds or even thousands – to determine the probability of success for your retirement income plan. Probability of success, meaning, the likelihood of you having assets at the end of your life.
If you have a 90% chance of success, that tells you that 90% of the simulations that have been tested had a positive outcome. These successful plans had retirement assets remaining at the end of the plan. The 10% of outcomes showing failure meant a plan ran out of money before the end of life.
Determining Your Retirement Income Risk
Retirees and their advisors work together to determine a probability that they feel good about as they set out on this path of probability-based retirement planning. Many advisors have a certain probability threshold that they don’t want to go below – oftentimes 80%. A retiree may be comfortable with this same success rate or desire something much higher. The main lever adjusted to meet an appropriate success rate is the amount of income withdrawn from assets. Less income will produce a higher success rate for these simulations, but will obviously mean a lower lifestyle for the retiree.
“Safety-First” Retirement Income Planning
We take a very different approach when it comes to creating a retirement income plan because we believe that your retirement income shouldn’t be based on probabilities. As much as is reasonable, we want to build in safety and guarantees on the income that you’re enjoying throughout retirement.
The Safety-First Mindset
This is the new retirement mindset that we want you to adopt as you engage with the 4Buckets. As humans, we value safety and security, particularly when it comes to our resources and our finances. We want to have that same approach as we build a retirement income plan.
Cash Reserves in a Retirement Income Plan
How do we create guarantees around our retirement income? Before discussing, let’s quickly walk you through the 4Buckets framework. Bucket 1 is an assets bucket called Cash Reserves. This is an anchor bucket that doesn’t play a role in your retirement income but it holds reserves for periodic needs as they come up throughout retirement. It’s a cash cushion often called emergency funds – this concept is nothing new for you as a retiree. We want to have that same anchor bucket just like it has played an anchor for you throughout your lifetime. This is Bucket 1: a non-income bucket of reserves to get quick cash. Bucket 1 is going to hold assets that are in checking, savings, and bank CDs. We don’t want to take any more risk with Bucket 1 assets.
Establishing Lifetime Income
Now as we look at Bucket 2, this is where we start to step into our income buckets. Bucket 2 is what we identify as the “Earned Income” bucket. This is Social Security, pensions, trust income, employment income or rental income from a real estate portfolio. These different lifetime income sources are going to fall into Bucket 2. This is the first of our lifetime income streams.
Before we talk about Bucket 3 let’s revisit Bucket 2. We’ve talked about the idea of many Bucket 2 income streams being guaranteed. Social Security is backed by the federal government and that’s about as good of a guarantee as we can get. Pensions, whether through a public or private employer, have a similar level of guarantee as Social Security so we can count on those to be reliable income streams for the rest of our life.
How to Create Guaranteed Retirement Income
As we approach Bucket 3 we’re starting to look at that nest egg – your accumulated savings and investments – and saying, “Okay, how do we round out this retirement income picture?” Bucket 2 will have a certain amount of income it provides and Bucket 3 is intended to complement it. We want it to have the same characteristics as Bucket 2 – guaranteed as much as possible. This means it’s not impacted by what’s going on in the stock market – it’s safe and secure. How do we get that in the private market? We’ve already talked about Social Security and pensions, what else is there to provide that sort of security?
Sources for Guaranteed Retirement Income
It’s called an income annuity. The annuity space can take on several different forms and variations, but the income annuity is focused on providing guaranteed lifetime income. We often refer to it as a ‘‘private pension’ – you’re establishing your own personal pension. The amount of lifetime income will be determined between you and the insurance company as they factor in age, current business environment, interest rates, etc. Guaranteed income issuers will compete to provide the highest amount of income possible. You as the insured need to carefully weigh the guaranteed income with the track record and financial strength of the issuer at hand.
Finalizing Lifetime Income
The combination of Buckets 2 and 3 are going to establish your 4 Buckets Lifetime Income. It’s very straightforward to determine what this figure will be. Social Security will have different benefit amounts based on the age it is taken. Your pension is structured in a similar way. There are different points that you can turn that income on, and your income will vary based on when it is taken. Bucket 3 income is going to be the same way – it’s going to be dictated by how much we’re providing the insurance company and when you would like to turn that income stream on.
How to Invest in Retirement
Bucket 4 is how we address any extra assets that might exist for a retiree. Let’s say a retiree has done a wonderful job of saving. They’re well prepared for retirement, and we have worked through Buckets 1, 2, and 3. They’ve landed on a 4 Bucket lifetime income that they feel really good about. The question becomes, “What do we do with those extra assets?”
Well, this is where we can invest and have some fun and hopefully over the long term see these investments grow. Bucket 4 provides flexibility and options. Some may prefer to have Bucket 4 accrue over their remaining lifetime to be left to family as a financial legacy. Or, perhaps it goes to a charity and it creates a charitable legacy.
How to Use Extra Savings in Retirement
Bucket 4 could also be used periodically for bigger purchases that are being planned out for added lifestyle enjoyment. Or, it could be incorporated into ongoing income in a small way to enhance overall retirement income. Just remember that this income isn’t guaranteed. Whenever income is introduced to a volatile portfolio there’s always a risk that this can’t be maintained. But, this is Bucket 4: a multitude of uses based on the preference of the retiree.
Combine Guarantees and Growth Opportunity Around Retirement Income
Let’s revisit our question about how much income can be enjoyed from retirement assets. When we start to put some guardrails and guidelines around the retirement income plan, we can actually get some wonderful clarity around the income that we can enjoy. If we steer away from probability-based retirement income plans and focus on how we blend the benefits of insurance and guarantees with the benefits of investments and growth, we can create a retirement income plan that is dependable and consistent, and we can look at it with much greater certainty than we ever could from a probability-based approach.
