Given the inherent complexity and unpredictable nature of retirement planning, it’s important that sustainable income is included in your plan. Merriam-Webster’s simple definition of sustainable is “able to last or continue for a long time.” Examples of sustainable income include Social Security, defined-benefit pension plans and fixed-income annuities.
There are five basic reasons for including sustainable income in your retirement plan. The specific types of income, investment sources (taxable or tax-favored), income amounts, and income start dates you choose will depend upon the level of expenses that you would like to cover as well as existing sustainable income sources.
1. Hedge against longevity
The number one reason for including sustainable, or predictable, income in your retirement plan is that we will probably live longer than we think. Life expectancies for men and women who reach age 65 have increased steadily from 13 and 15 years, respectively, in 1950 to 18 and 20 years in 2010 per the National Center for Health Statistics 2011 report. There’s a 20% chance that a healthy 65-year-old American male will live to 95, with the percentage increasing to 29% for a female per the Society of Actuaries 2012 Annuity Mortality Table. Furthermore, wealthier people tend to live longer.
2. Match income to projected expenses
The key to successful retirement planning is being able to pay for expenses for the duration of retirement. As simple as it seems, this can be quite challenging in the absence of a well-thought-out, regularly updated plan that includes projected expenses and amounts that reflect different stages of retirement. Once this is in place, sustainable income sources and after-tax amounts can be designed to match the level of projected annual expenses that you would like to cover.
3. Protect against the sequence of returns
One of the most significant risks to any retirement plan is the sequence of returns. This is the risk of receiving low or negative returns in the early years of taking withdrawals from investments. Your investment portfolio can decline substantially to the extent that you experience sizable losses in the first ten years of retirement. In addition to offering predictable income, the portion of your portfolio that’s transferred into fixed income annuities will be shielded from the sequence of returns.
4. Increase cash flow from potential income tax savings
There are two types of fixed-income annuities that produce income tax savings when non-qualified, or non-retirement, funds are used to purchase them. They are single premium immediate annuities, or SPIAs, and deferred income annuities, or DIAs. A portion of each payment is considered to be a return of principal and is nontaxable. The amount that’s excluded from taxation, which can be significant, is dependent on your life expectancy when payments begin.
5. Simplify your financial life
Simplification of our financial life becomes increasingly important as we age and deal with cognitive decline. It’s a known fact that fixed income annuities achieve this goal, allowing us to sleep better at night. Unlike a traditional investment portfolio that’s continuously exposed to the vagaries of the stock market, fixed income annuities provide a known predictable income stream beginning on the date of your choosing. Equally important, investment management, including potential fees, isn’t an issue.
The foregoing are five basic reasons for including sustainable income in your retirement plan. The common theme is security. You will experience reduced uncertainty and anxiety before and throughout retirement to the extent that one or more predictable income streams that meet your financial needs are included in your plan.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.