When planning for a major event, financial or otherwise, the key to success is starting with the right question. If you don’t do this, it’s easy to get sidetracked and not accomplish what you set out to do.
The looming question in every person’s mind contemplating retirement is, “Will I have enough assets to last for the rest of my life?”
The natural question
This is a natural question since asset accumulation is the name of the game for virtually every financial planning goal. Whether it’s buying your first car, coming up with a down payment on a house, or saving for your children’s college education, a plan needs to be developed and implemented for accumulating an inflation-adjusted lump sum.
This is the wrong question to ask, however, when it comes to retirement income planning. Unlike the three financial planning goal examples where you’re planning for an inflation-adjusted fixed amount, retirement income planning requires a different mind-set.
The primary issue with using the traditional asset accumulation approach for retirement planning is we don’t know how long we’re going to live. This is more problematic when planning for couples. Given the fact that we’re unable to define “the rest of my life,” the question, “Will I have enough assets to last for the rest of my life?” is extremely difficult to answer in most cases.
The right question
So what is the right question to ask when planning for retirement? Whether you’re planning for retirement or you’re already retired, you should ask yourself the following question on a regular basis: “What is the amount of sustainable income that I will need during different phases of my retirement years?”
Asking this question frames retirement planning in a totally different light than the traditional “Will I have enough assets to last for the rest of my life?” Whereas asset accumulation is the name of the game for most other financial planning goals, sustainable lifetime income is the cornerstone of retirement income planning.
Purpose of sustainable income
We all have non discretionary expenses that must be paid which, by definition, aren’t optional. These include rent or mortgage payments, real estate taxes, homeowners’ dues, utilities, food, and income taxes. The primary purpose of sustainable income is to create a known floor of income to cover non discretionary expenses throughout retirement. Sustainable income can also be used to cover quasi non discretionary expenses, including auto, clothing, insurance, and repairs. As a general rule, the more conservative you are, the greater your need for sustainable income will be.
While it’s important to have sustainable income, a fixed monthly income for the duration of retirement generally won’t meet your financial needs. It’s also essential to recognize that retirement has distinct phases with different types and amounts of expenses. Three phases of retirement are described in Michael Stein’s book, The Prosperous Retirement: Guide to the New Reality. They are the Go-Go, the Slow-Go and the No-Go. You need to identify and project your inflation-adjusted non discretionary and quasi non discretionary expenses in each of these three phases and design a sustainable income plan to meet your needs during each phase.
Sources of sustainable income
Let’s say you’ve identified your projected inflation-adjusted non discretionary and quasi non discretionary needs during your various phases of retirement, where do you turn for sustainable income?
Social Security is the most prevalent and best example of sustainable lifetime income. While everyone knows that there are issues with the Social Security system in its present form that must be addressed that will likely result in less favorable benefits for younger individuals compared with current recipients, the fact remains that you can plan for sustainable lifetime Social Security benefits.
Sustainable lifetime income sources aren’t as readily available in the private sector with the widespread elimination of traditional defined benefit pension plans. The good news is that there’s a long-established reliable source of sustainable lifetime income that’s competitively priced and offers creative solutions in the commercial sector. It’s known as a fixed income annuity and is offered by life insurance companies.
Fixed-income annuities have been available in the U.S. for over 250 years. They come in three flavors: single-premium immediate annuities (“SPIA’s”), deferred-income annuities (“DIA’s”), and fixed-index annuities (“FIA’s”) with income riders. While there are significant differences between each type, the basic purpose of each one is identical, i.e., provide sustainable income for a defined period of time. The income is generally for life; however, DIA’s can be purchased for a specified term of years or months.
Sustainable income plan
When analyzing fixed-income annuities, the goal is to use the least amount of assets to purchase the amount and timing of income to match your projected financial need in each phase of retirement, taking into consideration existing sources of sustainable income such as Social Security. This requires the design of a sustainable income plan by an experienced retirement income planner who will identify and optimize a customized blend of the appropriate fixed income annuity types, products, and current and future investment amounts and timing required to meet your retirement income planning needs.
What is the amount of sustainable income that you will need during different phases of your retirement years? If you ask this question when planning your retirement, the likelihood of developing a plan to experience a financially successful retirement will be much greater than if you simply ask, “Will I have enough assets to last for the rest of my life?”
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.