Retirement Income Planning

It’s All About Timing

No matter how many times we see magic shows, inevitably, in response to a professionally-performed magic trick, we blurt out, “How did he do that?” Even though we know that the magician’s goal is to elicit this reaction, we’re nonetheless amazed by it.

What’s more astounding is that we’re amazed despite the fact that we all know the secret to each and every trick – timing. The use of precise timing in the performance of a planned sequence of events is responsible for creating the illusion that’s played out before our eyes time and time again by a professional magician.

It’s no different when it comes to successful retirement income planning. It’s all about timing. Anyone can stop working permanently and say they’re retired. Successful financial retirement, however, requires the performance of a planned sequence of events before and throughout retirement.

As you may have noticed, unlike my description of the magic process, I omitted the word “precise” before “planned sequence of events.” This was intentional since, unlike magic where the magician has control over the outcome of his tricks provided his timing is precise, this is irrelevant when it comes to retirement income planning. There are too many variables beyond our control, e.g., longevity, inflation, etc., that affect the outcome of a retirement income plan, making the use of precise timing meaningless.

Nonetheless, the performance of a planned sequence of events in a timely manner is essential to increasing the likelihood of a successful financial retirement. It’s a complicated ongoing process that requires planning, managing, and protecting retirement income. Given the potential duration of retirement of up to 25+ years, the sooner the process is begun, the more likelihood of a successful result.

As a retirement income planner, my ability to perform “magic” for a client is dependent upon my ability to understand my client’s financial needs and my client’s willingness to allow me to implement and maintain a plan that includes the performance of a planned sequence of events that will increase the likeliness of my client meeting his/her financial needs throughout retirement. Timing is everything.

Retirement Income Planning

Mind the Gap

If you’ve been to London and taken the Underground, you’re probably familiar with the phrase, “Mind the gap.” It’s a recorded warning to train passengers to be cautious when crossing the gap between the train door and the station platform. Having an affinity for the British and their sense of humor, this resonated with me and puts a smile on my face whenever I think of it.

When planning for retirement, you also need to “Mind the gap.” Just like with the Underground where you have an unsafe opening between the station platform and the train door, there’s often a separation between retirement expenses and income, with income not being sufficient to match expenses in a particular year. I like to refer to this as a “net expense year.”

In order to “mind the gap” in retirement income planning, you first need to identify the gaps. This is extremely complicated due to the many uncertainties and associated assumptions that must be made when doing this type of planning, a discussion of which is beyond the scope of this post.

The preparation of a cash flow projection is an essential tool for most financial planning situations. It’s indispensable when it comes to retirement income planning, including identification, analysis, and resolution of net expense years. Like any financial projection, a cash flow projection is only as useful as the information that’s used to prepare it.

Retirement income planning cash flow projections, unlike other types of cash flow projections where you typically work with a defined number of years, is complicated by the fact that you need to plan for what is generally an unplannable event, i.e., death. This becomes even more problematic when planning for couples.

It’s important to keep in mind that cash flow planning isn’t a one-time exercise. Cash flow projections need to be prepared and updated using multiple what-if scenarios on a regular basis before and throughout retirement. The use of account aggregation software is advisable, if not essential, for consolidating real-time information from multiple financial accounts in one place whenever this is done. I make the secure, online system that I use for this purpose readily available to my clients for viewing cash flow, investment, net worth, and other essential financial reports.

Projected net expense years, in and of themselves, aren’t necessarily problematic. There may be sufficient cash reserves or other liquid assets available that can be used to cover projected deficiencies in a particular year(s). Income tax liability associated with sales of nonretirement assets or withdrawals from retirement plan accounts needs to be calculated to determine the net amount available to cover projected shortfalls. When the projected net expense years are reoccurring and are projected to deplete investment assets, the sale of real estate assets, when available, including one’s house, may be required to provide funds to reduce or eliminate the gaps.

When planning for the years leading up to or during retirement, remember to “mind the gap.”

Annuities Fixed Index Annuities Social Security

Delayed Gratification is the Key to Maximizing Income with Fixed Index Annuities

When you’re planning for retirement, income is the name of the game. The more sustainable income that you can generate, the less you need to worry about things like sequence of returns and major stock market downturns – before and during retirement.

The idea is to build a base, or floor, of predictable income that will cover your day-to-day expenses. For most people doing retirement income planning, Social Security is the core element of an income floor. Although pre-retirees today can plan to receive a full Social Security benefit beginning somewhere between age 66 and 67 depending upon their year of birth, the benefit that they, and potentially their spouse, will receive will increase by 8% per year for each year that they defer their start date up until age 70. This equates to as much as a 24% – 32% greater benefit depending upon your year of birth and how long you defer your start date.

Assuming that your goal is to build a solid base of sustainable income with the ability to increase your lifetime income amount similar to Social Security, one of the best ways to do this is to invest in a flexible fixed index annuity (“FIA”) with an income rider. The reason that you want to use a flexible, vs. a single, premium FIA is to provide you with the ability to add to your investment should you choose to do so. In addition, you need to purchase an income rider, which is optional with most FIA’s, in order to receive guaranteed (subject to the claims-paying ability of individual insurance companies) income.

Like Social Security, the longer you wait to begin receiving your income, the greater it will be. Unlike Social Security benefits which are increased by cost of living adjustments (“COLA’s”), the lifetime income from the majority of FIA’s available today will remain unchanged once it’s started.

To demonstrate the benefit of deferring the start date of FIA income withdrawals, let’s use one of the contracts purchased by my wife and me two years ago when we were 55 and 48, respectively. I will use my wife’s age as a point of reference for the remainder of this post since income withdrawal amounts are always calculated using the younger spouse’s age.

Per our annuity contract, my wife and I are eligible to begin income withdrawals at least 12 months after our contract was issued provided that both of us are at least age 50. It generally doesn’t make sense to take withdrawals from a FIA income rider before age 60 since the formula used to calculate the withdrawal amount is less favorable and the withdrawals will be subject to a 10% IRS premature distribution penalty and potentially a state penalty. Assuming that we plan on retiring after my wife is 60, there would be no need to begin income withdrawals before this age.

I have prepared a spreadsheet with various starting ages in increments of five years beginning at 55 through 75. The spreadsheet shows the projected percentage increase in our annual income withdrawal amount that we will realize by deferring our income start age compared to ages that are 5, 10, 15, 20, and 25 years younger, depending upon the starting age chosen.

Using an example that’s comparable to the Social Security starting age decision, suppose that we decide to defer our income start age from 65 to 70. This would result in a 31.2% annual increase in lifetime income. We will receive 120.3% more income if we begin our income withdrawals at age 70 instead of at 60. The percentage increases are significant in many cases depending upon the chosen withdrawal starting age compared to another potential starting age.

Similar to the Social Security starting age decision, there are numerous factors that need to be considered when determining the optimal age to begin income withdrawals from a FIA with an income rider, a discussion of which is beyond the scope of this post. Like Social Security, when possible and it makes sense, delayed gratification is the key to maximizing lifetime income.

Retirement Income Planning

Plan for a Range of Retirement Ages

It’s widely agreed that age 65 is no longer the magic retirement age. According to the U.S. Bureau of the Census Current Population Survey, 65 or 66 was the average retirement age for men from the early 60’s through the mid 70’s. It dropped to age 64 in the late 70’s, 63 in the 80’s, and 62 from 1989 until 1995. It then increased to 63 from 1997 through 2007 before it returned to age 64 in 2009.

The average retirement age for women has historically been younger than for men. There was a 6 to 13-year age difference from the early 60’s through the mid 80’s when the average age for women ranged from 53 to 57. It wasn’t until 1989 that the average retirement age for women climbed to 59, then 60 in 1995, 61 in 2003, and 62 in 2007. Since 1989, the spread between men and women’s average retirement age has held steady between two and three years.

You may be thinking, that’s pretty good – men are retiring at age 64 and women at 62. There are several things to keep in mind, however, when digesting these statistics:

  • These are average ages, with 50% of individuals retiring at a later age.
  • When someone retires, it isn’t always by choice and instead is often dictated by layoffs or health issues.
  • Most people who retire don’t have a retirement income plan with multiple potential sources of sustainable income.
  • Many people who retire do so with minimal income with a reduced lifestyle compared to what they previously enjoyed.
  • The absence of a retirement income protection plan, including long-term care protection, is common.
  • With longer life expectancies, it’s becoming more challenging to not outlive your financial resources.

With traditional pension plans becoming rarer in the private sector, increasing starting age for collecting full Social Security benefits as well as other anticipated unfavorable changes to the Social Security system, the average retirement age for men and women is likely to continue its climb. Given this situation, planning to retire at age 65 isn’t realistic for most people.

Assuming that you want to do retirement income planning, what is the retirement age for which you should plan? I’m a firm believer, for many reasons which are beyond the scope of this post, that retirement income planning, more so than any other type of financial planning, needs to be dynamic and flexible. It’s important that you don’t pigeon hole yourself into one specific age and instead plan for a range of possible retirement ages. A five-year range is generally appropriate, e.g., 64 to 68. In addition, this isn’t a one-time exercise. It should be reviewed and adjusted on a regular basis, preferably annually.

Don’t be guided and mislead by statistics. There’s no magic age at which you should retire. If you haven’t done so already, you need to hire a professional retirement income planner to assist you with the analysis and recommendations. You don’t want to make a mistake when it comes to calculating your ability to retire at a certain age since you probably won’t get a second chance once you retire.

Retirement Income Planning

Do You Have An Income Portfolio Plan?

We’re all familiar with the concept of an investment portfolio. Wikipedia defines it as “an appropriate mix or collection of investments held by institutions or a private individual.” It explains that “holding a portfolio is part of an investment and risk-limiting strategy called diversification.”

A well-diversified, professionally-managed investment portfolio can enable you to pursue various financial goals, including financial independence, in the accumulation stage of your life. As you approach, and move into, retirement, a customized income portfolio plan is essential for enabling you to close the gap between your projected income needs and your projected income sources without worrying about, and being dependent upon, the gyrations of the stock market.

How many of us have heard of a “retirement income portfolio,” or the term that I have coined, “Financial Independence Income Portfolio™?” I would suspect that not many people are familiar with these terms. I will simply use “income portfolio” for the remainder of this post to introduce this innovative planning strategy and explain why it should be the cornerstone of every retirement income plan for all individuals beginning ten years before retirement.

You may be wondering, what is an income portfolio? Whereas an investment portfolio uses a mix of assets, including stocks, bonds, and other types of investments with the goal of minimizing investment risk, an income portfolio uses streams of income to accomplish the same objective. The income streams can be produced at different intervals, i.e., monthly, quarterly, semi-annual, or annual, based on your needs.

There are several types of investments that can be used to generate income streams, each with their own advantages and disadvantages. These include, but are not limited to, CD’s, bonds, life insurance, and annuities.

Depending upon your situation, one or more of these investment vehicles can be used to design a strategy, or plan, to close the gap between your projected income needs and your projected income sources. Similar to an investment portfolio that is used in the accumulation stage, a secondary benefit to be derived from an income portfolio is minimization of investment risk.

It’s a fact of life that, unlike our parents’ generation who could depend on a monthly pension supplemented by Social Security, most individuals retiring today don’t receive a monthly income. Consequently, although no small task, we must create, manage, and protect our own income streams. The means to accomplish this, i.e., an income portfolio plan, should be the cornerstone of every retirement plan for all individuals beginning ten years before retirement.

Retirement Asset Planning Retirement Income Planning

Retirement Income Planning – The End Game

If you’re a subscriber to Retirement Income Visions™, you may have noticed that, although there have been nine posts prior to this one, none of them has stayed true to the theme of this blog, i.e., Innovative strategies for creating and optimizing retirement income. This post will be no exception. As the saying goes, there’s a method to my madness. In order to understand and appreciate the strategies and apply them to your situation, it’s important to understand the origin of retirement income planning, including the limitations of the retirement asset planning approach.

As explained in The Retirement Planning Paradigm Shift – Part 2, retirement planning is undergoing a paradigm shift. Instead of relying on retirement asset planning as a solution for both the accumulation and withdrawal phases of retirement, people are beginning to recognize, understand, and appreciate the need for, and value of, employing retirement income planning strategies during the withdrawal phase. No doubt about it, per Retirement Asset Planning – The Foundation, retirement asset planning is the way to go in the accumulation stage to build a solid foundation for a successful retirement plan. However, as discussed in The Retirement Planning Shift – Part 2, as a result of the uncertainty of traditional retirement asset planning as a solution for providing a predictable income stream to match one’s financial needs in retirement, retirement income planning was born.

Is Your Retirement Plan At Risk? introduced six risks common to all retirement plans: inflation, investment, income tax, longevity, health, and Social Security benefits reduction.

Beginning with Retirement Asset Planning – The Foundation, the inadequacy of retirement asset planning during the “spend-down” phase was discussed. This begins with the process itself. Unlike most types of financial planning where you get to see the results of your plan after reaching a specified target date, this is not the case with retirement asset planning since the timeframe is undefined.

Withdrawal Drag – The Silent Killer contrasted the beauty of compound rates of return during the accumulation stage with the erosion of portfolio income and the associated benefit of compounding, otherwise known as “withdrawal drag,” in the withdrawal stage of retirement. There is yet another phenomenon that can wreak havoc on your portfolio if you only rely on a retirement asset planning strategy during your retirement years. The Sequence of Returns – The Roulette Wheel of Retirement exposed this investment phenomenon and provided an example of how “luck of the rate-of-return draw” can prematurely devastate a conservative, well-diversified portfolio.

As if all of these variables and financial phenomenon were not a wake-up call to your planning, we mustn’t forget about the “safe withdrawal rate.” Safe Withdrawal Rate – A Nice Rule of Thumb demonstrated how the widely-accepted 4% “safe” withdrawal rate doesn’t necessarily guarantee that you won’t outlive your investment portfolio. Furthermore, the withdrawal amount that is calculated using this methodology typically won’t match your retirement needs.

All of the foregoing financial risks and phenomenon contribute to the inherent uncertainty associated with the retirement asset planning process during the withdrawal phase of retirement. As pointed out in Retirement Asset Planning – The Foundation, even if you’ve done an excellent job of accumulating what appear to be sufficient assets for retirement, you generally won’t know if this is true for many years

Retirement income planning is truly the end game in financial planning. Assuming that your goal is to generate a predictable income stream to match your financial needs in retirement while minimizing your exposure to withdrawal drag, the sequence of returns, and the various risks common to all retirement plans, it generally makes sense for you to begin employing retirement income planning strategies for a portion of your assets ten years before you plan to retire. The amount of assets and the exact timing of implementation are dependent upon your particular retirement and other financial goals as well as your current and projected financial situation.

Retirement Asset Planning

Safe Withdrawal Rate – A Nice Rule of Thumb

Last week’s post, The Sequence of Returns – The Roulette Wheel of Retirement, showed how “luck of the rate-of-return draw” can have a dramatic affect on a retirement asset plan in determining whether you will outlive your investment portfolio. In two scenarios where the retirement age (65), portfolio beginning value ($500,000), average rate of return (7%), withdrawal rate (5%), and inflation factor applied to the withdrawal rate (3%) were identical, and the only variable was good vs. bad early years, there were quite different results. With the “Good Early Years” scenario, after 25 years, at age 90, distributions totaled $964,000, the portfolio earned $1.385 million, and the portfolio value was $921,000. Under the “Bad Early Years” scenario, the portfolio was depleted after 16 years at age 81 after taking distributions totaling $541,000 and the portfolio earning $41,000.

Many people would argue that 5% seems like a reasonable withdrawal rate, however, as we saw, under the “Bad Early Years” scenario, this proved to be too aggressive. The financial planning industry, after many years of debate, has settled on a rule of thumb of 4% as a “safe withdrawal rate.” That is to say, you can withdraw 4% of the value of your portfolio in your first year of retirement and then increase your withdrawal amount by an inflation factor in subsequent years without depleting your portfolio during your lifetime. As an example, assuming a portfolio value of $500,000 at retirement and a 3% inflation factor, you could withdraw $20,000 ($500,000 x 4%) in Year 1, $20,600 ($20,000 x 1.03) in Year 2, $21,218 ($20,600 x 1.03) in Year 3, etc.

Is a “safe withdrawal rate” something we should live by or is it simply a rule of thumb? While a 4% withdrawal rate during retirement can potentially enable you to sustain your retirement capital for the duration of your retirement, this is not always the case, particularly in “Bad Early Years” scenarios. In addition to the withdrawal rate, the interplay of the following ten variables will determine whether or not you will outlive your portfolio:

  1. Type of portfolio, i.e., nonretirement vs. retirement
  2. Income tax rates
  3. Source of income tax payments, e.g., checking account, nonretirement sales proceeds, IRA withdrawal, etc.
  4. Retirement duration
  5. Average rate of return
  6. Sequence of returns
  7. Timing of earning of income
  8. Inflation rate
  9. Frequency of withdrawals
  10. Timing of withdrawals

As an example of the interplay of several of these variables, let’s make the following assumptions:

  1. Retirement age: 65
  2. Beginning portfolio value: $500,000
  3. Average rate of return: 6%
  4. Sequence of returns: Bad early years
  5. Withdrawal rate: 4%
  6. Inflation rate: 3%
  7. Frequency of withdrawals: Annual
  8. Timing of withdrawals: Beginning of year

In this scenario, despite the fact that the withdrawal rate has been reduced from 5% per the “Bad Early Years” scenario in the last post to 4%, which is generally considered to be a “safe” withdrawal rate, by simply changing one other variable, i.e., reducing the average rate of return from 7% to 6%, per Bad Early Years Assuming 6% Average Rate of Return, the portfolio is depleted at age 85. While the frequency and timing of withdrawals in this example may not be typical, the “safe withdrawal rate” of 4% isn’t conservative enough.

There are other scenarios where the interplay of the various variables is such that a withdrawal rate of 4% can prove to be problematic. As is typically illustrated, the previous example assumed an inflation rate of 3% each and every year. What happens if inflation averages 3%, however, the sequence of inflation rates is such that it is much higher in the first five years, say 7%. This would result in larger withdrawals in years 2 through 6, and, depending upon the rate of return, sequence of returns, and duration of retirement, this could result in premature depletion of the portfolio.

Mathematics aside, there are several other issues to consider when planning to use a safe withdrawal rate. For starters, why should you base your withdrawals for the duration of your retirement on the value of your retirement portfolio on a single day, i.e., the day before you retire? Also, it does not consider the fact that a sizeable portion of your expenses may be for mortgage and/or other fixed payments that don’t increase each year, and, as such, don’t require an inflation factor to be applied to them. In addition, the safe withdrawal rate methodology doesn’t take into consideration the fact that we typically incur nonrecurring expenses, planned and unplanned, e.g., new car, home improvements, wedding, etc., in addition to our ongoing expenses.

Another factor not incorporated in safe rate withdrawal calculations is the affect of differences in sources and amounts of non-portfolio income, e.g., Social Security, pensions, part-time income, etc. on portfolio values. What about the impact of inheritances on the amount of subsequent withdrawals? Finally, who is going to be responsible for doing the accounting to ensure that the amount of withdrawals doesn’t exceed the targeted amount in a particular year?

While the amount of withdrawals calculated using safe withdrawal rate methodology may match your income needs in some years, this probably won’t be the case in most years. This is arguably its single biggest weakness. I don’t know about you, but I don’t want to live my life based on a simple calculation that doesn’t consider my changing financial needs. While a safe withdrawal rate is a nice starting point, or rule of thumb, for calculating retirement withdrawal amounts, its limitations need to be considered when applying it to one’s retirement plan.

Retirement Asset Planning Retirement Income Planning

The Sequence of Returns – The Roulette Wheel of Retirement

So here you are, crossing the threshold from earning a living to going into retirement. You worked hard for many years. You built a sizeable, diversified investment portfolio. You hedged your bet by purchasing life insurance and long-term care insurance. Your will and other estate planning documents have been updated to reflect your current goals and financial situation. Everything’s in place, or so you think.

Welcome to the roulette wheel of retirement, otherwise known as the “sequence of returns.” If you haven’t planned for this financial phenomenon, your retirement could be quite different than you envisioned. To illustrate this important concept, let’s take a look at three hypothetical scenarios. In each one we’ll use the following five assumptions:

1. Retirement age: 65
2. Portfolio value: $500,000
3. Annual withdrawals: $25,000, or 5% of the initial portfolio value,
increasing by 3% each year
4. Life expectancy: 25 years, or until age 90
5. Average rate of return: 7%

The last assumption is the most critical one and can wreak havoc on your portfolio if you only rely on a retirement asset planning strategy during your retirement years.

Let’s start with Scenario #1 – 7% Return Each Year. While this scenario never occurs in real life, it’s often used for illustration purposes. Once you review Scenario #1 – 7% Return Each Year, you will see that even after taking out withdrawals that begin at $25,000 and more than double to $52,000 at age 90, your portfolio value increases from $500,000 at age 65 to $576,000 at age 78 and then gradually declines in value to $462,000 at age 90. You’ve taken distributions totaling $964,000 and your portfolio has earned $926,000 over 25 years. Nice result!

Scenario #2 – Good Early Years assumes that you are fortunate enough to retire at the beginning of a bull market where your investment returns exceed your inflation-adjusted withdrawal rate of 5% for several years, you experience a couple of years of negative rates of return, and a bear market kicks in your final three years, resulting in negative rates of return each year. Per Scenario #2 – Good Early Years, although it doesn’t occur in a straight line, your portfolio increases from $500,000 at age 65 to a peak of almost $1.5 million at age 87, with a final value of $921,000, or double the value of Scenario #1, at age 90. Like Scenario #1, you’ve taken distributions totaling $964,000 and your portfolio has earned $1.385 million over 25 years. Life is great!

So far, so good. To illustrate Scenario #3 – Bad Early Years, let’s simply reverse the order of investment rates of return that we assumed in Scenario #2. As in Scenario #1 and Scenario #2, over 25 years, we’re going to end up with the same average rate of return of 7%, however, the first three years are going to be bumpy, to say the least. Unlike Scenario #2, where your portfolio value increases by $208,000 the first five years, going from $500,000 at age 65 to $708,000 at age 70, per Scenario #3 – Bad Early Years, it decreases by $224,000, going from $500,000 at age 65 to $276,000 at age 70, or a swing of $432,000 during the same period.

Your portfolio continues to decrease in value each year until it is depleted at age 81. Instead of taking distributions totaling $964,000 as you did in Scenarios #1 and #2, your total distributions over 25 years are only $541,000. Furthermore, instead of realizing portfolio income totaling $926,000 in Scenario #1 and $1.385 million in Scenario #2 over 25 years, your total portfolio income is a measly $41,000. Yikes!

In both Scenario #2 and Scenario #3, there are negative rates of return in only five, or 20%, of the total of 25 years of retirement. Two years of negative rates of return out of ten years, on the average, is fairly typical for long-term historical rates of return for a diversified equity-based portfolio. As you can see, in Scenario #3, it doesn’t matter that 80% of the returns were positive, nor is it relevant that there was an average rate of return of 7%. As a result of the portfolio being depleted at age 81, the hypothetical individual in this situation wasn’t able to experience the 11.4% average rate of return during the final nine years.

The most important factor in Scenario #3, and the #1 risk to any retirement asset plan, is the sequence of returns. While you have no control over this investment phenomenon, you don’t need to play roulette with your retirement assets.

Retirement Asset Planning Retirement Income Planning

Withdrawal Drag – The Silent Killer

As you approach retirement, are you aware of the silent killer lurking on the horizon? Let’s call our silent killer “W.D.” When you enter the retirement zone, W.D. will be right behind you, looking over your shoulder, waiting to spring into action. When you dare to take your first withdrawal from your portfolio, W.D. will pounce – only you won’t know it. You will continue on, as if nothing happened, innocently taking your withdrawals each month. As each deposit hits your checking account, W.D. will extract a toll on your portfolio, one that will increase in size with each transaction. And guess what? You will never know what hit you. You see, W.D., or “Withdrawal Drag,” is the ultimate portfolio silent killer.

Before we expose the secrets of “withdrawal drag,” first some background. When you’re saving for retirement, or you’re in the “accumulation stage,” as we retirement income planners like to refer to it, assuming that you take no withdrawals from your portfolio, you realize the beauty and grace of compounding rates of return. To appreciate compounding, let’s start with simple interest.

With simple interest, you earn interest on your principal. Let’s say you have a portfolio that’s worth $500,000 and it earns simple interest of 7%. In year 1, you will earn $500,000 x 7%, or $35,000. Your portfolio will be worth $535,000 ($500,000 + $35,000) at the end of year 1. In year 2, you will earn $500,000 x 7%, or $35,000. At the end of year 2, your portfolio will be worth $570,000 ($535,000 + $35,000). And so on. That’s OK, however, there’s a better way to go – compounding.

Through compounding, in addition to earning interest on your principal, you also earn interest on your interest. Using the previous example, after year 1 when your portfolio is worth $535,000, in year 2 you earn interest on $535,000, not just $500,000. You earn $535,000 x 7%, or $37,450 vs. $35,000 and your portfolio is worth $572,450 vs. $570,000 at the end of year 2 using simple interest. The benefit to you of earning compound vs. simple rates of return increases each year. For a simple example of the magic of compounding, please see Exhibit 1 – $500,000 Growing At 7% Compound Interest. Per Exhibit 1, over 26 years, you have earned $2,403,676 and your portfolio has grown from $500,000 to $2,903,676. Although it isn’t illustrated, this is an increase of $1,493,676, or more than double, over the value of your portfolio of $1,410,000 using simple interest.

Enter Mr. W.D., or “Withdrawal Drag.” Continuing on with our example, let’s take a look at Exhibit 2 – $500,000 Growing at 7% Compound Interest With Annual Withdrawals. Now you’re 65 and you’ve entered the retirement zone. You’re still earning a compound rate of return of 7% on your portfolio, however, you’re taking withdrawals from your portfolio each year. Let’s assume that your withdrawals at age 65 total 5% of the value of your portfolio, or 5% of $500,000, or $25,000, and they increase by 3% each year. Per Exhibit 2, after starting with $500,000 at age 65, after 26 years, or at age 90, (1) your withdrawals total $964,000, (2) you earned $926,000, and (3) your portfolio is worth $462,000, or $38,000 less than what you started with. Not a bad result, right? Well, yes and no.

To answer the question, let’s step back and look at what your $500,000 portfolio would have been worth if you never took any withdrawals and you subtract your total withdrawals and ending balance of your portfolio at age 90 after taking withdrawals:

$500,000 growing at 7% compound interest for 26 years per Exhibit 1: $ 2,903,676
Less: Total withdrawals at age 90 per Exhibit 2 (   963,826)
Less: Ending balance of portfolio at age 90 per Exhibit 2 (   462,230)

Withdrawal Drag $ 1,477,620

What happened to almost $1.5 million? Ah, hah – mystery solved! The culprit is, guess who? Mr. W.D. Sure enough, per Exhibit 3 – Withdrawal Drag, the difference between your total earnings of $2,403,676, assuming no withdrawals per Exhibit 1, and your total earnings of $926,056, assuming withdrawals of 5% of your starting principal increasing by 3% per year per Exhibit 2, is exactly $1,477,620. At first, seemingly innocent, extracting a mere $1,750 from your portfolio at age 65 per Exhibit 3, Mr. W.D. doesn’t seem like such a bad guy. With each, passing year, however, Mr. W.D. gets greedier and greedier, taking almost $20,000 at age 72, $59,000 at age 80, and helping himself to $160,000 at age 90.

And so ladies and gentleman, as you enter the retirement zone, keep a close eye out for Mr. W.D. each and every time that you take a withdrawal from your portfolio. He’ll be watching you!

Celebration Retirement Income Planning

Retirement Income Visions™ Makes Its Debut

Welcome to Retirement Income Visions™! As many of you know, I’ve been writing and publishing Financially InKlein’d™, featured on Financial Design Center’s website, for the last 20 years.

Whereas Financially InKlein’d™ covers a spectrum of timely personal financial planning topics revolving around the theme of Planning, Managing, and Protecting Your Financial Independence™,   Financial Design Center’s trademark, the focus of Retirement Income Visions™ is Innovative Strategies for Creating and Optimizing Retirement Income™.

As always, I’m inspired and motivated by my clients. The birth of Retirement Income Visions™ is no exception. While retirement planning has been the cornerstone of my financial planning practice for years, the importance of retirement income planning as a separate and distinct discipline was magnified during the October, 2007 – March, 2009 stock market decline.

My goal in writing this blog is to bring to your attention innovative planning strategies that you can use to create and optimize your retirement income, and, in many cases, reduce your exposure to adverse financial market conditions. The customization and implementation of these strategies for your needs by an experienced retirement income planning professional should enable you to visualize and live a more fulfilling and less stressful life.

I’m excited and I look forward to sharing my knowledge and expertise with you on a regular basis. Subject to change, my plan is to publish a new blog post each Monday morning. I invite and encourage you to share your thoughts with other readers of Retirement Income Visions™ by clicking on “Comments” at the end of each blog. Your feedback is very much appreciated and will be considered in connection with the development of future topics.

If retirement income planning is of interest to you, please click on “Subscribe” in the navigation bar above and I will make sure that you automatically receive each edition of Retirement Income Visions™.  Finally, if you know others who you feel would benefit from Retirement Income Visions™, please click on “Email this” or “AddThis!” following this and each forthcoming blog post.

Finally, since the subject matter of this blog is technical in nature, a Glossary of Terms is available for your reference. New terms will be added as they appear in each blog post. You may access the Glossary by either clicking on Glossary in the navigation bar at the top of this blog or by clicking on unbolded blue links in each blog post.

Thank you for visiting.  Until next time!