Your Retirement Paycheck

We all rely heavily on our paychecks during our working years, but many of us don’t give much thought to the “paycheck” that will provide a dependable, steady stream of monthly income during retirement.

Planning the components of that “paycheck” is as critical as accumulating our retirement nest eggs in the first place.

To facilitate that planning, here are several key issues to consider when approaching retirement:

What “paycheck” sources do you have? Your retirement “paycheck” will likely be funded from multiple sources. Social Security, perhaps a pension, employer-sponsored retirement accounts, individual retirement accounts (IRAs and Roth IRAs), taxable investments and annuities are among the most likely.

A more-and-more common situation these days is some level of ongoing part-time or self-employment income during retirement, recognizing a changing view of what retirement is all about.

How large a “paycheck” will you need? You’ll need to match the size of your “paycheck” with your estimated retirement expenses, requiring some cash flow projections and budgeting. Experts used to suggest 70%-80% of pre-retirement income as a rule-of-thumb target.

Many planners today recommend closer to 100%. While it is true that pre-retirement expenses associated with Social Security withholding and savings contributions may be lower in retirement, other expenses associated with increased travel/leisure activities and health care needs may be correspondingly higher.

Most folks today want to at least maintain their pre-retirement standard of living throughout retirement. If that is your goal, you will need to determine the dollars associated with your desired standard of living, including taxes, and use that as your target “paycheck” amount.

What asset allocation should you maintain in retirement? Studies have shown that a balanced portfolio – somewhere in the 40%-50% stocks and 50%-60% fixed income (bonds)/cash range – is about right for retirement.

Such a mix recognizes that regular distributions will be taken from the portfolio during retirement, a much different situation from the pre-retirement accumulation phase when a higher fraction of stocks may be more appropriate. Such a mix also enjoys reduced volatility, since stocks and fixed income investments typically move in opposite directions during bear and bull market cycles. Lower volatility helps preserve capital in accounts from which distributions are taken regularly.

Some planners prefer the idea of converting a portion of a portfolio—say 25 to 50 percent—into an annuity that pays out fixed monthly benefits. Generally, that is done by selecting the annuity (vs. lump sum rollover) option in a company pension plan. If that option is not available, a purchased fixed annuity might be chosen. Such a regular income stream, coupled with Social Security which is indexed to inflation, offers a guaranteed, known lifetime income for the individual or couple.

The remaining portfolio can then be used to generate the remaining needed income and provide a hedge against inflation, since it contains a stock component.

How much can you afford to withdraw from your nest egg? Retirement experts lean toward a conservative withdrawal rate. They don’t all agree on what withdrawal rate is “safe”, but 4%-4.5% is a common recommendation. Such a rate should allow you to take annual distributions in a way that indexes distributions to inflation and affords a reasonably-high probability that you will not run out of money over, say, a 30-year period.

Experts do concur that you should not regularly withdraw the amount you expect your portfolio to earn on average. If you do, the year-to-year volatility in the annual return from your portfolio significantly increases the probability that you will run out of money.

Should you withdraw taxable or tax-deferred assets? The standard advice is to withdraw from taxable accounts first in order to let the retirement accounts continue to grow tax-deferred or even tax free, as with a Roth IRA. Such a strategy is even more appealing now that realized capital gains in taxable accounts are taxed at 5% or 15%. But it is important not to let this strategy unbalance your asset allocation. Also, estate planning goals need to be considered and could impact your withdrawal strategy.

Developing the retirement “paycheck” plan that is right for you is a task completely dependent on your goals and unique financial and personal situation. As we always recommend, consider partnering with a trusted financial planner to help you chart your path forward.

James Terwilliger, VP, CERTIFIED FINANCIAL PLANNER™, 585-419-0670 ext 50630 or email  jterwilliger@cnbank.com.