Are You Prepared? Retirement Income Planning for Individuals

Retirement is often seen as the golden years of life—an opportunity to enjoy the fruits of your hard work. However, without thoughtful planning, those years can turn into financial stress. Understanding retirement income planning is essential for a comfortable and enjoyable retirement. In this post, we will explore practical strategies and important considerations that can help you secure a financially stable future.

Understanding Your Financial Needs Are You Prepared? Retirement Income Planning for Individuals

Before diving into retirement income planning, it's crucial to determine your financial needs during retirement. How much money do you estimate needing each year? Take into account your current lifestyle, projected healthcare costs, and any other expenses that may arise as you age. Are You Prepared? Retirement Income Planning for Individuals

Many people underestimate their future expenses, which leads to inadequate savings. For example, if you currently spend $50,000 annually, you may need significantly more to maintain that lifestyle due to inflation and increased healthcare costs. Creating a detailed budget that includes both fixed expenses, like housing and utilities, and variable expenses, such as travel or leisure activities, will provide a clearer picture of your needs.

What is your plan for retirement?

·        Avoid Running Out of Money

·        Maintain or Improve Lifestyle

·        Increase Wealth

·        Spend Every Cent

The Role of Social Security

Social Security plays a vital role in many retirees’ income. Knowing when to claim Social Security can significantly influence your overall income. For instance, you can begin receiving benefits as early as age 62, but doing so could reduce your monthly payments by up to 30% compared to claiming at full retirement age (which varies from 66 to 67 based on your birth year).

On the flip side, waiting until age 70 can result in an increase of up to 8% in monthly benefits for each year you delay past full retirement age. Your personal health, financial situation, and estimated lifespan all factor into this decision, making it wise to consult with a financial advisor to determine the best strategy for your situation.

Exploring Retirement Accounts

Retirement accounts like 401(k)s, IRAs, and Roth IRAs provide significant tax advantages that can bolster your savings. For instance, contributions to a traditional 401(k) are tax-deductible, reducing your current taxable income and allowing your investments to grow tax-deferred until withdrawal.

In contrast, Roth IRAs are funded with post-tax money, allowing for tax-free withdrawals in retirement. If you start investing $5,000 annually at age 30 in a Roth IRA, by age 65, this could grow to over $1 million, assuming an average annual return of 7%. Choosing the right account to match your financial goals and diversifying your contributions can optimize your retirement savings.

The Impact of Inflation

When planning your retirement income, it is important to consider inflation. The value of your savings can diminish over time due to rising prices. For example, if inflation averages 3% per year, what costs you $100 today could require around $180 in 20 years.

To mitigate inflation's effects, think about including investments that historically surpass inflation, like stocks or real estate. Investing in a balanced portfolio not only addresses inflation but also helps maintain your purchasing power during retirement.

Creating Diverse Income Streams

Relying solely on Social Security or one retirement account can pose risks. A better approach is to establish multiple income streams. This could include part-time work, rental income from real estate, dividends from investments, or annuities.

For example, owning a rental property can provide a steady cash flow, especially if you charge $1,500 a month in rent, resulting in $18,000 annually—an important supplement to your income. Diverse income sources ensure financial stability, enabling you to weather potential downturns in any one area.

Understanding Healthcare Costs

Healthcare is one of the largest expenses retirees encounter, often overlooked in retirement planning. While Medicare covers many healthcare costs, it does not cover everything. For example, the average couple retiring today can expect to spend over $300,000 out-of-pocket on healthcare during retirement.

Be sure to consider additional expenses like long-term care, dental, and vision care. Investigating supplemental health insurance and utilizing Health Savings Accounts (HSAs) can provide tax-advantaged savings for medical expenses. Properly planning for healthcare costs can help you avoid unexpected financial strains.

Setting Goals and Monitoring Progress

Once you have a retirement income plan in place, don't stop there. Setting clear, measurable goals will help keep you on course as you save and invest. Regularly reviewing and updating your plan to reflect any changes in your life circumstances is crucial.

Utilizing retirement calculators and budgeting apps can aid in tracking your progress. Additionally, meeting with a financial advisor annually can offer valuable insights and help you stay accountable to your retirement goals.

How Will You Pay for Retirement?

Calculate all the income you generate without relying on your investments.

Non-Investment Income – Salary, Social Security, Business and Real Estate, Pensions and Retirement Plans

Calculate the totals:

INCOME 

Non-Investment Income

Salary $

Pension $

Social Security $

Business and Real Estate $

Other $

Total Income $

EXPENSES 

Non-Discretionary Spending

Basic Living $

Mortgage $

Credit Card Debt $

Taxes $

Insurance $

Health Care $

Non-Discretionary Subtotal $

Discretionary Spending

Travel $

Hobbies $

Luxuries $

Gifts to Family/Charity $

Other $

Discretionary Subtotal $

Total Expenses: (add both subtotals) $

Net Savings: $

(subtract Total Expenses from Total Income. If this is negative, you’ll need more cash flow from an investment portfolio)

Income vs. Cash Flow

There is a key distinction between income and cash flow. Income is money received, and cash flow is money withdrawn. When you sell a security, the difference between what you put in and what you take out is considered capital gain (or loss).

Using Your Investments to Pay for Your Retirement The total return (i.e., capital gains + dividends) is the same on a pre-tax basis; and depending on your situation, selling a security and paying tax on capital gains may be more tax-efficient than dividend income! Bottom line: When it comes to paying for your retirement, you should only be concerned about the total return of your portfolio and after-tax cash flow—not whether it comes from selling securities or regular income. Before you can generate income, though, you’ll need to decide what assets will make up your portfolio.

Investment Portfolio

Asset allocation is what you decide to invest in. For most this means stocks or bonds or, in rare cases, cash. Many people, when they hear their asset allocation could determine if they run out of money or live comfortably, instinctively want to play it safe. Fair enough, but most people get it backwards. There is a common misperception that bonds are safer than stocks. This originates in stocks’ higher short-term volatility. So, retirees looking to avoid volatility—playing it safe—sometimes opt for bonds but often end up neglecting their return needs. As you can see from the following charts, as you include more fixed income in your portfolio, you get less volatility (standard deviation), but also lower returns over a short five-year period. Stocks have lower volatility (standard deviation) than bonds over longer time periods. This means if you have a longer time horizon or higher return needs, stocks may need to make up a larger percentage of your asset allocation than you previously considered. This is especially true when you factor in withdrawals over the course of your retirement. If you’re worried about having safe investments, consider the greatest danger could lie in running out of money because of a low rate of return over the lifetime of your investments. Next, consider a problem equally as serious as returns that are too low: taking withdrawals that are too high. Risk of High Withdrawals; Though markets may annualize about 10% over time, returns vary greatly from year to year. Miscalculating withdrawals during market downturns can substantially decrease the probability of maintaining your principle. For example, if your portfolio is down 20% and you take a 10% distribution, you will need about a 39% gain just to get back to the initial value. When you consider how devastating years of too-high withdrawals could be, it’s clear how important it is to properly manage your cash-flow expectations and discretionary spending.

Traditional Investment Income Sources

Retirement Accounts: 403(b)s, Defined Benefit Plans, SEP & Simple IRAs, ROBS, ESOPS, Church Plans, 529 Educational Savings, and even retirement plans for Cannabis companies

Standard Investment Account

• A taxable investment account

• Appropriate for general investing and building wealth

• Potential earnings are taxable

• No contribution limits or eligibility restrictions (besides account minimum)

Traditional IRA

• Contributions may be tax-deductible subject to Modified Adjusted Gross Income (MAGI) limits

• Potential earnings grow tax-deferred.

• May be subject to an IRS 10% additional tax for early or

  
  

  pre-59 ½ distributions

• Required minimum distributions start at age 73

• No age limit to contribute as long as you, or if filing jointly your spouse, have earned income

Roth IRA

• Contributions are made with after-tax dollars, there is no tax deduction regardless of income.

• Potential earnings grow tax-advantaged.

• Qualified distributions are tax-free. Distributions are qualified if the account was funded for more than five years and you are at least age 59 ½, or as a result of your disability, or using the first-time homebuyer exception or taken by your beneficiaries due to your death.

• A non-qualified distribution may be subject to ordinary income tax and a 10% additional tax unless an exception applies.

• No required minimum distributions

• You can contribute at any age as long as you, or if filing jointly your spouse, have earned income and are within or under MAGI limits.

Bond Coupons

Bonds can be issued by countries, municipalities, companies or others seeking money to borrow from investors. Bonds are loans—you, the investor, are lending the borrower (company, government, etc.) money at a specific interest rate for a specified period. At the end of the specified period, if all goes as planned, the borrower repays you the principal of the loan. Of course, you can also sell the bond on the open market before its expiration date. There are a variety of more-complicated types of bonds, such as callable bonds, zero-coupon bonds and convertibles. These may have a place in your strategy, but familiarity with them isn’t necessary to understand the basics of using bonds to generate income. Assuming the issuer doesn’t default, your return is predictable and, if you hold to the bond’s maturity, you’ll get your principal back. Certain fixed income investments, like US Treasuries and other bonds, have very little risk of default. Typically, the lower the default risk, the lower the yield you receive. However, bonds vary widely in credit quality and, correspondingly, yield. For many investors, the lower volatility of bonds is attractive. The more predictable yield of bonds can be an advantage if you have clear, consistent and time-sensitive cash-flow needs. The flipside of bonds’ lower volatility is they also return less over longer periods of time. This can be difficult for investors who need to meet certain return goals to preserve their purchasing power over time. Bonds are also prone to different types of risk than stocks. There is, of course, default risk, but bond risks aren’t limited to default. Because bond prices move opposite the direction of interest rates, a rise in rates will often cause your bonds to fall in value—commonly called interest rate risk. This especially affects Treasury bonds, as corporate bonds can be cushioned by other factors (like improving profits) that Treasuries aren’t subject to, though all bonds are subject to the impact of change rates to varying degrees. You can think of bond yields and prices as sitting on opposing ends of a seesaw. Also, since most bonds have fixed interest rates, if inflation rises, the real purchasing power of your cash flow falls. Often, when inflation does tick up, so do interest rates—which means an existing bondholder can face a double whammy: falling purchasing power of their current coupons and falling bond prices due to rising rates. A related risk is reinvestment risk. This is the risk that when your bonds expire and your principal is returned, there are no options to reinvest the money with similar risk and return expectations as the bonds that just expired. This could mean you have to take more risks.

Selling Stocks

We like to call selectively selling stocks for cash flow “homegrown dividends.” Selling stocks to meet income needs can help you maintain a well-diversified portfolio appropriate for your goals and objectives—and has the additional benefit of being a flexible, potentially tax-efficient way to generate cash flow.

Stock Dividends

Dividends are attractive—who wouldn’t want to get paid just for holding a stock? But before you opt for a portfolio full of high-dividend stocks to address your cash-flow needs, it’s imperative to dig deeper. All major categories of stocks cycle in and out of favor, including high-dividend stocks. Whether it’s growth or value, small cap or large cap, each category goes through periods it leads and periods it lags. High-dividend stocks are no different—sometimes they do well, and sometimes they don’t. You also need to consider what happens to a company’s stock after a dividend is paid. It isn’t free money. Dividend-payers’ stock price tends to fall by about the amount of the dividend being paid, all else being equal. After all, the firm is giving away an asset—cash. There’s nothing about dividend-paying firms that makes them inherently better. Dividends aren’t guaranteed. Firms that pay them can and do cut the dividend—or ax it altogether. For example, a certain utility with a long history of paying dividends stopped for four years while its stock fell from the low $30s to around $5 between 2001 and 2002. At the end of the day, you will always want to consider the highest after-tax total return and diversify your investments.

Annuities

Annuities tend to appeal to investors who fear market volatility or the prospect of losing their principal investment. To address this risk, some investors choose annuities. They may be attracted to guaranteed withdrawals or minimum returns that seem to take the risk of investing. Annuities are pitched as simple, long-term investment products. In their most basic form, you give an insurance company an amount of money, called a premium, either in a lump sum or periodic payments. In return, you may elect to receive a steady stream of payments over time. Annuities are complex insurance vehicles that don’t always provide the simple safety they often promise. They typically have high costs, complex restrictions and other risks that could offset the potential benefits. While annuities may not seem risky at first glance, they may not be the best way to limit the risk of losing money.  

Tax treatment for long-term capital gains can be cheaper than for bond interest, which is taxed at your (likely) higher marginal earned income tax rate. With dividends, taxation can differ depending on the circumstances. Some dividends are subject to ordinary income tax rates, such as dividends from MLPs (Master Limited Partnerships), REITs (Real Estate Investment Trusts), or if an investor hasn’t satisfied the required minimum holding period to make the dividend qualified. While qualified dividends and long-term capital gains are taxed at similar rates, selling stocks affords you greater flexibility in balancing realized gains and losses. You can sell down stocks as a tax loss to offset capital gains you might realize, or you can pare back over-weighted positions you likely wouldn’t have if relying on dividends alone for cash flow. For example, if you have a $1,000,000 portfolio and you take $40,000 per year in monthly distributions of roughly $3,333, you might consider keeping around twice that much cash in your portfolio always. Then you aren’t committed to selling a precise number of stocks each month and you can be tactical about what you sell and when. But you should always be looking to prune back, planning for distributions a month or two out. Generally, you can get more out of your portfolio from selling stocks—if done wisely. And that means you can, if appropriate, keep more of your money in an asset class that has a higher probability of yielding better longer-term returns. You may even have some dividend paying stocks to add additional cash. However, that decision can be based on whether you think they’re the right stocks to hold from a total return standpoint—and you aren’t handcuffed to them just because of the dividend.

Alternative Investment Income Sources

REITs

A Real Estate Investment Trust (REIT) is a pass-through entity formed to invest in real estate properties. In general, these firms purchase office buildings, retail space, apartments, assisted-living or medical facilities and hotels or vacation resorts. REITs generate most of their revenues from rental or lease income. They are required to distribute at least 90% of their taxable income annually to shareholders via dividends and benefit from a favorable tax policy, as qualified REITs are not required to pay tax at the corporate level. A company that pays 90% of its income is often unable to reinvest into its business to grow organically. Consequently, the industry is primarily composed of smaller companies which lack the fundamental growth characteristics typically favored as bull markets mature and organic growth rates broadly decline.

MLPs

Master Limited Partnerships (MLPs) are partnerships that are publicly traded on a securities exchange. MLPs are popular because they offer tax advantages and return most of their cash to unitholders. As partnerships, MLPs do not pay state or federal corporate income tax. Instead, their tax liability is passed on to their investors, who receive a statement each year detailing their share of net income. Investors are then taxed on these distributions at their income tax rate. MLPs originated in the 1980s through laws passed by Congress to encourage investment in energy and natural resources. Later, regulations were tightened to counteract MLPs being used for tax avoidance beyond their intended scope. Now MLPs must generate 90% of their income from qualified sources, mainly related to natural resources. As a result, most MLPs operate in the Energy Infrastructure industry. Because of high depreciation and other non-cash charges, MLP investors are often taxed on less income than they receive via distributions. However, cash distributions more than taxable income are considered a return of capital; so, they are subtracted from the cost basis on the original investment. Basically, this means the tax treatment of excess taxable income isn’t a permanent escape from taxation, but rather a deferral of taxation until a later date—usually the time when you sell the partnership interest. When a unitholder sells an interest in an MLP, any profit over the adjusted cost basis is taxed as ordinary income. The only time you can consider these long-term capital gains is if there is an increase in market value between the time of the sale and the time of purchase. This is key—because tax rates imposed on ordinary income are substantially different than capital-gains tax rates.

Mandatory Retirement Plans

Many states in the U.S. have implemented or are in the process of implementing mandatory retirement plans for private-sector employees. These plans are designed to ensure that workers have access to retirement savings options, even if their employers

do not offer a retirement plan. Here are some states with mandatory retirement plans:

1. California: CalSavers

2. Illinois: Illinois Secure Choice

3. Oregon: OregonSaves

4. Connecticut: MyCTSavings

5. Maryland: MarylandSaves

6. New Jersey: NJ Secure Choice Savings Program

7. New York: New York State Secure Choice Savings Program

8. Colorado: Colorado Secure Savings Program

9. Virginia: VirginiaSaves

10. Massachusetts: CORE Plan (for non-profit organizations)

These states have enacted legislation requiring employers to either enroll their employees in the state-sponsored retirement plan or offer their own qualified retirement plan.

What to look for in an investment firm

Individualized Investment Approach

Your retirement plan should be custom-fit to your unique situation and long-term goals—

your investment advisor should take the time to get to know you, your finances, health, family and lifestyle. As your needs and markets change over time, your investment advisor should adapt your strategy to keep up.

Easy-to-Understand Fees

Some money managers, earn commissions on trades or by selling investments products, some use a transparent fee structure that’s based on your portfolio’s size—so interests of the firm are aligned with your growth.

Full-Service Support

You will want dedicated support to help you stay on track to your long-term goals.

You will want to be updated on your portfolio and changes in markets—even when volatility is high. You will also want information and resources on Social Security, Medicare, tax efficiency and more.

Conclusion

In retirement planning, knowledge is power. Staying updated on tax laws, investment opportunities, and other changes in the financial landscape will benefit your planning efforts. Engaging in continuous learning through workshops, trusted financial news, and relevant literature can help you make informed decisions.

By keeping yourself informed, you can adapt your retirement strategies to evolving market conditions and financial products, improving your chances for a secure retirement.

For many, leaving a financial legacy for loved ones is important. Consider how your retirement income planning can impact your family. Establishing trusts or life insurance can ensure your financial intentions are respected after you pass.

Having open discussions with family members about your plans can set expectations and prevent misunderstandings down the road.

Navigating retirement income planning may seem overwhelming, but with the right strategies and information, you can face it with confidence. Start by identifying your financial needs, exploring Social Security options, and creating multiple income sources. Don’t forget to factor in inflation and healthcare costs while forming a sustainable plan.

Staying informed and regularly reviewing your progress will enhance your retirement journey. The sooner you start planning, the more choices and flexibility you will have when it’s time to embrace your golden years. Are you prepared?

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See Also: Savings Calculator

See Also: Investopedia

Are You Prepared? Retirement Income Planning for Individuals