retirement income

Are You Financially Prepared to Retire?

middle age couple - financially ready to retire

You are getting close to your retirement age. But do you know if you are financially prepared to retire?

Retirement is a big step and it will be hard to reverse a decision. Not everybody wants to retire. Many people who are old enough are not ready to retire. But according to the surveys, there are a significant number of people who feel they retired too early and were not fully prepared for that step.

Most people dream of having a great time when they stop working. They dream about having a nice place to live, exciting travels, and leisure time spent with a family. But it all costs money. Not to mention ordinary bills for food, transportation, utilities, medical insurance, and taxes that must be paid every month. It is hard to do things or even live comfortably if you do not have enough money saved for retirement.

Following this checklist should help you being financially prepared for retirement:

Get a clear picture of your retirement lifestyle.

What do you want to do when you retire?

It is important to have a clear picture of how you want to spend your time in retirement. Ask yourself:

Do I like to travel? If you are like me and dream about traveling in retirement, you need to know where and how much it will cost.

Do I have a list of activities or hobbies I want to start? Does it require you to buy new equipment or to have an additional space? Will I need internet and cable in my day-to-day life?

How are you planning to fill in your days?

There are a few questions to ask yourself:

Do I want to spend more time with my grandchildren?

Do I want to volunteer for a local organization or take a part-time job?

Do I want to join a club or start attending classes at a local college?

What is my passion? Cooking? Gardening? Maybe I will cook homemade meals and invite friends instead of eating out.

Where do you want to live when you retire?

Are you planning to retire in place or relocate? If you want to relocate have you made a list of your priorities:

Retirement community?
Proximity to the beach? Or near the mountains?
A small town? Or a big city?
Close to children and grandchildren?
Medical facilities?

Have you researched places you want to relocate? Or have you visited these places? Do you know how much will it cost to relocate? Housing will be the most expensive category of your retirement budget.

If you want to retire in place, ask yourself:

Will my home be paid off? Or will I have a mortgage to carry into retirement?
Do I want to have a few small projects upgrading my home? Or one big home renovation?
Is downsizing an option? Is it time to consider something smaller and easier to maintain?

Calculate financial needs to support your retirement lifestyle.

The first step to being financially prepared for retirement is to determine how much money you need to afford your dream lifestyle. Once you have a picture of your retirement lifestyle you can get a sense of how much money you need each month to pay for this life. The number should include your daily living expenses and the money you want to spend on hobbies and activities.

You should have enough saved to live on 80 percent of your annual pre-retirement income. This number is a good rule of thumb if you do not plan on making any major budget changes when retire. However, not all retirees spend less in retirement.

The best advice is to create an estimated retirement budget based on your current and future expenses. You might have a general idea of what you spend now. But you will be better prepared financially for retirement if you have a clear picture of your expenses now and how that might change in the future.

When you retire you do not need a lot of things that you did when you were working. The costs of commute, take-out lunches, and business clothes will go down. But you will start spending more money on travel, hobbies, and activities. And maybe your medical expenses will increase with time.

It is important to include big-ticket expenses into retirement budget as well. Sending a grandchild to a college or paying for a wedding. Buying a new car or a lake house with a boat will require a significant amount of money withdrawn from your retirement funds.

Get a clear picture of your retirement income.

When you are working you probably have a single employer and a single source of income – your salary. In retirement, everyone has different sources of income.

As a retiree, you receive income from multiple sources:

There are several sources of guaranteed income:

Social Security
Pension
Annuity – a guaranteed income you must purchase yourself

Other sources of income:

Part-time job
Rental income
Business
Dividends

Sources of income from your investments and savings (your nest egg):

Tax-deferred accounts – 401(k), IRA
Tax-free – Roth IRA, Roth 401(k)
Taxable investment accounts
Taxable bank checking and savings accounts

While working, you receive a paycheck regularly – probably every two weeks. When you retire, you might receive income monthly, quarterly, annually, and even irregularly. Getting a clear picture of your retirement income should help to make sure that you have enough money to cover all your living expenses.

Develop your withdrawal strategy.

Do you know how much income you can pull from your nest egg?

If you want to be financially ready for retirement you need to have an income plan or your withdrawal strategy. An income plan is a strategy for withdrawing money from your retirement accounts.

A good starting point for many retirees will be a well-known rule of thumb – the “4% rule”. The 4% retirement rule refers to your withdrawal rate. If you have a well-balanced retirement portfolio (60% stocks and 40% bonds), you can withdraw 4% of your account balance.

For example, if you have $500,000 saved in retirement funds you can withdraw 4% of that amount – $20,000 in the first year of your retirement. You can adjust that number every year for inflation but following this rule should help not to run out of money for at least 30 years.

Though, you have to be aware that this rule of thumb is not perfect. When I have researched the “4% rule” it has shown all kinds of pros and cons.

There are a few problems associated with following this rule:

Return risk – the risk of earning lower returns than it was in the past.
Longevity risk – the risk of living a long time and running out of money at the end of your life.
Series of return risks – the risk of a market downturn during your early withdrawal phase.

Even it is not perfect, the 4% rule is a good starting point you can adjust with time.

Pay off debt.

Paying off debt, no matter how much you owe, is a key to a stress-free retirement. Getting into retirement with any kind of debt will put a burden on your lifestyle. I am sure you will be irritated knowing that you need to make a credit card payment every month with your retirement savings. The best advice is to pay off all your debts before you retire including a mortgage.

Your mortgage payment will be the largest and most consistent expense in retirement. When you live on a fixed income you need to have a plan on how to handle these payments.

Check how many more years of payments you have on your loan and try to pay it off before you stop working. Maybe you can use some savings to pay off the home loan. However, if you cannot pay it off in full, consider downsizing and selling your home.

Some retirees have enough money saved to afford mortgage payments and to enjoy their life in full. But if you have limited retirement funds you will be better off without a burden of a home loan.

While paying off debt including a home loan might not be realistic for everyone, the less debt you have the better you prepared financially for retirement.

Determine how to cover medical expenses.

You will become eligible for Medicare at the age of 65. If you plan to retire before age 65 you will need to find a separate plan to cover your medical expenses.

When you stop working, your health insurance provided by your employer ends. Even if your current employer promise to cover your health insurance in retirement does not mean they will not change their mind in the future or reduce coverage significantly.

Thus, you will need to find and buy your health insurance coverage. Individual health insurance is expensive and could cost more than $1,000 a month. Make sure to shop around for the best prices.

Even being eligible for Medicare brings its own set of challenges because it does not cover all medical expenses. Medicare does not cover premiums, deductibles, co-pays for doctor visits, dental and vision care, long term care, personal care, and other expenses. This means you need to include healthcare costs in your retirement budget.

Remember about tax strategies.

In retirement, we still need to pay taxes, but not all sources of income are taxed the same. Withdrawals from tax-deferred accounts such as 401(k) plans and traditional IRAs will be taxed as an ordinary income.

Withdrawals from Roth IRAs and Roth 401(k) plans will be tax-free. If you want to withdraw money from taxable investment accounts, you will have to pay capital gains taxes.

In addition to taxes, you need to remember about required minimum distributions (RMD). You will face this requirement when you reach the age of 72. By the US tax law, you are required to start taking withdrawals from your retirement accounts such as 401(k) and IRA (excluding Roth IRAs). The amount you must withdraw will be determined by the IRS. If you have more than one retirement account, you can withdraw money from each account or total RMD from just one account.

For example, you have several IRA accounts. First, you need to calculate the RMD for each IRA separately each year. Next, you can sum up your RMD amounts for all your IRAs and then withdraw the total from one IRA. You do not have to take a separate RMD from each IRA account.

It is important to remember that your RMD withdrawals might push you into a higher tax bracket.

Think about what tax strategies will work for you the best. If it makes more sense you can roll your assets into Roth IRA before you reach RMD age. Another option is to start taking withdrawals from your retirement accounts before RMD kicks in so you would not face the sudden jump in taxes.

Putting It All Together

Getting closer to retirement can be both exciting and stressful. But if you want to have a happy and comfortable retirement you need to take time to understand your retirement picture.

You do not want to be one of those people who want to retire, but when that day finally arrives, they just let it happen. You want to be smart and invest time in planning and preparing for a big day. Before you take the plunge make sure that you are financially ready!

If you do it right it might be the best time of your life!

Are you financially ready to retire? Please share your thoughts in the comments below.

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Disclosure: This information is only educational. The intent if this post is to provide a simple guideline for an extremely complicated matter. I am not providing any specific financial advice or recommendations to any of my readers.

How to Prepare a Retirement Budget in 5 Simple Steps

by Maggie 4 Comments

two women with laptop at the table-retirement budget

There is a fear of running out of money in retirement among many baby boomers. As boomer women, we live longer than men, but our savings are not always enough to last long in retirement.

The main goal of retirement planning is to see how to cover your retirement expenses while living on a fixed income. Part of creating a solid retirement plan is to understand your retirement income and expenses. That means you need a retirement budget.

The best advice is to start planning when you are still working and can adjust the numbers. Preparing retirement budget will help to see if you have enough money to retire. If you are still working you have time to add to your savings, pay off debt and change your spending habits.

How do you prepare a retirement budget? I will take you through 5 simple steps.

Step 1. Calculate your retirement income

bees flying over lavender-preparing retirement budget

The more sources of retirement income you have the better off you will be in your golden years. The income in retirement will come from different sources. For many retirees, a Social Security paycheck will be the ONLY income. Other retirees will have an additional income coming from 401(k), IRA, Roth IRA, savings, annuities, dividends, and/or rental properties.

Start with Social Security and find out how much you will get paid once you retire at 62, at full retirement age which 66 or 67 for most of us or delay it until you turn 70.

Social Security website will help you to open an account if you do not have one and find out the size of your guaranteed paycheck.

Social Security website

The next source to consider is pension income. Most Americans do not have pensions anymore. But if you are lucky and have a pension add the estimated paycheck to your Social Security.

Then, look at your retirement accounts including 401(k), IRA and Roth IRA and calculate the balance on all of them.

After you calculated your retirement savings balance, find out how much it will grow in the next 5 or 10 years. For example, you have saved $200,000 on your retirement accounts. If this money grows at 6 percent per year, it will be worth $267,645 in 5 years or $358,170 in 10 years. I like to use an online calculator for estimating my investment portfolio growth:

Smart Asset investment calculator

Using a 4 percent safe withdrawal rule will help to see how much income you can generate from retirement accounts. It would generate around $10,405 or $14,326 a year of income.

Finally, calculate the total of your combined retirement income:

SSB + pension + retirement accounts + bank savings balance + rental income + business income = combined retirement income.

Step 2. Estimate your retirement expenses.

man using notepad and laptop-preparing retirement budget

Step 2 will help to find out how much money you need in retirement by accurately projecting your retirement expenses. It is easier to control your spending than retirement income. And we all know that if we spend less than our monthly income, our retirement funds will last longer.

A simple way to estimate your retirement expenses is to know where and how you spend your money today while still working.

Divide your expenses into 3 main categories:

Essential – need to have
Non-essential – want to have
Unexpected and/or one-time expenses

Label your expenses as either essential or non-essential. It will help to see where your money is going.

Essential expenses – need to have:

Your essential expenses are expenses you cannot live without in retirement:

Mortgage or rent
Utilities
Transportation
Food
Medical

When you retire, you will still have to spend money on these expenses each month. But how it will change in the future when you stop working?

Here are the same budget categories but the cost of it might change when you retire.

Housing – Are you planning to downsize, pay off your mortgage, rent, or relocate to a more affordable place? You have to include the property taxes and maintenance costs if you’re an owner.
Utilities – Cost of utilities might go up or down. If you relocate to a warmer state, include the additional cost of air conditioning.
Internet/ cable/ phone – Are you planning to spend a lot of time at home reading and gardening or some of your hobbies include using the internet? You should include the approximate cost of the internet and cable in your retirement budget. Many people cut costs by switching from cable TV to a streaming service.
Transportation – How your transportation needs will change in retirement? How many cars do you have? Are you planning to downsize your vehicles? Will you buy a new car or a boat? Calculate how much you pay each month for gas, car insurance, and parking and decide how it will change when you stop working.
Food – How much you will spend on food depends on your eating habits. Most retirees start eating out less and prefer to have homemade meals. This budget category expense can be significantly reduced.
Medical – It is hard to calculate medical out-of-pocket expenses, along with premiums for Medicare. Yes, Medicare provides health insurance, but it does not pay for all medical bills and it does not pay for long-term care at all. There is no way to know how much it will cost. But according to Fidelity Investments, a healthy couple can expect to spend on average, a total of $275,000 out of pocket on healthcare expenses in retirement. And a long-term care cost is not included in this number.

Non-essential expenses – want to have:

These expenses are your extras. Make sure to leave room for fun when calculating your future cost of living. You worked hard most of your life while saving and planning for retirement. Traveling, camping, attending a concert, or eating dinner with friends will be part of your fun years. You need to plan for that and include the cost of it into your retirement expenses.

Traveling/ vacations
Hobbies
Entertainment
Gift/ charity

Many of my friends who already retire admitted that every month of their retirement look different than the month before. Some months they spend a lot of time at home. Other months, they are on the road visiting friends and family or traveling abroad.

Unexpected and/or one-time expenses:

Urgent medical expenses
Unexpected car or home repairs
Home improvement
Wedding
Grandkid’s college tuition
Funeral

By including these expenses into your retirement budget, you will minimize the chance to be surprised by these events. You wanted to be sure that you have enough money to cover these expenses. One way to deal with unexpected is to have an emergency fund. Instead of panicking at every unexpected bill, you will have a small pot of money at hand and ready for use.

For our retirement expenses I like to use a worksheet from Vanguard:

Vanguard retirement expenses worksheet.

Step 3. Compare your retirement income and expenses.

architecture - retirement income and expenses

After calculating retirement expenses compare it with your retirement income and see how much you have left over.

Retirement income – retirement expenses = cash flow

Once you stop working you can rely only on the income generated from your savings and Social Security. And if you do not have enough retirement savings, you will have to rely only on one source of income – Social Security. Even Social Security is considered a guaranteed income, but it might be not enough to cover all your expenses.

It is important to have enough income to pay for your monthly essentials. Thus, first look at your Social Security benefits and see how much it will cover. Next, calculate how much money you have to withdraw from retirement savings to cover other expenses.

You can boost your retirement income by downsizing your home or delay retirement for a few years. But those may be not the options for everybody. Most baby boomers will need to reduce their expenses and change spending habits so they can live on their available income.

I calculated that Roman and I will need to have $60,000 a year ($5,000 a month) to cover our expenses for the first 5 years of our retirement. We plan to downsize, sell our house and rent an apartment before we decide if we want to buy a condo. We like to travel and have a long bucket list of places we want to visit. If we do not delay our benefits until age 70, our estimated Social Security paycheck will be $42,000 a year ($3,500 a month).

Thus, we will need to withdraw an additional $18,000 a year ($1,500 a month) from our savings. Many advisors recommend withdrawing 4 percent from savings so your retirement funds last longer. We can withdraw up to $20,000 a year from our savings to follow this rule and feel safe.

If I want to bump that number to 5 percent and withdraw $25,000 a year from our savings, we will spend our retirement funds faster. I would rather adjust our lifestyle and reduce our expenses to fit a safe rule of 4 percent withdrawal than to deplete our funds fast. The goal is to adjust our lifestyle to fit our available income.

Even the whole process looks like a lot of work, remember that calculating these numbers now will make life in retirement much easier.

Step 4. Add inflation and taxes to your retirement budget.

Inflation is real and it will erode the value of today’s dollars over time. Many advisors suggest including 2 or 3 percent inflation to retirement budget. But if you are like me and have no intention of moving your retirement portfolio out of the market, you should expect that keeping money in the market will help to fight inflation.

When you start preparing a retirement budget first thing you want to know is how much income you have available to pay the bills each month. But whatever number you calculated in Step 1 may not be yours to keep in full. Your withdrawals from retirement accounts like 401(k) and IRA will be taxed year after year. And depending on your retirement income so might be a portion of your Social Security paycheck.

Hence, instead of being surprised by taxes, budget for them. Look at your current tax brackets and try to figure out yours in retirement based on estimated income. Then add that money to your retirement budget. You will pay lower taxes in retirement because you will have less income. But you still need to have money to pay taxes every year.

Step 5. Keep updating your retirement budget.

a woman on a suitcase-retirement expenses

I know that my retirement budget is not perfect and needs to be updated. But it is a starting point that allows me to learn how much income Roman and I need to replace when we stop working.

Budgeting for retirement is not a do-it-once-and-forget exercise. Retirement budgets are living things that need periodic checkups. Once you retire you need to keep updating your spending, income, and withdrawal numbers, because spending in retirement could go easy out of hands.

Also, you need to keep an eye on your retirement portfolio growth and make sure that all is going according to your plan. Otherwise, you need to adjust and fit your lifestyle to available income.

Final Thoughts

None of us wants to spend our fun years worrying about money. Everyone wants to enjoy retirement. Follow these 5 simple steps and start preparing your retirement budget. It should help you to stay on track financially so you can enjoy your fun years and avoid stress.

Do you have a retirement budget? Have you thought about preparing a retirement budget? Share your ideas with us in the comments below.

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The 3 Buckets Strategy for Retirement Income

by Maggie 8 Comments

old car with two man - bucket strategy for retirement income

Do you know how much is your retirement income and where it comes from? Have you figured out if you have enough savings to cover your expenses in retirement?

When you’re in your 30’s or 40’s, the idea of retirement is far away. But when you’re in your 50’s and 60’s, the retirement is around the corner and not a theory anymore. You need to understand how much you will receive from Social Security or pension (if you’re a lucky one). You need to calculate the balances on your retirement accounts like 401(k), IRAs, Roth IRAs. Also, you need to figure out how much you will be able to withdraw each month.

When you retire and stop receiving a steady paycheck, you need to learn how to generate retirement income to pay for your expenses. Some of your income will come from Social Security, but the rest should come from your nest egg.

Recently I read a lot about the bucket strategy for retirement income. This strategy becomes popular and got discussed among many financial experts. With this strategy, you will divide your saved money between several buckets – investment portfolios. Each bucket or portfolio will be divided based on the time when you need money, asset allocation, and other goals.

The benefits of a bucket strategy:

The major benefit of the bucket strategy is simplicity.

I think dividing your savings into smaller portfolios or buckets with specific goals will help to manage them better than one big account. With the traditional 4% rule of thumb approach, you will generate retirement income by systematically withdrawing money from one big account.

You might lose money if you’re forced to sell your investments to get cash in the stock market downturn. But using the bucket strategy approach, you will keep some money in cash for the current expenses and leave the rest of them to grow for the future.

Here is the 3 buckets strategy to generate retirement income:

This bucket strategy plan is based on 3 different phases of retirement:

Bucket 1 – 1 to 5 years of retirement

The first 5 years of your retirement will be the most active. It’s often called “go-go” years.

passport, map on the table - travel in retirement

Most of the time you’ll stay active, and you might be even still working part-time. People entering retirement today are more active and adventurous. In this phase, many retirees splurge themselves on exploring the world, buying a vacation home, a new car or even a boat.

Depending on where you currently live and the cost of living in your area, you might want to relocate to a warmer and sunnier place. The relocation usually comes with an additional coast of buying or renting, moving the furniture and belongings and renovating or upgrading the new place. The first 5 years of your retirement might be expensive, and you will need to have enough income to cover all additional expenses.

When you retire, you’ll likely spend more than you ever have before. The good advice is to hold back on big spending and stick to your budget. You don’t want quickly to blow through your savings like there is no tomorrow. The bucket strategy approach will help you to stick to your budget and provide income for those fun years.

For example, you have accumulated $700,000 in savings and planning to retire in a couple of years. You figured out that you want to spend $5,000 a month ($60,000 a year) when you retire. Let’s assume that your combined guaranteed income from Social Security and/or pension is $3,330 a month ($40,000 a year).

Based on the calculations below you have an income gap of $1,670 a month ($20,000 a year) to cover your cost of living:

$5,000 – $3,330 = $1,670

Use the bucket strategy and put aside $100,000 to cover expenses and maintain your lifestyle for the first 5 years of retirement.

$20,000 x 5 years = $100,000

Bucket 1 is created to provide immediate income and cash for emergencies. You’ll want to fill this bucket with secure income sources like CDs (certificate of deposits), bonds, annuities, money market account, or just bank savings account. Keeping your savings away from higher-risk assets like stocks can help to insulate those savings from market downturns.

Advantages of Money Market Funds

7 Best Money Market Accounts from bankrate

Bucket 2 – 5 to 10 years of retirement

This bucket is for the middle retirement phase – between ages 70 and 80.

At this phase, you might slow down on your activities and will start spending less. Of course, you’ll still want purpose and fulfillment. But you might want to travel less or go on the less expensive trips to visit your friends and family.

You might find yourself more engaged in free activities like volunteering, gardening, taking classes at a local community center or spending time with grandkids. The most retirees will continue enjoying many different activities depending on their physical and mental state of health. And you will still need to have enough income to pay for your lifestyle and the cost of living.

The goal for this bucket is to produce income and preserve the capital. The bucket 2 is created to be tapped for income when bucket 1 runs out of money.

For example, you have accumulated $700,000 in savings and then allocated $100,000 for your first 5 years of retirement.

Then, divide the remaining $600,000 equally or in any numbers between buckets 2 and 3. I would put $350,000 in bucket 2 and $250,000 in bucket 3.

According to the theory behind the bucket approach, you’ll want to fill bucket 2 with income-producing investments like stocks with dividends, mutual funds, REITs, bonds, annuities.

The 10 Best Dividend Funds for Any Investor

Best High Yield Bond Funds

Bucket 3 – 10 to remaining years of retirement

The bucket 3 is for the late retirement years – 80 and older.

In your late years of retirement, you will spend less money on activities and travels, but more on healthcare. Unfortunately, medical spending tends to be higher in the last years of your life. Many retirees must move to an assisted living facility or a nursing home. Some can stay home and hire a home health aide. If you have long-term care insurance, it might help to pay a portion of nursing home or home health aide bills.

The goal for bucket 3 is long-term growth. Since you don’t need this money for 20 or more years, you could be more aggressive with your investment.

The money you put in this bucket should be invested in stocks and mutual funds. Although investing in assets like stocks is considered a risky investment, it’s still a good way to grow the money you don’t need for long time.

There are some disadvantages of a bucket strategy:

When you’re older, it will be difficult to maintain many accounts with different asset allocation
It might be hard to keep the right amount of money in each bucket
You need to self-manage your portfolios. If you’re going to use the bucket strategy you cannot adopt a set-it-and-forget-it attitude

The biggest concern is that you’ll spend your safest assets first. But when you’re older you end up holding a big chunk of your savings in high-risk investments.

The Takeaway

Many baby boomers approach their retirement years. If you one of them, you might start thinking about how to manage your savings once you retire.

The expenses at each phase of retirement will depend on where you want to live, how you choose to spend your time, and how healthy you are.

You need to generate enough retirement income to fund your lifestyle, keep pace with inflation and protect your investments from market downturns. Your savings must cover your expenses for three decades and more.

The bucket system is designed to give you peace of mind. When you have money divided between “now, soon and later” investment portfolios, you don’t sell your shares when the market is in decline.

The best part of the bucket strategy is it helps to create a consistent income stream to last through your retirement years. It gives you more choice and flexibility where to draw your income from.

Share your thoughts about bucket strategy for retirement income.

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Disclosure: This information is only educational. I am not providing any specific financial advice or recommendations to any of my readers.

3 Best Ways to Generate Retirement Income

by Maggie 2 Comments

When we start investing in our retirement accounts – 401(k), IRA, Roth IRA – we keep in mind that the money eventually will be taken out and serve as an income when we stop working.

Those savings are our own and don’t come from the government or an employer. It’s not a guaranteed income as a Social Security or pension. It will only last as long as we plan for. So, when we start withdrawing money from our retirement funds, we should be careful and remember not to outlive our savings.

Most of us don’t have any idea how long we will live. We work hard and save as much as we can, so later we can enjoy our life in retirement. We feel proud and secure when we see how money starts accumulating in our savings account.

But surveys show that many retirees withdraw funds from their savings too quickly, with the potential result of running out of money before they die.

Recently I read that many baby boomers use their 401(k) money for buying vacation houses, new cars, or going on luxury vacations. The problem is that many retirees don’t have a strategy of how to draw down their retirement savings and just “wing it”. If you spend your retirement savings without a good plan or just “wing it”, your nest egg might not last for a few decades.

The decision of how to generate a retirement income and don’t run out of money before you die is the most difficult one. There are plenty of books and articles describing how to save and invest money, but not so many when it comes to how to withdraw them, in what order and how to make it last for the rest of your life.

That’s why I wanted to focus this post on retirement income-generating strategies. I wanted to share what I have learned about how to use your retirement savings for creating an income that hopefully lasts as long as you live.

How many sources of retirement income?

piggy bank and a pile of coins in front of it-retirement income

For most of us the retirement income will come from several sources:

Social Security
Pension (if you are lucky one)
Work (full-time or part-time)
Retirement accounts – 401(k), IRA, Roth IRA
Other savings

Social Security and pension are considered a guaranteed income because they got paid as long as you live. The full-time or part-time income is paid by your employer if you are still working and stop coming in when you retire.

The money from retirement accounts and savings will become an important part of your retirement income and the one YOU have the most control over.

How to manage your retirement savings?

When you accumulated a good sum of money in your retirement accounts it’s so easy to start spending it without careful planning. If you run through your savings fast and have so many years to live left, you’ll be facing some hard choices. You will be facing the options of going back to work, cutting back your living expenses or maybe moving in with your kids or relatives.

There are a few ways to withdraw money from retirement accounts and make it last for long. While we’re working, most of us live paycheck to paycheck. So, if we stick to the same financial discipline in retirement it will help us to control and manage our savings.

Based on that experience, a good strategy will be to create a monthly paycheck coming from your retirement savings.

But how to determine the size of your monthly paycheck?

First, take a realistic look at your retirement assets and how much money you have saved.

Then, think about what kind of lifestyle you want to have in retirement, how much it will cost to maintain it and for how long.

Establishing your priorities and understanding the trade-offs of each option will help to balance your emotional and financial decisions.

How much money to withdraw from your retirement savings?

laptop, smart phone and a notepad on the table-retirement income strategies

To determine how much to withdraw from your retirement savings is a critical decision. A simple withdrawal plan will help you to live comfortably and not to spend sleepless nights worrying about outliving your savings. But first, you need to figure out how much you will spend in retirement.

Do you know how much you will spend when you stop working?

Did you calculate how much you will spend on housing, transportation, utilities, groceries, medical and traveling?

Calculating your future expenses is an important part of retirement planning. The retirement expenses or I call it “your future spending plan” will help to determine how much to withdraw from retirement savings in addition to Social Security or pension.

A piece of good advice to remember that the more guaranteed income you have coming in, the less money you need to withdraw from your retirement savings.

Once you set up your future spending plan, you need to figure out how to withdraw money from 401(k), IRA, Roth IRA, and other savings. There are several ways to take money out of retirement savings.

3 best ways to generate retirement income:

1. The 4% withdrawal rule

The 4% rule of thumb is the most popular method to withdraw money from a retirement account each year.

How does it work?

The idea behind this method is to calculate 4% of your retirement savings that are remaining on your retirement accounts at the beginning of each year and then divide it by 12. That calculated number will determine your monthly paycheck for the year. The next year you should do the same calculation.

For example, if you have saved $300,000, this means you could safely withdraw 4% or $12,000 per year or $1,000 monthly. When you start your calculations, don’t forget to adjust those numbers for inflation, because the inflation erodes our savings. Whatever our cost of living today it will double in 20 years.

Simple withdrawal calculations for nest egg of $300,000:

Year 1 = $300,000 x 4% = $12,000 (or $1,000 per month)

Year 2 = $300,000 – $12,000 = $288,000; $288,000 x 4% = $11,520 (or $960 per month); $11,520 x 3% (inflation rate) = $11,865 (or $988 per month with increase for inflation rate)

Year 3 = $288,000 – $11,865 = $276,135; $276,135 x 4% = $11,045 (or $920 per month); $11,045 x 3% (inflation rate) = $11,376 (or $948 per month with increase for inflation rate)

And so on…

Why so much calculations?

When you use the 4% withdrawal rule, you will tap into your portfolio income and principal. Your retirement portfolio might go up and down during the year. Yearly calculations will help to protect your assets from being drawn down fast.

This method will give you the flexibility to occasionally tap into your principal and access to your savings for emergencies, but the money may not last through your lifetime.

While a yearly 4% withdrawal rule might not be ideal and may require more active management of your savings, but it should give you a general ballpark of where to start.

2. Withdrawals from investment income – interests and dividends

If your retirement income from Social Security and/or pension is big enough to cover your living expenses, then you can just withdraw interest and dividends from your retirement portfolio.

This strategy will allow you to withdraw only investment income (interests and dividends) and don’t touch the principal. With this method, you will keep most of your principal invested and it should last for your lifetime.

You’ll still have access to your savings and generate a retirement income, but it will be much lower, than with a 4% withdrawal rule. However, if you want to use this method to generate a retirement income, you’ll need to accumulate a big enough portfolio.

How much capital do you need to have to generate $50,000 in annual income? The answer will be it all depends on your dividend’s yield, but generally speaking close to $1.3 million. And if you need to have only $40,000 in your annual income, the number of your capital will be smaller close to $1 million.

So, if you want to live off your interests and dividends generated by your investment portfolio without touching a principal you will need to save much more than 20%, and then invest aggressively. Unfortunately, most people don’t get into this group.

3. Annuity as a guaranteed retirement income

table with a pot of coffee, cup, creamer and a flower pot

You can create a guaranteed retirement income by using a portion of your savings to buy an annuity. You can call it a DIY pension with a regular “retirement paycheck”.

How does it work?

You give a lump sum of your retirement savings to an insurance company and they promise to pay you a monthly income for life. Once you have your basic expenses covered by an annuity, you will gain peace of mind. Knowing that you have some financial security, you may want to invest your remaining money for growth, rather than worrying about how to stretch your savings for the rest of your life.

Annuities come in different size and shape:

Fixed income rate and variable income rate annuities
Lifetime annuity or Term annuity
Deferred Annuity or Immediate Annuity

Gary from Super Saving Tips blog gave a very good and detailed overview of annuities and their features:

Are Annuities Good or Bad for Your Retirement?

I must admit that I am not a big fan of annuities because it comes with high fees and commissions. However, I like the idea of buying an immediate annuity with the portion of retirement savings.

The immediate annuity will pay you a fixed income for the rest of your life. Unfortunately, there is no inflation protection for an immediate annuity with a fixed monthly income.

If you want to find out how much lifetime retirement income your savings could buy, use The New Retirement Annuity Calculator:

Retirement Annuity Calculator

What I am planning to do:

My plan is to buy an immediate annuity to cover our basic living expenses using one-third of our savings. I will keep one-third of our portfolio invested in stocks, so we will see our assets growing and get some inflation protection. The remaining part of our savings I will keep in cash, CD’s and bonds. When we retire, I can start using a 4% withdrawal rule to generate an additional income for our travels and hobbies.

Final thoughts

There is no right and wrong way to generate income from your retirement savings. It’s all depended on many factors like the size of your retirement portfolio, your living expenses, and the lifestyle you are dreaming about.

The problem is that we don’t want to deprive ourselves of certain luxuries when we stop working for a paycheck. We worked hard and waited for many years to live a nice life in our golden years.

So, if you are still 10 or more years away from retirement, I encourage you to stick to your budget, control your spending habits, and increase your savings. Those savings will help you to generate more income and provide you with safety and comfort in retirement.

Readers – What do you think? Have you thought about how to use retirement savings for creating a retirement income? Any thoughts on the annuities as a guaranteed retirement income?

The intent of this post is to be only educational and provide a simple guideline for a very complicated matter. I would recommend discussing your retirement income strategies with an accountant, financial planner or tax professional.

5 Easy Steps to Calculate YOUR Retirement Income Gap

by Maggie 2 Comments

Two women riding the bicycles along the countryside road

Millions of women approaching retirement age have nothing saved up and depend on Social Security alone. Other women are worried of what will happen to them because they will retire with a small balance in their retirement account.

If you are a reader of this blog, it means you take preparing for retirement seriously and want to learn more on the topic.

When I think about planning for retirement I think about it like assembling the financial pieces of the puzzle. It takes time before everything fit into the right places and you can see the whole picture.

The important part of this process is to calculate your retirement income and expenses and see if you have a gap between them.

Why identifying an income gap is important?

When you retire, you can no longer count on a paycheck from work. You will start relying on a fixed income, such as Social Security or pension. But the income from these sources may not be enough to cover all your regular expenses.

That will leave you with the gap between income and expenses. In this situation, you will depend on money from your savings and retirement accounts to cover the expenses.

Let’s find out how much is your income gap in 5 easy steps.

Step 1. Review your current financial situation

A bee is collecting nectar from the small flowers on the green bush

You need to see where you are right now and what do you have. Take an inventory of all your financial assets.

Start by collecting all your financial information:

How much is the current value of your house?
How much do you have in your retirement accounts, 401(k), IRA, Roth IRA?
How much do you have in your investment accounts?
How much is the current value of your rental property or vacation house (if you have one)?
How much is the value of your collectibles, gold coins, if you have any?

If you want to know the current value of your house, use Zillow for an approximate estimate.

Recently we refinanced our mortgage and it came with an appraisal report. I use this estimate as the approximate value of our house. You can ask the local real estate broker to give you the most current evaluation of your home, your rental property or a beach house if you have any.

Put all this information in the Excel spreadsheet or just use a piece of paper and call it Financial Assets Category.

Step 2. Estimate your retirement income

The next step will be to find out how much is your combined retirement income.

The income in retirement will come from different sources.

For many people, a Social Security paycheck will be THE ONLY income in retirement.

Other people will have an additional income coming from savings, retirement accounts, annuities, rental properties and/or dividends.

The more sources of retirement income you have the better off you are in your golden years.

Collect all this information and add to your Excel or paper spreadsheet under the Retirement Income Category.

Most of the information you have already collected while taking inventory of your financial assets. You just need to add the amount of your Social Security benefits.

Use the link to the Social Security Administration for information.

Step 3. Estimate your retirement expenses

There are many ways to estimate expenses in retirement.

A simple way to estimate your retirement expenses is to know where and how you spend your money today while you are still working.

Grab all your bank and credit card statements, your bills and any other financial information you have and calculate the total. This total number shows your monthly expenses today. The hard part of estimating retirement expenses is to predict how it will change in 10 or 15 years.

A common rule of thumb to use is that you will need about 70 to 80% of your current spending.

Here is a simple calculation.

If your current spending is $5,000, in retirement it will be approximately $3,500 to $4,000.

But if you are planning to maintain the same lifestyle as today, or splurge on a lot of travel trips or have expensive hobbies, your retirement expenses will be $5,000 or even higher.

Step 4. Calculate the balance between income and expenses

A woman looking at IPad while sitting at the table with a cup of coffee

Finally, you collected all the information and have the full financial picture in front of you:

Inventory of all your assets
Your retirement income
Your calculated expenses

The next step will be to calculate the balance between your income and expenses.

Did you find out that you have an income gap in your future budget? If yes, how do you cover it?

Here is a simple example.

You are planning to spend in retirement $5,000 a month ($60,000 a year).

Your guaranteed income from Social Security and/or pension is $4,000 a month ($48,000 a year).

$5,000 – $4,000 = $1,000

Based on the calculations you have an income gap of $1,000 a month ($12,000 a year)

Step 5. A few ways to cover a retirement income gap

How do you cover the retirement income gap?

Reduce your spending in retirement
Plan to work longer, so you can save more
Delay to collect Social Security to increase the future pay
Withdraw money from savings and retirement accounts

Even you are planning on working longer, to save more and delay Social Security might be still not enough to eliminate the gap completely.

According to statistics the average retired worker will receive around $1,360 per month. And the average retired couple will receive $2,260 per month. These numbers are adjusted with every year and not to the higher end.

The idea of working longer, saving and investing more becomes important when we look at the statistics. For many of us, the Social Security check will cover some of the basic retirement expenses.

However, if we want to maintain our current lifestyle or dreaming about active and fun years in retirement, we need to know how we will cover the gap between income and expenses.

How much money to withdraw from retirement accounts?

You have built a good size nest egg to live off it in retirement. After you retire and stop receiving the paycheck from your employer, you will start spending your retirement savings to cover the expenses. You need to be careful about how to withdraw money from your retirement savings.

The popular rule of thumb is 4 percent or “safe withdrawal rate”.

Its recommended by many financial planners and advisers. There are many debates between financial professionals if 4 percent is safe enough. Some of them recommend to reduce it to 3 or 3.5 percent. The main idea is you should be able to withdraw 4 percent of your portfolio value without ever depleting it to a dangerous level.

In what order to withdraw money?

When you retire, you get to decide how much to take from your savings and retirement accounts and in what order. The order in which you withdraw money from your accounts can impact how long your portfolio lasts in retirement.

In general, you should withdraw money in this order:

First – from taxable investment accounts
Second – from tax-deferred accounts – 401(k), IRA
Last – from tax-free accounts – Roth IRA

The reason behind this order is how much you must pay in taxes. Taxes will likely be one of your largest expenses in retirement. You will have more control over taxes, if you will be smart about withdrawal strategies.

The longer you can keep money in your tax-deferred and tax-free accounts, the better. It means that more money stays in your accounts and grow over time.

A screen showing images of stock market numbers, american dollar banknotes and an arrow

Everything will change once you reach 70 ½. At this age you must start taking money from your tax-deferred accounts based on IRS rule.

The rule is called a required minimum distributions (RMD) and it cannot be ignored, otherwise, you will get penalized.

So, if you are 70 ½ years old the order of money withdrawals will change:

First – withdraw your required minimum distribution (RMDs) from a combined balance in retirement accounts
Second – if you still have an income gap, pull money from taxable investment accounts
Third – if you deplete the taxable accounts, go back to your tax-deferred accounts
Last – pull money from tax-free accounts

Final thoughts

You’re in good shape, if you can stretch your financial assets to create enough income to cover basic expenses in retirement. But if not, you’ll need to find additional ways to increase your income or reduce your spending.

Even if you think that you’re far away from retirement age, you might still consider some of the options above. The main reason we are saving money for retirement is so we can spend them when the time comes. To learn and prepare yourself and your finances for the future is better than to ignore it.

This post is only for educational purposes and serves as a guideline for the readers of this blog who wants to learn about retirement planning. Please don’t rely on it as a tax or investment advice.

Did you come up with the numbers for your retirement income and expenses? Do you have an income gap?

Have you started thinking about how to withdraw money from your savings and retirement accounts?

Please share your thoughts with us.