5 Step Retirement Income Guide
This guide is designed to help work towards answer some of the most common questions I hear working as a financial planner.
Part I of the guide is focused on the questions, Part II is much longer and is focused on how to work towards answering these questions
Part I
1.How much are you going to spend in Retirement?
What does your regular monthly budget look like? What amount would you be able to live on?
What does “normal” spending look like for you?
2.How much are you going to make in Retirement?
From what sources? How will they be taxed? How variable is the income?
Will your income adjust for inflation?
3.What’s your ideal emergency fund?
How many months of expenses are covered?
Would those months be “bare bones,” or “normal?”
4.How is the portfolio allocated?
How much up / down are you willing to accept?
What timeline are we considering?
How do you quantify diversification and efficiency?
In the last market downturn, how much did your portfolio drop?
5.How much do you want to leave behind?
Do you want it to be a dollar amount, cover education, or simply prevent being a burden on the next generation? Are there assets to pass on? How will those assets pass to the next steward?
Can you articulate the taxation of this event?
Part II
1. How much are you going to spend in Retirement?
This exercise is not intended to find the exact amount of money you need every single month, as expenses and spending vary month to month. However, getting a general idea of the amount of income to be replaced in retirement is a wonderful place to start. Typically, we add in a bit of “fluff” to this starter budget because we anticipate folks spending a bit more in retirement than they do while working.
Here are three ways to find the monthly spend number:
If most of your spending happens on a debit or credit card, download your last 6-9 months of transaction history and use that to find your average spending habits.
On Average, how much do you spend per month? __________________ What expenses are missing? Think mortgage, utilities, insurance, etc
We all sometimes spend more than we need, so ask yourself: How much should be enough? “How much income per month would probably be enough for me to be comfortable and content?” This will include the same regular expenses like food, transportation, clothing, etc., but with a different and more intentional perspective. What is that number for you? ___________________
Find your normal monthly spending using a budget – fill out the Sample Monthly Budget for a quick estimate. This is not an all-inclusive list (debt is not included, for example), just a place to start and get an estimated total. Having a detailed and written budget can be one of the best financial tools, however, this is tedious and most don’t like tracking each and every expense. If you want more help on this, there are numerous budget tracking programs and apps. One we like is called “Every Dollar.”
2. How much are you going to make in Retirement?
Retirement has as many meanings as there are retirees. A growing trend for retirement has been to retire from your stressful work and retire to some type of low-stress enjoyable work or consulting. Knowing how much income, if any, can be helpful in building an income needs analysis for retirement.
What income sources will there be?
If you have any working income after you retire from your main “job” income, what do the income sources look like? Will you have a few clients you do consulting work for? Will you be making and selling things? Will it be contracts, will it be a W2 position?
Social Security Income – when will you take the benefit? Do you know how they are taxed and coordinate with Medicare? Do you know how the Social Security Income will that coordinate with other income sources?
Pension or Annuity Income – if you have any of these income source, does the income adjust with inflation and what amount of the payment will be taxed?
How will it be taxed?
Will you be a business owner, 1099, W2?
The taxation will depend largely on the type of work, and the structure of the income.
For example, if you’re consulting, and have an LLC, your tax picture will look much different than someone who is a part-time W2 employee. Knowing how much you keep is just as important as knowing how much you’ll make.
How variable will it be?
For each income source – and there may be several, how variable is that income? Let’s take consulting work for an example: do you have a system to generate recurring business leads or referrals? If so, how reliable is it? How reliant is this income on one or two clients?
Inflation – will your income sources adjust with inflation? If not, how will you supplement?
Approximately how long will it last?
Should you work post-retirement, for how long? How long do you want/need it to last?
Does the work include any physical or manual stress or labor that might affect you the
longer you work?
Is there any other priority that may cause you to put down the work, such as
grandchildren, travel, or charity work?
3. What’s your ideal emergency fund?
Emergency funds – specifically, the amount of cash you keep on hand for emergency cases, like needing to fix the car, water heater, medical emergencies, etc. – is an important consideration in retirement. We want the financial plan to be able to support having that ‘ideal’ amount in cash or cash-like vehicles, where it likely will not grow very much at all. The goal of emergency funds is typically to turn emergencies into inconveniences, and to protect against suddenly needing to take on debt. The common “rule-of-thumb” for an emergency is somewhere between 3-6 months of expenses. However, this doesn’t exactly paint a full picture until we address a few other questions:
What was the range you found in question #1?
• In the first topic, “how much are you going to spend in retirement,” we sought to find a range of monthly expenses. We’ll use that range to help determine your range of Emergency Funds.
Do you have other liquid assets that are accessible and should be included?
One common theme we see with clients is that as people move along their financial journey and accumulate assets, the “ideal” emergency fund changes as well.
If you have liquid, accessible dollars, for example in a taxable investment account (sometimes referred to as a joint account, individual account etc.), it can make sense to reduce the emergency fund closer to 3-4 months. However, people in this position with sizeable taxable investment accounts often find themselves with a large cash position as well.
o For some people in this scenario, it can be advantageous to simply place the money above and beyond the acceptable or ideal emergency fund into the taxable investment account so that the money is working for them.
There are a few scenarios where it can be advantageous to increase the emergency fund:
o If there are not ample accessible assets as in the case above, or if you have highly variable income, it may be prudent to have closer to 6-12 months or more of expenses as an emergency fund.
o Another scenario would be if someone’s investment strategy is all or mostly equities (as opposed to fixed-income securities like bonds), it may make sense to have a larger emergency fund – even up to two years or more of expenses as cash! With those kinds of savings, they would be able to delay taking income from their portfolio during a market downturn, such as the 2008/2009 recession or the COVID-related downturn in 2020.
**Of course your specific situation will vary and we encourage speaking with a professional!
4. How is the portfolio allocated?
The portfolio allocation has a big impact on the expected portfolio growth in the future, and therefore has a big impact on the amount that can be distributed from the portfolio. We believe each portfolio should be built to serve your lifetime financial goals and aspirations. Understanding the current allocation of a portfolio as well as the goals for the portfolio (income, growth, etc.) helps us to align the portfolio with our desired outcomes. As you read this section, think about your long-term goals and what you’d like to accomplish by investing.
This worksheet is a good place to start, but bring your findings to a professional advisor you trust.
Here are some questions that can be helpful regarding your portfolio:
In your portfolio, what is the ratio between equities and fixed-income securities?
• The value of equities (stocks, mutual funds, ETFs, etc.) typically fluctuates more quickly than the value of fixed-income securities (bonds, treasury notes, etc.)
How much up/down are you willing to accept?
• Essentially every asset goes up and down in value over time; real estate, equities, bonds, they all fluctuate in value. How important is having a ‘stable value’ to you? How important is portfolio growth to you? For some people, a lot of fluctuation in value can be emotionally challenging. While investment portfolios are not a good source of contentment regardless of their allocation and strategy, a portfolio that fluctuates less while growing less may be appropriate for some. Remember that ups and downs are correlated – we’ll cover this more extensively on pages 6-7
What timeline are we considering?
• One common mistake is to think the investment timeline or horizon is only between “now” and “retirement.” However, it’s very common for investment portfolios to play a big role in creating income in retirement. This means that the investment timeline can be from “now” to the end of life, when it’ll be given away or to heirs. How long do you plan to be invested?
How do you quantify diversification and efficiency?
• Diversification can mean different things to different people, but here we’re referring to the concept of spreading out your investment portfolio in order to reduce risk. Having a large concentration in one company, sector, or fund in a portfolio comes with the reality that the performance of that portfolio is dependent upon that company, sector, or fund.
Quantifying Diversification:
• One common way to visualize or quantify the diversification of an equity is the “style box:”
On the left side of the box, we have Large, Mid, and Small cap – this refers to the relative size of the companies in a given portfolio.
On the top, we have “Value, Blend, and Growth” which refers to the style of company. “Value” style companies are typically mature companies with strong business models that an investor feels may be undervalued. Examples of Large Cap, Value style companies: Disney, Verizon, and Johnson and Johnson. Growth companies are usually younger and looking to grow very quickly; examples of Large Cap Growth style companies: Tesla, Facebook, Amazon, and Google.
One of the goals of diversification is to “check all the boxes,” in the style box. A fully diversified portfolio would have something in each of these boxes – though not necessarily the same amount in each category. In your portfolio, are all these boxes checked? Is there a significant concentration or weighting in any of these categories? If so, is that appropriate and justified?
Another factor to consider in the diversification of your portfolio is the “sector,” which refers to the type of company or industry that the company focuses in. Facebook could be considered technology or communications. Other sectors include financials, healthcare, industrials, energy, real estate, etc. Does your portfolio contain several of these sectors? What’s the biggest sector in your portfolio? What % of your total portfolio is held in that sector?
In summary, diversification considers the size, style, and type of investments within a portfolio.
Quantifying Efficiency:
“Efficiency” here refers to the correlation between the amount of risk and the potential growth of a portfolio. One of the basic tenants of the stock market and investing is that risk and reward come hand in hand – investors take on risk (the chance that the value of their investment will go down) because they want the potential rewards (the chance for the value to go up). However, there is a certain point where adding more risk will not necessarily add more potential reward, this is called the “efficient frontier.” The “efficient frontier” (simplified version below) can be a helpful way to visualize the relationship between risk and reward. As the line moves further to the right, the potential reward increases by less and less,
leveling out.
Simple Efficient Frontier visualization:
Measuring your portfolio on the efficient frontier can be tricky without specific tools, we encourage to speak with a qualified professional to assist.
Another metric that can be useful in quantifying the efficiency of a portfolio is the Up/Down capture ratio. This ratio refers to the trend of a given fund, stock, or total portfolio as it captures gains and losses alongside the market; up/down capture ratios are typically measured against a benchmark index like the S&P500, NASDAQ, Russell 2000, or some other index.
A quick example: let’s say I have a portfolio roughly comparable to the S&P500, and over a given time period the S&P500 goes up 10%. Additionally, let’s say my portfolio went up 10.2% in that same time period - that means I captured 102% of the index return. Conversely, let’s say the market goes down, and the S&P500 goes down by 10% - and your portfolio goes down 11%. That means I captured 110% of that downturn. The idea here is to have a higher percentage on the upside and a lower percentage on the downside. This is of course all relative to the desired risk in the specific portfolio and measuring that specific portfolio to the current benchmark/index.
Measuring these two separate parts of the up/down capture ratio gives us an idea of the efficiency of our portfolio.
What has the up/down capture ratio of your portfolio been?
5. How much do you want to leave behind?
The last choice we get to make with our assets is where they go when we leave this Earth. There are several factors to take into consideration here, as the impact of decisions made in the Estate Planning chapter of a financial plan have a tremendous impact on the beneficiaries, which are commonly people very dear to our heart or a cause/organization that is important to us.
First, let’s consider goals:
• Identifying the specific causes or goals you want to help your beneficiaries with can be a helpful and important first step; as we get clear on the goal we want to accomplish, the tools and techniques can be used with purpose. Remember, tools and techniques help us accomplish the goal, but they are not the goal.
Do you want to leave behind a dollar amount, cover education for certain people or up to an amount, or simply prevent being a burden on the next generation?
• Ask yourself some hard questions: What is the purpose I want to instill into the dollars I’ll leave behind? What do I most want to help my beneficiaries with? What do they want help with? What impact will your estate planning decisions have on them?
How will those assets pass to the next steward?
• Are they beneficiaries on a retirement account of yours, are they listed in your last will and testament?
Can you articulate the taxation of this event?
• Will the transfers trigger Generation Skipping Transfer Tax? Will you incur an estate tax? Will you incur a gift tax? At what rate will any applicable taxes apply to the transfers?
Are those beneficiaries prepared?
• Are you confident they know how to handle the amount of money you intend to give them?
Have you spoken to those beneficiaries about your plan?
• One of the most commonly overlooked steps is communicating with the beneficiaries you intend to give to, so that they are fully prepared and ready for the task of managing those assets. Have you had a family discussion?
What to do Next:
Record the answers to the questions in this guide.
Take those answers with you to a financial advisor you trust.
Implement changes to align your resources with your retirement income
plan.
We strove to make this guide as helpful, powerful, and simple to use as we could. However, retirement comes with quite a bit of complexities and can be overwhelming for some even after going through a guide like this. This guide is designed to equip you with questions to consider, but from here a great step to take would be to communicate with your advisor, or find a professional advisor that you trust.
It’s absolutely normal to still have questions. It wouldn’t be possible to cover every aspect of retirement income in a single guide. While we hope this guide helped you get started in the right direction, know that additional questions are normal and to be expected – that’s why we recommend talking with a professional advisor from here.
If you like the views and line of questions we pose, reach out to us, we’d love to learn more about you and share how our services may benefit you.
As we mentioned in the guide, your assets, wealth, income, etc., are all resources to be acted upon. One of the biggest central questions behind all the complexities of wealth is this:
What is the purpose of your wealth? What do you want this wealth to accomplish?
Steven Covey famously said, “begin with the end in mind.”
We believe that once you can articulate the purpose of your wealth and what you want it to accomplish, the planning and investing becomes wildly simpler.
Standard & Poor’s 500 (S&P 500) - a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy.
Russell 2000 – The index measures the performance of the small-cap segment of the US equity universe. It is a subset of the Russell 3000 and includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.
MSCI ACWI ex USA – The index measures the performance of the large and mid-cap segments of the particular regions, excluding USA equity securities, including developed and emerging market. It is free float-adjusted market-capitalization weighted.
Federal Funds Rate - refers to the target interest rate set by the Federal Open Market Committee (FOMC). This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.
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An index is an unmanaged portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown.
The mention of specific securities and sectors illustrates the application of our investment approach only and is not to be considered a recommendation. The specific securities identified and described herein do not represent all of the securities purchased or sold for the portfolio, and it should not be assumed that investment in these securities were or will be profitable. There is no assurance that the securities purchased remain in the portfolio or that securities sold have not been repurchased. For a complete list of holdings please contact your portfolio advisor.