How to generate income in retirement

Most people spend their careers saving and accumulating funds so that one day they can retire. But when retirement finally arrives, a whole new process begins.

Economists call it, “the decumulation phase.”

This is the process of turning saved or invested assets into regular income.

Decumulation is an entirely different animal than accumulation. Paying regular bills by slowly liquidating investment shares can be an extremely complicated task to undertake.

  • Which stock (or fund shares) should you sell first?
  • Should you sell shares of a stock that is up or a stock that is down?
  • Should you sell an average of all the stocks you own?
  • Should you be selling shares of some other investment such as a bond fund?

I often think of the challenges of decumulation when I am at the grocery store and see very senior people doing their shopping.

(OK…if that makes me some kind of economics/financial nerd, so be it. There is a serious human side to this story.)

I think to myself,

“Does this person now have to go home, log in to his or her online brokerage account, and sell shares to pay for those groceries?”

I also often wonder,

“What if this person is alone and has lost his or her spouse?”

What if the spouse who is now gone was the one who “took care” of the money?

What’s left is someone at a very delicate and vulnerable senior age – who is likely intimidated or even downright afraid – forced by necessity to manage an extremely complicated and difficult task, just to pay for basic things like groceries.

Yikes…

There is a better way.

There are products designed to generate and distribute income more smoothly. These products generally “pool” funds in order to distribute income steadily and predictably over time.

  • Funds of this general type date back to the Roman Empire when individuals were paid an annual stipend called an “annua.”
  • Roman soldiers received such stipends in exchange for military service.
  • Participants would make a single payment to the fund and receive payments each year until they died.
  • Other funds of this type – called tontines – were used during the middle ages by kings and lords to finance the cost of frequent military campaigns.
  • The first annuity used in America was established in Pennsylvania as a retirement fund for pastors in 1759.
  • Lotteries today use similar mechanisms to distribute prize money to winners. After an initial lump sum is contributed, funds are paid out evenly over a number of years.

Converting savings into income can be a very complicated process, but it doesn’t have to be.

After a certain age, for mercy’s sake, it really shouldn’t be.

Don’t leave your spouse trying to manage a “do-it-yourself” decumulation plan.

Learn how annuities can help convert savings into guaranteed, worry-free income and make the decumulation process a whole lot easier.

Try this simple method to calculate how much income you may need in retirement.

If you would like to contact me to discuss whether annuities may be suitable in your situation, I can be reached by email or through my Cincinnati, OH insurance agency, McCarthy Stevenot Agency, Inc., at 513-891-9888.

The Risk of Sequence of Returns

For years we have heard it repeated over and over from the financial sector – and their willing allies in academia and the media – that investing in stocks will provide us the best possible returns over time.

In a recent post, I pointed out that one of the problems with this conventional wisdom is how one defines “over time.” Depending on when you invest, how long you stay invested, and the time frame in which you need your money back, can have a dramatic impact on your actual results.

But the difficulties don’t end there…

The risk of Sequence of Returns

This problem relates to the “sequence” or the order in which a person receives his or her investment returns while withdrawing funds from a portfolio during retirement.

It is an enormous concern, though few people have any idea it exists.

It is both uncontrollable and unpredictable, and, depending on how it plays out, it can lead to a the early depletion of person’s retirement fund.

Here’s how it works.

Consider the following three numbers:

-13, 7, 27

Add them up and you get 21.

Divide 21 by 3 and you get an average of 7.

This is called an “arithmetic average.” Similarly, the oft quoted “7% inflation adjusted rate of return including dividends on stocks over time” is an arithmetic average.

You can add the three numbers above in any “sequence” you like and you’ll still get a total of 21 and an average of 7.

-13 + 27 + 7 = 21. (21 divided by 3 = 7)
7 + -13 + 27 = 21. (21 divided by 3 = 7)
27 + 7 + -13 = 21. (21 divided by 3 = 7)

But, here’s the rub…

The order in which those numbers appear as “returns” in a person’s portfolio can have a major impact on how long his or her portfolio lasts during retirement.

Let’s take the same three numbers: -13%, 7%, 27%, and apply them in different orders as rates of return on a portfolio that is funding systematic withdrawals – just as would be the case for someone funding his or her retirement.

  • We’ll start with a $100 nest-egg and take $10 out of the portfolio each year to pay bills.
  • We’ll run two sequences, both with 7% average returns
  • The only difference between the two scenarios is the sequence or the order in which the returns are achieved.

In Sequence One, the order of returns will be: -13% in year one, 7% in year two, and 27% in year three. The returns will continuously repeat for a running average return of 7%.

In Sequence Two, the order of returns will be: 27% in year one, 7% in year two, and -13% in year three. The returns will continuously repeat for a running average return of 7%.

Let’s see what happens…

Sequence #1

Sequence Number 2

Sequence Two ends up yielding 44% more income than Sequence One (i.e. $168.37 versus $116.81) and lasts five years longer.

This happens with exactly the same $100 nest egg, exactly the same rate of withdrawal, and exactly the same long-term average rate of return.

The only difference is the unpredictable and uncontrollable sequence of returns.

These examples show that a difference in the order of returns – notably, more negatives in the early years just before or just after retirement begins – can have a dramatic impact on how long a person’s retirement money will ultimately last.

Click to learn more about how to overcome the risk of sequence of returns and guarantee you never run out of income in the future – regardless of how long you live or what the markets do.

So, what do you think?

  • Have you ever heard of the risk of “sequence of returns” before?
  • With tens of millions of people in 401(k) type plans that may be affected by this concern, why don’t we hear more people talking about it?
  • Does the example above illustrate the concept clearly enough?
  • What other issues does becoming aware of this risk bring to mind? (I’ll tell you one – women are the most at risk because they live substantially longer than men…)

Email me your thoughts or comment below.

Why income beats savings in retirement

Imagine yourself far in the future. Yesterday, you celebrated your 82nd birthday! It was an enjoyable day spent with family and friends followed by a relaxing dinner with cake, ice cream, and many happy memories.

But this morning you awoke to some troubling news…

When you clicked on your favorite news app, you learned that an overnight far-eastern currency concern has sent U.S. markets into a tailspin.

As the next several days go by, market conditions rapidly deteriorate. The damage even begins to spread to other sectors. Both real estate and bonds start taking substantial hits.

Logging into your online brokerage account, you watch your account balances dropping more and more each day. Years and years of hard-earned savings are vanishing before your eyes.

You ask yourself, “Is this ever going to end? Should I be selling? Should I be staying put? Will my retirement funds be able to survive this latest ‘correction’? If not, how am I going to pay my future bills?”

This story is just a sample of the kind of worry that can arise when long-term retirement income is based solely on invested savings and systematic withdrawals from savings.

Do you currently have only a 401k plan and no guaranteed company pension?

Then, someday, this could be you…

The good news is, however, with a few simple planning steps, there are ways you can help reduce or even eliminate many of the above concerns. In fact, it can even be possible to establish a foundation for a reliable and worry-free retirement income.

The key to doing so is locking down enough guaranteed retirement income to cover your basic future expenses.

Guaranteed income is money that will be paid to you no matter what happens in future markets and no matter how long you end up living. Guaranteed income can be derived from a variety of sources including a combination of Social Security, a company or union pension, and life income annuities.

How much retirement income will you need?

Many planners point toward a “target” for retirement income that is equal to roughly 70% of a person’s pre-retirement income. In general, the more “base income” a person has from guaranteed sources, the easier time they will have meeting ongoing expenses in retirement. Studies show that individuals with more guaranteed income during retirement are also known to be happier and have less stress in their senior years.

How to create a successful retirement income plan

The fundamental elements of building a solid income plan for retirement are as follows;

  1. Reduce your long-term retirement living expenses where possible (downsize, simplify your life, pay off any mortgages or consumer debt).
  2. Establish an emergency fund for short-term cash needs (set aside the equivalent of six months to a year of income in an easily accessible FDIC-insured bank account).
  3. Calculate your NEEDED retirement income using the 70% rule or other similar method.
    (pre-retirement income = $100,000. 70% of $100,000 = $70,000)
  4. Add up ALL the income you will have from GUARANTEED sources such as Social Security, pensions, and life annuities.
    ($46,000 Social Security + $0 company pension + $0 annuity income = $46,000)
  5. Subtract your GUARANTEED income from your NEEDED income. This is your income “gap.” ($70,000 – $46,000 = $24,000 income gap)
  6. Click here to learn more about ways to fill your income gap!

Once funding for your basic income needs is set, you can think about allocating your remaining assets for future savings, special purchases, investments, and legacy planning (i.e. money that you plan to leave to kids, grandchildren, or charity).

For most people, covering basic retirement living expenses through guaranteed income will be better than relying on savings. Guaranteed income takes uncertainty out of affording your monthly bills and removes stress about what will happen to your savings in future markets. Guaranteed income also simplifies planning and assures you will receive a “check” each month no matter how long you our your spouse may live.

When added together, the benefits of guaranteed income help lead to a happier, more secure, and more relaxing retirement.

So, what about you? Do you worry about how to create income for your retirement? Do the potential ups and downs of the market bother you? If so, what is your plan to solve for this problem?

Let me know your thoughts by email or in the comments below.