William Lako: Protected income and sustainable retirement spending
Lako
You might call it “retirement income planning,” “liquidity needs,” or perhaps “withdrawal rate.” Whatever the term, it all refers to the same thing: the cash you spend in retirement, regardless of its source — dividends, fixed-income investments, or withdrawals from retirement plans.
The Alliance for Lifetime Income’s “2024 Protected Retirement Income and Planning Study” revealed only 27 percent of investors recall their financial advisers discussing secure income, despite 62 percent of advisers reporting that they do. Moreover, 54 percent of survey respondents aged 61 to 65 mistakenly believed their IRA could provide guaranteed income, and 53 percent thought the same about their 401(k). In reality, Social Security, pensions, and annuities are the primary sources of protected income. With pensions relatively rare and Social Security designed to cover only about 40 percent of pre-retirement income, retirees often face a significant gap between their income and expenses.
These misconceptions underscore why financial planners emphasize saving for retirement. With most retirements lasting about 20 years, the amount investors need to save is unbelievably daunting. This is why many seek a simple answer to questions like, “How much can I spend in retirement?” or “How much can I withdraw while making my savings last?”
Unfortunately, there’s no magic number. Retirement planning does not have a “one-size-fits-all” solution. How much you need to save and eventually withdraw should depend on how much you want to spend in retirement. Ideally, your financial adviser should take the time to analyze your current annual spending and work with you to estimate your retirement expenses. Don’t fall into the assumption that you’ll only need 80 percent of your current spending in retirement. If you typically spend $200,000 a year, it’s unlikely that you’ll suddenly reduce that to $160,000. Your lifestyle is ingrained, and it’s unlikely to change drastically once you retire.
I recommend using a cash flow projection that accounts for investment growth, annual spending, inflation, rising health care costs, taxes, and the depletion of assets by the time the youngest spouse reaches age 92. This projection should provide a maximum spending limit in retirement. To ensure a high probability that your savings last your lifetime, I generally recommend spending no more than 85 percent of this “maximum.” At least every two years, I also recommend revising your projections to reflect your actual spending patterns more accurately. If the projections indicate you may run out of money, the harsh reality is that you’ll need to rein in your spending. However, if you’re still 10 years from retirement, there’s time to adjust your lifestyle and increase your savings.
Once you have established your annual spending needs, I advise allocating 10 years of spending into laddered fixed-income investments, typically invested in FDIC-insured CDs or U.S. Treasury bonds that mature when you need the cash. These assets are shielded from stock market volatility, while the remainder of your portfolio should be invested in the stock market to pursue growth.
How aggressively you’re invested depends on your capacity and willingness to take on risk. Your cash flow projection might show you only need a 6 percent return to meet your retirement goals, yet your asset allocation is designed to achieve a 10 percent return. While higher returns may be appealing, it’s worth asking, “Why take on extra risk if it isn’t necessary?”
William G. Lako, Jr., CFP®, is a principal at Henssler Financial and a co-host on “Money Talks” — your trusted resource for your money, your future, your life — airing Saturdays at 10 a.m. on AM 920 The Answer. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.
