I believe my greatest responsibility as a financial planner for my retired clients is to help ensure they never run out of money during their lifetimes. A bottom up approach to retirement income planning is one way to do that.
A bottom up approach to retirement income planning involves taking a close look at your retirement income needs, comparing that to your guaranteed income sources and coming up with a plan to cover the difference. Be careful not to confuse this strategy with a “bottoms up” approach that you may be tempted to take the next time the market drops.
Bottom up in action
Let’s say you need $5,000 a month after taxes to pay for basic living expenses in retirement. How much will you be getting in reliable or guaranteed income from sources like social security or a pension? The average person on social security today receives a benefit of about $1,300 per month. How much you receive depends on you earned over your lifetime and how old you are when you begin collecting benefits.
If you expect to receive pension income, work that into your math. Let’s assume your pension income is $2,200 every month. Combined with social security, you can count on $3,500 of reliable monthly income.
Since you need $5,000 every month, there is a gap of $1,500 that must be covered to meet your monthly income needs:
- Monthly Income Need$5,000
- Guaranteed Income $3,500
- Income Gap $1,500
It’s that bottom line of $1,500 that you need to solve for. That’s why I refer to this as a bottom up approach to retirement income planning.
How do you get $1,500 of additional monthly income to meet your income needs?
For a growing number of retirees some or all of that income might come from part-time work, at least for a while. According to Careerbuilder.com, 54% of workers over age 60 say they expect to work after retiring from their current career. I can tell you from professional experience that the number of people who say they will work in retirement and the number that actually do is very different – in my experience anyway.
Besides, isn’t the whole point of retirement that you don’t have to work anymore?
For many retirees that income gap will need to be covered from existing savings and investments. How much of a lump sum you will need to produce that kind of income depends on how your retirement savings are invested, your assumptions for inflation and investment returns, and how long you expect to live.
Once you calculate the amount, you will need to determine how to invest it. Stock and mutual fund dividends, annuity income, interest from bonds and cd’s, these are all possible contenders in a retirement income portfolio. Every option has its pros and cons. The key is to create a retirement income strategy that closes your income gap in a way that you understand and are comfortable with, and that is consistent with your risk tolerance and time horizon.
Creating a retirement income that you can never outlive isn’t easy. But if you take a bottom up approach to determining your income needs, you might find that closing the gap is easier than you thought.