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OUR RETIREMENT INCOME is built on a slew of financial products and strategies. But we should think less about the gory details of each—and more about the role they play in our overall retirement finances.
The fact is, while each of us comes to retirement with different levels of wealth and different desires, we all want both a sense of financial security today and confidence about our financial future. How can we best meet those twin goals? We might think about our retirement finances in terms of seven dimensions:
1. Setting a floor. Arguably, our fixed living costs should be the starting point for our retirement-income plan—because, if we’re struggling to cover property taxes, insurance premiums, utilities, grocery bills and other recurring costs, our final years will likely be awash with financial stress.
To that end, we should figure out how much we need each year to, quite literally, keep the lights on. Would it be prudent to reduce that annual nut? This, of course, is the reason folks downsize, sometimes coupled with moving to a lower-cost and lower-tax state.
2. Building in flexibility. Fixed costs have to be paid. But discretionary spending—we’re talking fun stuff like travel, eating out, concerts and more—is easily cut. No, we don’t want to nix next year’s trip to Hawaii. But varying our discretionary spending is an important financial lever, one we may have to use if we get hit with, say, hefty medical expenses or brutally bad financial markets. What would we cut if our financial life took a turn for the worse? Each of us should have some sense of our spending priorities.
3. Buying predictability. Where will we get our retirement’s spending money? It could either come from selling assets—our home, stocks, bonds, cashing out part of a savings account—or via regular income. The latter might include dividends from stocks, interest from bonds, pension income, annuity income and Social Security.
It can be a mistake to invest solely for income by, say, chasing higher-yielding investments. Still, receiving ample regular income can make retirement less financially stressful, and it’s a reason folks might want to delay claiming Social Security to get a larger monthly check, and perhaps also purchase immediate-fixed annuities.
4. Cushioning crashes. Many retirees focus less on generating regular income and more on gunning for growth, with an eye to periodically cashing out stocks and bonds to pay living expenses. What if we get a year like 2022, when both stocks and bonds got pummeled? As a precaution, consider setting aside five years’ worth of required portfolio withdrawals as a financial safety net. We might stash these dollars in money market funds, high-yield savings accounts, short-term certificates of deposit, high-quality short-term bond funds and other super-safe investments.
5. Fending off inflation. Recent inflation has been a wakeup call for many retirees. But the truth is, even modest inflation can put a big dent in a retiree’s lifestyle after 15 or 20 years. What to do? As a hedge against higher costs in our late 70s and beyond, we might save some of the income we receive earlier in retirement.
But perhaps a better route would be to delay Social Security and purchase inflation-indexed Treasury bonds, both of which are designed to keep up with inflation. Retirees might also include a healthy allocation to stocks in their portfolio. While stocks come with no guarantees, a well-diversified portfolio should outpace inflation over the long haul, especially if we also have a cushion of cash that allows us to avoid selling during bad markets.
6. Protecting the long end. What if we outlive our savings? Just in case, we might want longevity insurance, in the form of income that’s guaranteed to last as long as we do. The most common form of longevity insurance is Social Security. Indeed, because Social Security also provides both inflation protection and reliable income, it’s one of the keys to a financially successful retirement—and I, for one, want as much of it as I can get, which is why I plan to delay benefits until age 70.
But Social Security isn’t the only form of longevity insurance. Many folks also have traditional employer pensions, and some have annuities that pay lifetime income, including both immediate-fixed annuities and deferred-income annuities. The more longevity insurance we have, the more risk we can take with our other money and the freer we can be in spending down our nest egg.
While I’m not a fan of long-term-care (LTC) insurance, it can also be viewed as financial protection for our later years. If folks have an LTC policy and hence they know they can at least partially cover such costs, that can free them up to spend more of their nest egg early in retirement.
7. When all else fails. The tighter our retirement finances, the more we need to ponder this issue. How will we cope if our retirement savings start dwindling and we’re faced with expenses we simply can’t cover. This is where our retirement’s financial backstop comes in. We might have to spend home equity, perhaps using a reverse mortgage. We might need to dip into the money we’d hoped to leave to the kids. We could have to cash in that old whole-life insurance policy we’ve been hanging on to.
None of these options is especially palatable. But as with the discretionary spending cuts we might make if we got hit with a financial emergency or a bad stock market, it’s worth pondering what our retirement’s financial backstop is, so we’re prepared if that time ever comes.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney, on Facebook and on Threads, and check out his earlier articles.
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Regarding the 5 year safety net, is this based on the average period of time it takes a portfolio to recover 100% after a bear market? does anyone know historically what’s been the max years it’s taken to recover? Also assume one should add emergency unexpected expenses to this 5 year amount?
There are some periods when it’s taken more than five years for stocks to recover, but the number is very small. Still, if you’re a belt and suspenders kind of guy, you might go for seven or even 10 years.
I take comfort in your reply of “very small”. thanks!
Great article. Longevity insurance vs investing in nest egg to fight inflation was a major dilemma for me when I retired. More people preferred lump sum vs pension in my company. But I opted to take pension to assure myself of a comfortable spending floor, while retaining the flexibility to aggressively invest nest egg. Hopefully, that is the right decision for me. Would like to hear from others about their experience post-retirement on choosing lump sum Vs pension.
Sundar Mohan
I did a period certain annuity from age 62-70 using IRA money instead of fixed annuity. More bang for the interim buck. Also your distaste for LTC I think unwarranted for hybrids which provide a huge umbrella for the longevity issue- as does a CCRC.
A lot of columns here discuss how we have taken care of elderly parents.
A lot of us don’t have kids to rely on, but for those of us who have close younger family who are solvent and willing to (help) care for us, this may be considered an additional optional pillar of retirement too.
Good article that makes a key point, that is so often not discussed…..
“The more longevity insurance we have, the more risk we can take with our other money and the freer we can be in spending down our nest egg.”
Someone with lots of “insurance” can have a portfolio that is 90% equity throughout retirement. Under that circumstance, the equity is essentially a legacy investment. Conversely, someone with little insurance can ill afford to invest even 10% in equity.
This is why generalizing on appropriate investment portfolios, as simply a function of age, is such a terrible approach to retirement financial planning.
I took my SS at full retirement age, which was 66, after calculating the break even point, which was close to age 80. I figured I could use that money when younger and more active, and even invest some. After age 80 discretionary spending will not be as much. However, I am not worried about running out of money, so that was not a factor.
Why was breakeven a concern? Does it matter?
Why isn’t break even a concern? If it isn’t then take SS as soon as possible, right because the amount doesn’t matter?
Because what matters is having the most income each month when you need it the most – sooner or later. The total amount collected over a lifetime never matters. It’s insurance, an annuity, you might collect for one year or thirty and you can’t control that in any case.
There are so many variables to consider that it can be a bit overwhelming at times to try to balance all the various inputs and options. In my area the government has started eliminating property taxes for seniors. That will be a great help to many, but I have to wonder how the money will be replaced?
We are fortunate to have some excess in our funding and could decrease expenses substantially if needed.
Our house continues to be a very major expense for us. Anyone who wants to reduce and/or control (flatten) their housing expense might consider a rental. We live in an earthquake area and deductibles for earthquake are usually 15% to 25% of the insured value of the home. And the deductible applies to the house, the contents, and other coverages. For example, a $500,000 house with a 15% earthquake deductible would be $75,000 on just the house. Contents coverage of $250,000 would be $37,500. And so on for the various coverages. $75,000 + $37,500 = $112,500 that a homeowner would need to pay first on an earthquake loss before the insurance company started paying.
“Events” like this can immediately alter any retirement planning you’ve done, unless you have a lot of excess money to work with.
Great summary. I waited until 70 for Social Security specifically to get a bigger base for future cost of living increases. I’m finally tapping my portfolio this year, and have set up a five year CD ladder as a start. My longevity protection is my CCRC, which promises not to throw me out if I run out of money. I hope never to need the help, but better than sleeping rough.
I know several who are interested in CCRC.. May be you can write an article for HD about CCRC in general, expenses, Pros, and Cons. Thanks!
Sundar Mohan
Check out this article:
https://humbledollar.com/2024/04/gift-to-myself/
Thanks! This is perfect.
Dick Quinn’s warning below is the great value of HumbleDollar. Jonathan hammers home the most vital financial moves to make and avoid. Meanwhile, a plethora of mistakes and occasional wins are presented through the other articles and comments, to cover the wide gamut of personal finance. We ignore the good advice at our own peril!
Excellent point, those mistakes we learn about can be of great value. If I’m honest I learned about the dark side of retirement from listening to our company retirees and what actions they took or didn’t.
One event stands out. The person retired and took most of his 401(k) $200,000 as I recall and bought a bus type RV only to find a couple of years later for several reasons it wasn’t a great move.
Decades of observing thousands of retirees and their decisions had an impact on me.
> “took most of his 401(k) $200,000 as I recall and bought a bus type RV only to find a couple of years later for several reasons it wasn’t a great move.”
Spent most of his 401k for an RV. Wow
I’m trying to picture our HR Benefits CVP even knowing more than a couple dozen employees where I worked, never mind knowing something about their circumstances, but it was a huge company.
I can easily understand your comments. I was not typical.
I worked in employee benefits in the same company from 1962 until I retired in 2010. I made VP in 2005. I negotiated employee benefits with our unions for twenty years. My company had about 12,000 employees in several units.
I conducted hundreds of retirement planning workshops and attended scores retire club luncheons in different states.
From the days when I was a clerk helping employees and retirees file medical claims to when I retired I was directly involved every day with employees and retirees. In fact, today 14 years after retiring, through Facebook retiree groups not a week goes by I am not contacted to explain some benefit issue, or thanked by some retiree. I am proud of that.
I know it’s all hard to comprehend, but it is the way I operated for nearly 50 years. Needless to say that way of operating retired when I did. It’s all hands off and outsourced these days.
“Needless to say that way of operating retired when I did. It’s all hands off and outsourced these days.”
And in my view the company is much poorer for it. Their loss is our gain. This kind of wisdom, gleaned from direct exposure to the lived experiences of so many others, is rare.
Thanks
That pretty much encompasses my philosophy and my strategy.
Not from any special skill or plan – maybe from reading Jonathan’s WSJ articles many years ago. Our investments follow this pattern, including some inflation adjusted whatever they are called.
Bulk of our income is a fixed pension so inflation has an impact. As mentioned here our hedge when needed is dividends, gains and interest and, of course SS – which I took at FRA. We have also added to our cash pool in the last two years, in fact every month.
Not starting with income too close to fixed and necessary expenses helps as well.
Every day I hear from retirees about prices and inflation- retirees who had good pensions and a 401k plan when they retired along with SS, but today can’t seem to cope. Generally little excuse in my book.
For readers not yet retired, YOU HAVE BEEN WARNED!
Excellent stuff. I’m leery of annuities… maybe I should get over that. I’m concerned about my life expectancy. I am getting close to five years of fixed expenses in bonds and CDs and money markets once I’m retired … but I’m including investment-grade corporate and high yield along with mortgage-backed securities. (I have one of those go-anywhere funds.) Only about half my stash is super safe. I wonder if I’m taking too much risk there, but I’m still at least four years from retirement so maybe I have time to take a bit more risk on the bond side.
Last year my former employer used $2 billion from the pension fund to buy annuities to cover the pensions of retirees from one division. No difference for them except where their benefit comes from.
And what institution is backing them. Annuities come under state guarantees, not the federal PBGC, and the caps on coverage are generally a good bit lower.
Prudential
No need to fear “fixed annuities” if there is a need to use one. Social Security and defined benefit pensions are basically fixed annuities. With a FA you tell the insurance what you want and they give you a quote. You can specify things like beneficiary, term, period certain, return of unused premium should you die to soon, and etc. There are no ongoing fees as with variable annuities. Annuities are also protected by your states indemnity insurance (up to a certain level). We don’t use one only because our expenses are easily covered by our Social Security income alone, but I won’t hesitate to buy a FA if the situation ever changes.
Social Security comes with inflation protection. Most corporate pensions and fixed annuities do not.
Inflation protection is an option on FAs. You are correct that most people don’t choose that option.
When I bought our deferred income annuity, the only available inflation mitigation option I could find was an fixed annual COLA. I bought ours with a 3% COLA, based on historical, average inflation rates, but the last two years have shown the limits to this approach, a risk I understood going in.
Yup, but most public employee pensions, ones we finance, do have COLAs.
Which is why I specified corporate. If I were being even more specific I would have written US corporate, as the minuscule part of my pension paid by the UK branch of the company does have a COLA.
Four years out is a good time to get ready because you really don’t know if circumstances beyond your control (RIF, health surprise, etc) will start your retirement early.
A safer strategy would be to keep most risk out of the bond part of your retirement portfolio. When there’s financial calamity, like a 2+ standard deviation market bubble bursting, or the sub-prime mortgage goat rodeo, even investment grade corp bonds tank in price and coupon payments drop as companies struggle to make payments or refinance while earnings fall. And high-yield bonds? Gulp, look out below. Using FRED, you can see how both corp and high yield bonds move with stock indexes off a cliff in bad times. I’ll post a link later.
Hi Bill. Here are the links I promised.
This is not exactly what I wanted, but it’s close enough. The red line shows Wilshire 5000 stock index prices since Jan 2000. The blue line shows the additional yield junk-rated companies pay, above yield on Treasurys, when they issue bonds. Since bond prices move opposite yield by the same magnitude, you can mentally invert the blue line to imagine what will happen to the value of your high-yield bonds over the next crisis.
https://fred.stlouisfed.org/graph/?g=1o2xd
You can do this same exercise for yourself using Moody’s Seasoned Baa Corporate Bond yield graph to see how investment grade corp bonds behave. The only difference is the magnitude of the loss, but the key insight remains: most corporate bonds will drop in price when stock prices plummet during scary, economically bad, or very uncertain times.
https://fred.stlouisfed.org/graph/?g=1o2xD
Bonus: The Financial Times ran a piece in March which reinforces the point that now may be the best time to get your retirement portfolio ready to produce dependable income (not a reason to panic, but to pause and think about what you need when you’ve kicked the paycheck habit):
Corporate defaults at highest rate since global financial crisis, says S&P (ft.com)
Thanks for this excellent overview of retirement income sources. Thanks to my reading of Morningstar and the Humble Dollar I think my wife and I are in great shape!