When can I retire? Part 2

In Part 1, we provided an easy to calculate approach to determining if you will be able to retire when you wish. For some people, this simple calculation helps confirm that they can retire when they want. For others, the “income gap” is too large to safely retire at the age they desire.

In this article, we explore ways to decrease income gaps. We will also suggest techniques to convert financial resources into the income required for an abundant retirement.

Here are four simple approaches to reducing your retirement income gap:

1. Continue to work past your projected retirement age. This provides three advantages by a) delaying the need to begin taking Social Security benefits, b) increasing Social Security benefits when they are started and c) reducing the number of retirement years that your retirement savings must fund.
2. Increase savings while working. Lowering your current expenditures could substantially increase funds available during your retirement years.
3. Spend less in retirement. Lowering your discretionary spending in retirement will decrease the income gap and increase the number of years that your retirement income will last.
4. Increase returns on your investment assets. By carefully monitoring your investment assets you will likely increase investment returns, providing a larger retirement asset base.
Once all acceptable steps for reducing your “income gap” have been taken, the next step is determining the best approach for converting financial resources into income.

Many people use a systematic withdrawal plan (SWP), in which they withdraw between 4 percent and 5 percent of total retirement savings each year. With an SWP, it is important to carefully consider the tax consequences associated with withdrawals from each type of investment.

It is often prudent to first withdraw funds from taxable accounts, as these assets provide the most flexibility in tax planning. With tax deferred accounts, such as IRAs and 401(k) plans, all withdrawals are taxed at the same rate as earned income.

Typically, the most tax efficient retirement withdrawal approach is to use taxable accounts for withdrawals before age 70½. At 70½ you must begin taking the required minimum distribution (RMD) from tax deferred accounts. Take only the RMD amount from these accounts for as long as possible. Avoid Roth IRA distributions until all other funds are exhausted, as Roth IRA funds are the perfect inheritance asset. Roth IRAs can continue to grow on a tax free basis throughout the lifetime of your beneficiary.

With the SWP approach, the retiree assumes all of the income risk. This often leads to a significant portion of the total portfolio being put into less risky, “conservative” investments. An overly conservative investment allocation may reduce long term investment returns, reducing funds available for retirement.

It may be safer to use immediate annuities to fill the “essential income gap.” This approach can help assure that the funds required for your essential well being are available for the rest of your life. Since inflation will eat into these funds, it is prudent to provide for at least 33% more income with immediate annuities than is required by your essential income gap. In the early years, this additional income can either be reinvested or used to fill the “discretionary income gap.”

With immediate annuities for your “essential income gap,” a systematic withdrawal plan (SWP) of remaining funds can provide for discretionary spending. Since essential expenses are covered, a “riskier” investment allocation can be used for the remaining funds.

There are many variations to the above approach, including laddered immediate annuities, laddered long term treasury bonds, laddered TIPS etc. Details of how to use each of these approaches is beyond the scope of this article.

A successful retirement requires working long enough to assure that the essential and discretionary incomes gaps can be filled by a combination of your Social Security, pensions, investment income and retirement savings. Once this is accomplished, maximize your retirement income by determining the safest and most tax efficient methods for converting retirement savings into retirement income. If this task appears overly complicated, find a capable financial advisor to help you accomplish your retirement goals.

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