How Do I Turn My Savings Into An Income Stream?
The market volatility of the past two years combined with a healthy sense of uncertainty going forward has left almost everyone feeling a bit anxious about their financial futures. While the recent financial crisis and the ensuing recession has made it both more difficult and more important to save adequately for retirement, it has also made it even more critical for those approaching retirement to effectively plan for that transition and to manage their portfolios appropriately. As retirement approaches, there are several steps involved in answering the most common question: “How do I turn my current savings into an income stream?”
Determine Your Income Needs
From a planning perspective, the very first question that needs to be answered is “What will my retirement income needs be?” Generating an accurate and detailed assessment of your post-retirement income needs and expectations is a critical, but often neglected step in the process. Too often people will rely on rule-of-thumb estimates that rarely correspond to their specific situation.
The other essential element to the planning process is utilizing realistic assumptions for variables such as investment returns, inflation, Social Security, taxation, life expectancy, etc.
Too often unreasonable assumptions will lead to inaccurate planning results. Being overly optimistic about assumptions can lull you into a false sense of security that will lead to unpleasant surprises down the road while using unnecessarily conservative assumptions can indicate that you need to work longer than is actually required.
Done properly, the planning process should explore multiple scenarios to provide a sense of perspective for what is both reasonable and achievable under realistic assumptions.
There are numerous cautionary tales of people forced to postpone their retirement plans or to rejoin the workforce because they failed to prudently create a detailed plan for the transition into retirement that will meet their specific needs.
Is Your Portfolio Structured To Generate Income?
Assuming your savings (asset base) is sufficient to meet your ongoing income needs, the next issue to be addressed is structuring your portfolio appropriately to produce the required income.
As you prepare for retirement, maximizing portfolio growth will become secondary to steady and consistent income generation. Unfortunately, very few people transition their investment portfolios for income generation soon enough, if ever at all. This transition should be carefully planned 10 years prior to retirement with implementation beginning 5 – 7 years prior to retirement.
The ubiquitous option of using an annuity to produce an ongoing income stream is often sold for its guarantees; however, the high expenses, steep surrender charges and general lack of flexibility will preclude this from being the ideal solution for most people.
Create A Sustainable Strategy
As you begin to rely on your portfolio for current living expenses, it is important that the majority of planned distributions are based on ongoing income versus appreciation.
The commonplace methodology of selling investments as cash is required to meet distribution needs will eventually cause you to sell investments at an inopportune time. By contrast, a well developed and well-executed strategy to create a regular income flow via sources like prudently managed individual bonds or the regular dividend payments from income-oriented stocks can provide the required income without having to sell an investment prematurely. Most typically, this is where the benefits of professional portfolio management become most evident.
Control Your Taxation
In addition to utilizing a reasonable tax rate assumption in your planning, there are several opportunities to create a lower and more consistent tax rate throughout your retirement.
The most basic technique is to structure pre-retirement savings in a fashion that creates an appropriate mix of Qualified (pre-tax) and Non-Qualified (post-tax) savings. While Qualified savings are attractive for deferring current taxation, eventual distributions from these plans typically offer little tax flexibility and are fully taxed at ordinary income rates.
Accumulating an appropriate mix between Qualified and Non-Qualified dollars will allow you to examine your tax situation each year of retirement and manage distributions in the proportion that is most advantageous for that year’s circumstances. Each year’s decision should involve the counsel of both your accountant and your investment advisor.
Seize The Opportunity
Although the past two years have created a difficult environment for both planning and investing, the end result is a heightened sense of awareness for addressing each issue with a disciplined process. While you cannot control the economic and market-driven environments; having a detailed understanding of your situation, an appropriate strategy to implement and the discipline to implement it will ensure your ultimate success.
How Do I Turn My Savings Into An Income Stream? is reprinted from The Patriot-News January 2, 2011.
Bradley R. Newman, CFP® is affiliated with Roof Advisory Group, Inc., an independent investment management and financial advisory firm based in Harrisburg. The firm is a fee-only Registered Investment Advisor that provides portfolio management and financial planning services for individuals and institutional clientele. The firm’s email address is email@example.com.