Whether your retirement is just around the corner or years away, ensuring your preparations are in order can be the centerpiece of an effective retirement strategy. This is especially poignant when you consider that approximately 4 out of 10 households are predicted to run short of money in retirement.1
So, how can you assess your approach? Read on for 3 steps you can take to find out.
Cash Flow is King
It’s important to understand the principle of cash flow. Cash flow is the net amount of cash moving into and out of your accounts at any given time. The key word here is “time.” Cash flow can be best understood through the lens of a given time frame.
Keeping a close eye on your cash flow may provide you with a better understanding of your financial flexibility.2 The biggest balancing act retirees face is “money in” versus “money out.” Knowing this metric is central to building a strong retirement strategy.
There are 4 main types of cash flow to consider when creating a retirement strategy: the interest your accounts accrue, the dividends you may receive,
the capital gains you may receive from the sale of an investment or property, and finally, your original investment.3,4
Identify Your Retirement Vehicles
If you’ve been saving and contributing to your retirement funds over the years, way to go! You may find it a helpful first step to identify and evaluate the strength of your savings from those years. Gathering this information can take a bit of effort, but it’s an important undertaking. The list below is a good place to start, but don’t hesitate to contact your accountant or financial advisor for help. There are 4 general sources of retirement income in retirement:
• Social Security
• Personal Savings and Investments
• Retirement Accounts
• Continued Employment
Estimate Your Costs
With your income sources in mind, it’s time to think about expenses. Knowing how much you expect to spend in retirement is crucial to establishing a strategy that works for you. However, estimating future expenses and creating a pragmatic budget for a lifestyle you don’t have yet can be difficult, even for the math whizzes among us. Luckily, there is a simple method that doesn’t require a spreadsheet.
First, take a look at your current annual income. In general, retirees spend about 80% of their current income per year in retirement, so if your estimated pre-retirement income is a hypothetical $100,000 a year, you can plan on spending about $80,000 annually in retirement. Sounds simple enough, but you still have to budget beyond that amount. Think of your 80% as a place to start. This idea is for informational purposes only and should not be considered a substitute for a more comprehensive retirement strategy.5
Next, consider the factors that will come into play once you retire. Things like changes in your lifestyle. Will you travel more? Take up new hobbies that require extra funds? Remember to factor in your anticipated medical care costs. For a more precise estimate of your costs, consider repeating this exercise, but over a 3-year and 5-year time period. This may help you see how consistent your spending is, in order to further anticipate the costs you could incur in retirement.
Time for Some Math
Now for the fun part: you’re going to compare your estimated costs against your scheduled retirement disbursements. At this point, you may come to the realization that your cash flow is less than your anticipated retirement costs. While it can be unsettling, this is valuable information that you can use to modify your strategy, with the help of your advisor. However, if you have been working with a financial professional for a while, you may have a more positive outlook about what lies ahead. As always, we are available to help or answer any questions you may have.
Save Enough, Withdraw Enough
With life expectancies growing, it’s understandable that Americans may worry about saving too little for retirement or running out of money halfway through. But with careful preparation, you can allow for a well-balanced withdrawal strategy. Ultimately, the longevity of your savings comes down to two factors: how much you have saved, and how quickly you take money out of your accounts.
One strategy is to only draw down the investment gains you experience and leave your principal balance alone. Another approach is to follow the 4% rule, which recommends that you withdraw 4% of your account balance in your first year of retirement, then increase your withdrawal rate each year to allow for inflation. So, a
retiree with a $1 million portfolio could take out $40,000 in year one.6 Keep in mind, this example illustrates the concept of the 4% rule and should not be considered a substitute for a more comprehensive retirement strategy.
Keep in mind the Required Minimum Distributions (RMD) you must take in retirement. The Internal Revenue Service (IRS) publishes these to help determine the amount you should withdraw annually. The RMD tables illustrate the minimum age one must be to withdraw from certain retirement accounts to avoid tax penalties.7
Have a Conversation
Whether you’ve been prudently tucking away your nest egg for years, or find the thought of tallying up all those figures overwhelming, it’s important to keep the conversation open. Discussing the future with your financial professional can help you keep a clear picture of what lies ahead and get over any mental hurdles. Together, we can work toward a cash flow strategy that lasts well into retirement and beyond.
1 EBRI, 2019 https://www.ebri.org/retirement/publications/issue-briefs/content/retirement-savings-shortfalls-evidence-from-ebri-s-2019-retirement-security-projection-model
2 Fundera.com, 2019 https://www.fundera.com/blog/cash-flow-positive
3 Mornigstar, 2019 https://www.morningstar.com/articles/800272/the-4-pillars-of-cash-flow-in-retirement
4 The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation.
5 Fidelity.com, 2019 https://www.fidelity.com/viewpoints/retirement/spending-in-retirement
6 Investmentnews.com, 2019 https://www.investmentnews.com/article/20190204/BLOG09/190209983/an-update-on-the-4-rule
7 IRS.gov, 2019 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Any named entity and Pinnacle Wealth Management are not affiliated.