Guide to Retirement Income

Retirement can be one of the most rewarding and exciting times in a person’s life, but it also comes with unique challenges.

One of the most significant is transitioning from a steady paycheck to generating income from your savings and investments. It requires careful financial planning and understanding of the various options available to generate returns on your money while preserving your wealth over time.

In addition, having multiple sources of income in retirement opens up numerous opportunities to boost your retirement funds, but it also creates unique challenges.

Proper planning is critical to ensure you don’t outlive your money. By budgeting and forecasting expected expenses, you can make the most of your money while enjoying a comfortable lifestyle. However, overlooking even small details could impact your long-term financial goals, so staying organized is critical to creating an effective retirement income plan.

It’s essential to take a global view of your finances, as neglecting one or more sources of retirement income can result in overpaying in taxes or even running out of money. So, taking the time to properly plan for and understand all potential sources of retirement income can give you greater financial security throughout your retirement.

This guide is designed to help you master your retirement income and answer many common questions retirees have. With it, you can feel confident when transitioning into retirement with the right information and strategies at your disposal. In addition, you can use this guide to help you better understand how you’re doing on the path to financial security and quickly track your progress along the way.

Lastly, you can read this guide section by section to develop a broad understanding of how to create and manage your retirement income, or you can skip to specific sections that answer your individual questions.

Regardless of how you approach it, we hope this guide provides valuable information and resources for you to have a happy, healthy, and financially secure retirement.

Section 1: 5 Steps To Quickly Create Your Own Retirement Income Plan

You’ve worked hard your entire life to save for retirement. But now that you’re retired, how do you ensure your money lasts? Creating an income plan is a crucial first step.

In this section, we’ll walk you through the process of quickly creating your own income plan. We’ll cover everything from estimating your annual income to ensuring you’re on track for a healthy and secure retirement. By the end of this section, you’ll have a custom-tailored plan to help ensure your money lasts as long as you need it.

Step 1: Start By Adding All Your Various Sources Of Income.

Securing financial stability during retirement is an important task and starts with a comprehensive understanding of all your sources of income.

Begin by adding up all your various retirement income streams. Typically, that includes some combination of the following:

1. Social Security Benefits: You can view your estimated benefit by visiting the Social Security Administration’s website and clicking “my Social Security.”

2. Portfolio Distributions: A good rule of thumb to consider is that you can withdraw 4% of the principal balance of your portfolio each year during retirement. So, if you have an investment portfolio of $750,000, you can safely withdraw $30,000 per year in retirement. ($750,000 x .04 = $30,000)

3. Pension Income: While pensions are becoming less common, some individuals may still have a pension through their employer. You can either add the annual income you expect from your pension OR, if you are receiving a lump sum, you can use the 4% rule listed above to calculate the annual income you can expect.

4. Rentals and any other sources that may be available to you: Lastly, add together any remaining sources of income, such as rental properties, royalties, annuities, and more.

Establishing this clear overview will help you identify where your retirement paycheck will come from, giving you a quick and clear understanding of your retirement picture.

Step 2: Subtract Estimated Taxes From Your Retirement Income.

Once you’ve tallied your total retirement income, it’s time to quantify the impact of taxes.

It can be intimidating to think about taxes in retirement, but figuring out how much you will owe each year doesn’t have to be a source of stress. The key is being proactive—you’ve already summed up your retirement income, and now it’s time to estimate your annual tax liability.

• An easy way to do this is using SmartAsset’s free federal income tax calculator.

Using their calculator, you can enter your household income, location, and filing status. Then, the calculator will estimate your total federal and state income tax liabilities for the year. However, when calculating your tax liability, the calculator will also estimate the FICA taxes due on your income for the year. Since this is your retirement income, no FICA taxes will be due, so simply remove the amount of FICA taxes from your tax breakdown.

Alternatively, you can seek assistance from a tax professional or financial advisor if that helps give you more confidence in what you are doing. With their help, you can ensure that you’re accurately projecting your annual tax liability based on your various income sources during retirement.

Once you’ve got a clear estimate of your annual tax liability, simply subtract that from your total annual income during retirement. Everything leftover is your available income—the amount you can confidently spend during retirement each year without jeopardizing your nest egg.

Step 3: Compare Your Available Income To Your Desired Spending Amount In Retirement.

Once you know your available income during retirement, you can compare that to your desired spending amount in retirement. This will give you a good sense of whether you are “on” or “off” track. Remember, retirement planning is all about ensuring you have enough money to give you the lifestyle you desire in your retirement years.

• If your desired spending is less than your available income, you’re on track for a healthy and secure retirement.
• But, if your desired spending exceeds your available income, you may need to make some adjustments.

Step 4: Calculate The Portfolio You Need To Achieve Your Desired Withdrawal Amount.

As you go through this exercise, you may wonder how much money you need saved to provide the income you want during retirement.

A simple and effective way to calculate the portfolio you need in retirement is to multiply your desired withdrawal by 25.

For example, assume that after you’ve tallied up your expected Social Security benefits, pension income, and any rental income in retirement, you realize you want to withdraw $40,000 per year from your portfolio to complete your retirement paycheck. To quickly calculate the total portfolio size you need to provide that $40,000 per year, simply multiply it by 25 to arrive at a total portfolio needed of $1,000,000. ($40,000 X 25 = $1,000,000)

This simple calculation can set you on track for financial security during retirement by giving you a clear target to shoot for. And with a carefully prepared plan, you can make your retirement dreams a reality.

Step 5: If You’re Off-Track, Take Action To Course-Correct.

If you’re off-track for your ideal retirement, consider taking action today. Fortunately, by realizing that you’re off-track and taking immediate steps to remedy the situation, you may only need to make modest adjustments to get your plan back into alignment.

Here are a few tips and strategies to consider:

• Take advantage of retirement catch-up contributions. Anyone 50 and older can contribute an extra $7,500 per year in 2023 to their 401(k) or similar plan and an additional $1,000 per year to their IRA. In addition, new legislation as part of SECURE 2.0 adds a “special” catch-up limit for anyone aged 60 to 63 beginning in 2025. That special limit is $10,000 or 150% of the standard catch-up amount for 2024, whichever is greater. But, with the new legislation comes a special rule that requires all high-wage earners (wages over $145,000 in the prior year) to contribute their catch-up contributions to a Roth account beginning in 2024.

• Consider a spousal IRA. Whether your spouse works or not, they may be eligible to contribute to a Traditional or Roth IRA based on your earned income. This can be a great way to get additional money into tax-advantaged retirement accounts.

• Reevaluate your financial priorities. If you’re off-track, consider reevaluating your priorities. For example, you may find that some of the items on your ideal retirement list are no longer relevant based on your current interests and lifestyle and can be excluded from your retirement plan.

• Consider relocating or downsizing. Many retirees choose to downsize or relocate during the retirement transition. Often, this is driven by a desire to be closer to family or is an intentional step toward simplification by purchasing a smaller home. If this is an option you’re considering, analyze how this could impact your financial plan in terms of additional retirement funds or lower costs of living.

• Calculate how much extra you need to save. Last and most importantly, you can use a free compound interest calculator to help determine how much extra you’d need to save and what rate of return you’ll need to achieve your desired portfolio in retirement.

Creating an income plan is one of the first steps toward a healthy and secure retirement.

And fortunately, it doesn’t have to be complicated—you can quickly calculate your income plan by adding all your income sources, then subtracting your estimated taxes. This will give you a good idea of your total income available during retirement. Then, by comparing that to your desired spending in retirement, you can quickly determine if you are on or off track. For those that are off track and haven’t retired yet, consider the different ways you can “catch up” to create a healthy and secure retirement.

In the end, planning today helps bring peace of mind and ensures you are better equipped to weather any unexpected financial storms that come your way.

Section 2: Choosing The Right Social Security Benefit For You.

According to data from the Social Security Administration, the average retiree receives one-third of their total retirement income from Social Security. In other words, Social Security is an important piece of most retirees’ income.

So, when retiring, one of the biggest decisions you’ll make is when to file for your Social Security retirement benefits. At a high level, your goal should be to maximize your total lifetime benefit while ensuring you can cover your immediate retirement income needs. 

What Are Your Options?

When filing for benefits, you’ll generally have three options to consider:

1. Early: You can receive Social Security retirement benefits as early as age 62. But, doing so will result in a lower benefit amount.

2. Full Retirement Age: By waiting until your “full retirement age,” you can receive your full Social Security retirement benefit. You can find your full retirement age using the retirement age calculator on the Social Security Administration’s website. For anyone born after 1960, your full retirement age is 67.

3. Delayed: If you continue to wait past your full retirement age to file for benefits, you can receive an increased benefit amount from Delayed Retirement Credits. The benefit increase stops when you reach age 70.

What Are Delayed Retirement Credits?

One of the critical things to understand about your Social Security benefit is delayed retirement credits (DRCs.)

Essentially, you can increase your Social Security retirement benefits if you delay filing beyond your full retirement age.

The annual percentage increase varies depending on the year you were born, but for anyone born in 1943 or later, the annual percentage increase is 8% per year. So, if your full retirement age is 66, but you decide to wait until age 70 to file for benefits, you would receive 132% of your Social Security retirement benefit by delaying 48 months.

But keep in mind that when you reach age 70, your monthly benefit stops increasing and you must begin collecting.

What’s Your Breakeven Age?

As you seek to maximize your Social Security benefits, it’s essential to identify your breakeven age.

That’s the age you’ll need to reach before it’s financially beneficial to have delayed your retirement benefits. In other words, if you file early, you’ll receive a smaller benefit for a longer time. But, if you file later, you will receive a larger benefit, and if you live past a certain age, that decision will pay off as you will end up receiving more.

Generally speaking, the average break even age is around 80 years old. If you don’t live to that age then delaying Social Security may not make sense. Your situation may be different, so use the numbers that are applicable for you. So, consider using a free online calculator to estimate your breakeven age.

What Are The Nuances Of Your Specific Situation?

Armed with your breakeven age, you can decide your optimal filing age. But, while it can be valuable to maximize your benefit over your lifetime, other factors are worth considering.

First, how is your health and your family’s health history? For example, if your break even age is 80, but you have an underlying health condition and may not make it to 80, opting for an earlier filing date could be wise. Or, if your family has a history of living well into their 90s, delaying your benefit may be an excellent option for you.

Second, consider your current income needs. How easy would it be for your portfolio to cover your expenses if you choose to delay filing? If delaying retirement benefits would force you to withdraw an unsustainable amount, then filing earlier may be best for you.

Third, consider your personal preferences and beliefs. For some, delaying feels like a bad idea, either because they want the funds for a specific retirement goal now OR they aren’t confident in the future viability of the Social Security program which as of March 2023 is scheduled to cut benefits by 24% in 2037. These are two reasons you may decide to file early, even if it means a lower lifetime benefit.

Finally, Choose The Right Filing Date For You By Focusing On The Two Primary Levers: Longevity And Portfolio Value.

Now that you have a solid understanding of the various options and items to consider with your Social Security retirement benefit, it’s time to choose when to file.

And when you’re making your decision, it can be helpful to hone in on the two primary levers: longevity and portfolio value. In other words, will you live past your break even age, and can your portfolio sustain your retirement needs if you delay?

Consider Delaying Benefits IF:

You expect to live into your mid-80s or beyond, and your portfolio can cover your retirement expenses while you defer your Social Security retirement benefits.

Consider Filing at Full Retirement Age or Earlier IF:

You don’t expect to live into your mid-80s, and your portfolio couldn’t cover your retirement expenses while you defer your Social Security retirement benefits.

Ultimately, the key is understanding all the variables in your situation and remembering there is no right or wrong when deciding when to file for retirement benefits.

Section 3: Understanding Portfolio Allocation

The next primary area to consider when planning your retirement income is your portfolio allocation.

Portfolio allocation is the process of dividing your portfolio into different asset classes, such as stocks, bonds, cash, and other investments. Doing so helps you manage risk while also aiming for a desired rate of return. Selecting an appropriate asset allocation that meets your current and long-term financial goals is essential.

What Are The Benefits Of A Diversified Portfolio?

There are many benefits to having a diversified portfolio, such as reducing the chances of a poor outcome and creating rebalancing opportunities by holding uncorrelated assets.

By diversifying your portfolio and holding a mixture of stocks and bonds, you can capture the long-term returns offered by stocks while also smoothing out the volatility in the short term with bonds. This can not only help you sleep better at night by increasing your probability of success, but it can also help you limit the sequence of return risk you face—the risk that the market crashes immediately after you retire, forcing you to withdraw more from your portfolio than you had planned, possibly creating a long-term negative impact on your portfolio value.

To understand the appeal of a diversified portfolio, it can be helpful to use an analogy. So, imagine you need to hop in an elevator and ride up to the top of a 20-story building. The first elevator relies on a single cable to carry you to the 20th floor, while the second elevator is held up by thousands of different cables.

Which elevator would you choose?

The first elevator is not diversified and puts all your safety on a single cable. The second elevator is well-diversified and spreads your safety across thousands of different cables.

Investing is no different.

By spreading your portfolio across many types of stocks, bonds, asset classes, and investment types, you’re effectively spreading your risk and eliminating the dependency on any single stock or investment type.

Lastly, one additional benefit of having a diversified portfolio is that it opens the opportunity for rebalancing.

Essentially, rebalancing is buying and selling different assets in your portfolio to get back into your target allocation. For example, if you originally designed a 60% stock and 40% bond portfolio, but the stock market is down, you may find yourself in a 50% stock and 50% bond portfolio. To rebalance, you would sell 10% of your bond allocation and purchase 10% worth of stocks. In essence, this technique has helped you systematically sell bonds when they are high and buy stocks when they are low. This is one of the many ways that rebalancing can help improve your chances of success. 

What’s The Right Asset Allocation For You?

When determining the right asset allocation for you, it’s essential to consider various factors.

First, the proper asset allocation for you will depend on your risk tolerance and desired returns, but a 60% stock and 40% bond asset allocation is a staple among retirees. This can be a great starting point as you decide on the right asset allocation for your situation.

Next, here are a few steps to determine your ideal asset allocation:

1. Understand your risk tolerance: Your risk tolerance is the amount of risk you can tolerate with your investments. In other words, how much price fluctuation can you handle while staying invested for the long run? If you’re comfortable with risk and confident you won’t be emotionally affected by fluctuations in your portfolio, you may be able to increase the stock exposure in your portfolio. But, as a retiree, remember that even if you can emotionally tolerate the fluctuations, you need your portfolio to remain intact year by year as you use it to cover your retirement expenses. So, avoid taking on too much risk, as it could put you in a challenging position.

2. Understand the projected returns: Next, as you decide on a portfolio that’s right for you, you must consider whether it will offer the returns you need to live comfortably in retirement. So, consider the forward-looking or projected returns you can expect. Using current interest rates as of March 2023, assuming a 5% return on bonds and an 8% return on stocks, here are two forward-looking projections to consider for different portfolios:

• Conservative Portfolio (20% stocks / 80% bonds): You can expect around a 5.6% pre-tax return.

• Balanced Portfolio (60% stocks / 40% bonds): You can expect around a 6.8% pre-tax return.

By evaluating your risk tolerance and identifying the returns you’ll need to live comfortably in retirement, you can decide on a proper asset allocation for your retirement portfolio.

Then, Understand How Your Asset Allocation Will Impact Your Withdrawal Rate Using The 4% Rule.

One of the fundamental guidelines for retirement income is the 4% safe withdrawal rule. This rule results from a large body of research, beginning with the Trinity Study in 1998.

The 4% rule states that you can safely withdraw 4% of your portfolio each year during retirement without running out of money. This is a great starting point as you estimate how much you can withdraw from your portfolio each year during retirement.

For example, if you have a $2,250,000 portfolio, you can safely withdraw $90,000 annually during retirement ($2,250,000 x .04 = $90,000.)

This works out because it is reasonable to assume that you can generate around a 6% after-tax return each year using a standard retiree’s portfolio that contains a mixture of stocks and bonds. Then, accounting for 2% inflation, you can pull the remaining 4% out of your portfolio without running out of money.

But remember that the more conservative your asset allocation, the lower your projected returns. This could create a situation where you must lower your safe withdrawal rate to account for your lower projected returns.

For example, suppose you choose a more conservative portfolio and anticipate after-tax returns of 5%. Assuming inflation is still 2% per year, you may need to lower your withdrawal rate to 3% to avoid running out of money during retirement.

Ultimately, by creating a well-diversified portfolio that matches your risk tolerance and continuously rebalancing it to keep it in alignment, you can give your portfolio the ability to provide a secure and healthy retirement income for decades. And by understanding the projected returns you can anticipate from your portfolio and adjusting your safe withdrawal rate to match, you can be sure that your money will sustain you throughout your retirement.

Section 4: Generating Portfolio Income

One of the primary components of most retirees’ income is their investment portfolio. This section will explore the basics of generating income from your portfolio and highlight two key strategies to consider.

What Are The Basics Of Stock And Bond Investing?

When it comes to investing, two of the primary asset classes retirees use are stocks and bonds.

Stocks represent ownership in a company. They generate income through price appreciation as a company increases its profitability over time or through dividends when it distributes profits to its shareholders.

Alternatively, bonds represent a loan to an entity like a government or company. These loans generally produce a fixed interest rate for a set period and then return your principal at the end, known as the maturity date.

As an investor, there are several different ways for you to own stocks and bonds.

One simple and effective way to consider is by purchasing index funds, mutual funds, or ETFs containing the stocks or bonds you want to own. This is a great way to buy a “basket” of various stocks or bonds rather than purchasing individual ones. In addition, many low-cost index funds, ETFs, and mutual funds are available so you can limit the impact of fees on your investment portfolio.

What Are The Two Primary Strategies To Consider?

As you develop a plan to generate income from your portfolio, consider the following strategies: total return and traditional income.

What Is The Total Return Strategy?

The total return strategy has you invest in a well-diversified portfolio and uses interest, dividends, and price appreciation to provide the income you need from your portfolio. For example, if the interest and dividends from your investments aren’t enough to cover your income needs, you can simply sell a portion of your price-appreciated-investments to cover the remainder. This strategy allows your principal to stay intact.

You can combine this strategy with a bucket strategy that helps you align your portfolio withdrawals with your available income. The bucket strategy recommends you create three different buckets for your money: short, medium, and long-term. Then, you invest the funds accordingly to ensure the money is available when you need it.

A total return strategy is an excellent option for most retirees when generating income from their portfolios.

What Is The Traditional Income Strategy?

Alternatively, the traditional income strategy has you primarily invest in income-producing assets like high-yield dividend stocks and REITs. This strategy aims to generate enough income from dividends and interest to cover your retirement needs. Then, you won’t have to sell any of the assets to cover your expenses and can simply live off the interest and dividends.

Unlike the total return strategy, traditional income limits your investment options to assets that produce regular income through interest or dividends.

Which Income Strategy Is Right For You?

Ultimately, the right strategy for you will depend on various factors, but generally speaking, the total return strategy produces better outcomes for several reasons.

1. Total return uses the power of compounding. Using the total return strategy, you’ll own stock investments that reinvest the profit they make internally, creating price appreciation over time. Alternatively, the investments in a traditional income strategy portfolio are designed for income, not appreciation, and may lag behind in growth.

2. Total return allows you to control the flow of income. In addition, by using a total return strategy, you maintain control over how much income you want and when you want it by selling shares as you need. Alternatively, the traditional income strategy will generate a set amount of income each year, whether you are using it or not. This means that you could end up paying taxes on dividends and interest that you don’t necessarily need each year without any control over the timing of those payments.

3. Total return offers additional tax benefits through capital gains. Lastly, using the total return strategy, you can take full advantage of preferential tax treatment on long-term capital gains and be strategic about which shares you sell to minimize the tax impact.

In the end, there are many different ways to generate income from your portfolio and many different strategies to consider. The goal is to identify and execute a strategy that will give you the best chances of success and maintain a well-diversified, low-fee, and tax-optimized portfolio that will last throughout retirement.

Section 5: Know Your Budget

Lastly, once you’ve got a handle on your retirement income, it’s time to calculate your expenses by building your retirement budget.

What Is Your Retirement Budget?

Your retirement budget is a detailed breakdown of your anticipated annual expenses during retirement.

One of the critical questions you must answer when planning for your ideal retirement is how much you will spend each year. This will help guide many of the investment, savings, and withdrawal decisions you make during retirement.

So start by building your retirement budget—create an excel spreadsheet showing income, taxes, and itemized expenses.

What Are Your Itemized Expenses?

Your itemized expenses should include broad categories like the following:

• Mortgage or rent
• Utilities
• Health insurance
• Groceries
• Entertainment
• Eating out
• Car insurance
• Car maintenance and fuel
• Internet
• Phone
• Travel
• Gifting

As you lay out your budget, remember that retirement may include unique or different expenses than your pre-retirement budget.

For example, your home could be paid off during retirement, eliminating your mortgage expense. In addition, if you plan to relocate or downsize, it’s essential to factor in how a change in cost-of-living or housing situation could impact your retirement budget. Or, maybe you plan to travel more during retirement and need to increase that line item in your budget accordingly.

Next, as you work through your budget, be sure to account for the one-off or irregular expenses. These include:

• Home repairs or improvements like a new roof or updated landscaping.
• Unexpected car repairs.
• Annual or semi-annual insurance premiums.

By accounting for both the expected and unexpected, you can come up with an accurate forecast of your retirement expenses.

And as you develop your budget, keep in mind that the best budget for you will allocate as much money as possible to the things you enjoy while cutting back as needed in the areas that aren’t as important: this is often called “values-based spending.”

For example, if travel is really important to you, allocate as much of your budget for travel as possible while staying on track for a healthy retirement. Alternatively, if driving new cars isn’t important to you, don’t be afraid to cut back on your car spending budget and use the extra funds for other areas.

And in the end, knowing your retirement expenses is critical because that will help you determine how much you need to draw from your investments to create your retirement paycheck. By mapping out your budget on a spreadsheet, accounting for common and irregular expenses, adjusting for retirement, and aligning your spending and values, you will be on your way to a healthy retirement.

You Deserve a Happy, Healthy, and Financially Secure Retirement.

“Retirement is not the end of the road. It is the beginning of the open highway.” – Unknown

Ultimately, the entire goal of this guide is to help you understand how to create your retirement paycheck and live a happy, healthy, and financially secure retirement.

And I believe that’s possible if you can successfully execute the steps outlined in this guide:

1. Create an income plan by adding all your sources of retirement income and subtracting estimated taxes.

2. Maximize your Social Security benefits by understanding your various filing options and adjusting for the nuances of your specific situation.

3. Design a well-diversified portfolio with an asset allocation that matches your risk tolerance, includes regular rebalancing, and maintains sustainable withdrawals of around 4% to ensure you don’t run out of money.

4. Identify a portfolio income strategy that will provide the best chances of success while generating tax-optimized income.

5. Understand your retirement budget by laying out your expenses on a spreadsheet, accounting for common and irregular expenses, adjusting for retirement, and aligning your spending and values.

By completing these steps, you’ll be on your way to a happy, healthy, and financially secure retirement.