Achieving a degree of financial stability throughout retirement years does not happen on a wink and prayer alone. Without a respectable amount of effort put into planning for sustainable income prior to leaving the workforce, your dream retirement years could quickly turn into a far different, rather dreary reality.
Fortunately, minding the retirement income gap – that is, making sure you do not outlive your assets – can be achieved by focusing on two crucial components of income planning: longevity and investment performance.
The Challenges
Part of the struggle in planning for the appropriate amount of income in retirement is the unpredictability of life expectancy. Although research provides data on average lifespan for males and females born in certain years, pinpointing the exact moment income is no longer needed is an impossible task. You may initially base retirement income needs on a 20-year retirement, but should health or other circumstances change, you may be forced to stretch your assets an additional five, 10 or even 15 years.
Similarly, adverse health diagnoses may mean an increase of income for a shorter period of time. If you selected an annuity as the sole vehicle for generating retirement income, shifting cash-flow to meet changing needs is not an option. When flexibility is not infused into your retirement income plan from the start, specifically through diversification of income sources, minding that gap may be out of the question.
Mr Market
Market performance lends a hand in retirement income planning as well. In an ideal plan, underlying investments are able to generate a return high enough to sustain a selected withdrawal rate. For instance, following the conventional rule of thumb suggesting one take no more than a 4% withdrawal from assets each year typically allows retirees the ability to survive the worst of what the broad market has to offer in terms of performance, all while sustaining an adequate level of income.
Managing Drawdown
However, research has found that maintaining a 4% withdrawal rate throughout retirement years actually results in excess funds – more than double initial asset worth for 2/3 of individuals. The traditional school of thought surrounding the 4% rule is a safe place to start when it comes to not outliving assets, but money is left on the table for a large number of retirees who do not include some degree of flexibility within their overarching plan.
Sound income planning is paramount for individuals if they want to ensure the hard-earned money set aside specifically for retirement is able to satisfy cash flow needs over time. However, the unpredictability of market performance and longevity make creating a concrete income plan a true challenge. To mind the retirement income gap, it is necessary for individuals to create a plan that carries a degree of flexibility, not only in terms of the source of retirement income but also as it relates to the amount withdrawn each year.
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