Turning Savings Into a Retirement Paycheck

When the stock market is near all-time highs, smart investors feel confident as they reflect on the strategies that have made them successful.  As their wealth has grown, they have benefitted from many of the advantages of savers. This includes buying the dips, rising income and savings, and tax-free growth in their retirement plans. However, savvy investors will often pause when they think of how to turn their savings into a retirement paycheck.

Now, they may need to sell during the dips, their income is declining, and there are tax implications to taking money out of their accounts. With the stakes high and no experience in creating a paycheck from their savings, even smart investors make mistakes when crafting a distribution strategy in retirement. 

Retirement income mistakes can usually be traced back to one flawed question:

“How do I generate $______ in income this year from my savings?”

The answer to that question addresses an immediate need but does not address the real goal of income planning.  The better question to ask is: How do I generate sustainable income for the duration of retirement and maintain flexibility to adapt my plan?

Three Common Mistakes when planning for a retirement paycheck

Instead of building a sustainable, long-term, and flexible income plan, retirees often make these mistakes when thinking about their retirement paycheck.

Using Flawed Rules

The 4% Rule states that investors can safely draw 4% from their diversified investments each year without running out of money. The rule assumes you invest 50% in stocks and 50% in bonds over a thirty-year period. It also assumes you increase your spending by the rate of inflation each year, never more and never less. 

If you back-test this strategy over the last thirty years, it holds up. But the assumptions baked into this rule should concern today’s retiree. For example, the S&P 500 has averaged over 10% returns over the last thirty years, but investors have also weathered three dramatic bear markets over that time. Someone adopting this rule needs to be sure to stay invested through the volatility for the strategy to work.

Bonds have provided stability. But in 1991, the yield on a 10-year Treasury Bond was over 8%. Now, that yield is less than 1%. That is an almost 90% decline in the expected income from half of your portfolio! If your return expectations are lower for bonds, they need to be even higher for stocks, according to the 4% Rule. And that may be a dangerous assumption. Considering the levels of the stock and bond markets right now, it becomes even more important to pay attention to the risks of spending too much and the impact of inflation.

Relying on Guarantees

“Is there any way I can earn a safe 5%?” No. When interest rates are this low, you could be making a mistake by reaching for high-income paying stocks, bonds, or investment products. To earn higher income on your investments, you are probably either putting your money at risk or giving up liquidity. It is very difficult to be a conservative investor when interest income is so low and even smart investors can be tempted to take on more risk than they should. Higher yielding bonds are associated with lower quality issuers. If a company or municipality is paying you substantially more than a Treasury bond, it is because you are taking on the risk of not getting all your money back.

Financial products like annuities are often presented as a way to guarantee income, principal protection, or both. Smart investors are often sold on the idea of buying an annuity first and asking questions later. These are complex, high-cost products that are never the full solution for retirement income. A major drawback to annuities is that you give up some or all your access to your money in return for guarantees. This limits your ability to adapt to changes in your life and the financial world. 

You should approach any conversation about financial guarantees with the question, “What am I giving up?”  In some cases, the trade-off may be worthwhile. But that knowledge comes from a deep understanding of your whole financial picture and the specific risks of what you are buying. 

Limiting Strategy

Some smart investors make the mistake of trying to plan their income in a vacuum. They do not weigh all the sources and all the methods that they could use to generate a retirement paycheck. You should consider three strategic decisions as you design your distribution plan:

1. Portfolio Income
2. Source
3. Timing

Portfolio Income

When it comes to portfolio income, we are strong advocates of a Total-Return Approach* over relying solely on investment income. This approach means using a combination of growth, dividends, and interest to meet income needs from year to year. In some years, it means harvesting gains from appreciated stock. In other years when the stock market is volatile, it may mean drawing more from bonds that have preserved their value.

Source of Income

The source of income is important for someone who has accumulated wealth in Individual Retirement Accounts (IRAs), brokerage accounts, annuities, and savings. It often makes sense to make IRAs the last asset to draw from, but with recent changes to the rules for inheriting IRAs it might be better for your heirs to inherit non-qualified accounts. Each account should serve a purpose in the income plan and be invested accordingly. Smart investors should ask, “What bucket do I draw from…and when?”

Timing

Timing matters when looking to maximize benefit from your money. Especially considering the different taxes and rules involved with all your accounts and income streams. This is especially true in Social Security decisions. Most people get this decision wrong because they choose to start Social Security when it is available and not when it is optimal for them. If you have saved and invested successfully, waiting to take Social Security until at least your full retirement age may be one of the best retirement income decisions you make. 

Over the last 50 years, saving and investing has become easier, in many ways. Smart investors have learned to buy and hold, seek lower costs, and take advantage of tax qualified accounts. Taking money out is more complicated and requires coordination to avoid mistakes that cannot be undone. If you are a smart investor and feel your knowledge is limited, there are no silly questions when planning for your retirement paycheck. In fact, the best way to become a smart retiree is to acknowledge that you have not done this before and know to ask for help. If you are seeking guidance, I would be happy to speak with you. Contact me at dmorton@mortonbrownfw.com or call 610.709.5072.

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*Made available by Charles Schwab & Co., the unaffiliated, third-party custodian that maintains Morton Brown Family Wealth’s managed accounts.