Generating Income in Retirement – How Does it Work?

Over the last few years, I’ve had the privilege of witnessing multiple long-term clients transition into the one goal they’ve been planning for decades…retirement. For each of these individuals, we’ve run through different financial planning scenarios, stress-testing different factors to confirm they can retire with confidence. Although all of this planning has allowed these individuals to approach retirement confidently, as the date gets closer, they always inevitably ask “Where’s my paycheck coming from now?”

Having that question is completely understandable. It’s a huge psychological shift to go from earning a paycheck for 35+ years to all of the sudden paying yourself instead. On top of that, within the days leading up to and shortly following your retirement date, you have to make more financial decisions than you’ve probably ever had to before. What should I do for Health Insurance? When should I take my Pension or Social Security? Should I liquidate my 401k or Roth first? When should I lower the risk in my portfolio?

To answer all of these questions effectively, we’re firm believers that creating a detailed plan and income strategy that optimizes your retirement income for performance, lifestyle, and taxes is the route to go. However, for individuals that prefer to understand it from a bigger picture, I believe you can boil it down to 5 major steps.

Step 1 – Identify your cash flow needs.

The biggest step in developing a retirement income plan is understanding your cash flow needs, or budgeting. Quite frankly, this is something that should be monitored and known years in advance. Knowing how much income you need, as well as how that could change over time, is non-negotiable. For many clients, we recommend that they look at their retirement cash flow needs through three major periods. The “Go-Go” years, where you’re spending more money on travel and experiences to take advantage of your new free time. The “Slow Go” years, where you’re still active but spend less money on those experiences. And finally, the “No-Go” years where health and age may make it more difficult to do as much. Mapping out these cash flow needs will allow you to use steps 2-5 to identify the income sources to meet these needs.

Step 2 – Identify your “forced” income sources.

For many retirees, there are forms of income that are forced upon them whether they planned on it or not. Great examples would be Deferred Compensation payouts, Stock Grant payouts, and Required Minimum Distributions. Since these sources are going to pay out according to their set schedules, we believe this is the starting point when planning income sources. Identify how much income will be generated, when it will be paid, and identify if there are any strategies you can implement to optimize them.

Step 3 – Identify your guaranteed income sources.

After understanding forced income requirements, we then look at guaranteed sources of income in retirement. This may include pensions, annuities, social security, or rental income. When analyzing this source of income, we recommend focusing on decisions like longevity and timing to make sure the income stream is maximized.

Step 4 – Identify how much income needs to be generated from your portfolio.

When you subtract your forced and guaranteed income sources from your cash flow needs, the remaining balance is what needs to be generated from your portfolio. As a general rule of thumb, this should typically be less than 3-4% of your total portfolio value per year, as that allows the portfolio principal to stay intact for a long, healthy retirement. Whatever the percentage distribution may be, it’s incredibly important that you determine how that income will be generated. Dividend Strategies, Bucket Strategies, Systematic Withdrawals, and Targeted Withdrawal strategies are all common strategies that are used. Each has a different nuance to it, which leads us to the final step.

Step 5 – Map out an investment strategy to generate that income.

Once you know how much income the portfolio has to generate, and the distribution strategy you plan to utilize, the final step in retirement income planning is executing an investment approach that tailors to the income strategy. That approach may differ from strategy to strategy, but aligning them allows you to optimize the portfolio and minimize the amount lost to taxes or poor timing.

Each of these 5 steps has numerous discussions that should happen within them, but starting with these 5 steps is a great way to get you on the right track. If you find yourself needing assistance in properly mapping out each step, please don’t hesitate to reach out to a team member for an initial discussion.

Cleveland Wealth, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.