How can you be confident that you will not outlive your income? Here’s how:
First, you must know that you have three primary objectives when you PIVOT into retirement: You must create consistent cash flow; cash flow must increase if groceries, hotels and movie tickets get more expensive; and finally, cash flow needs to last until your final breath.
These three objectives are slightly different than life’s financial goals before you PIVOT out of the working world. Before retirement, a person’s desires are to earn a big paycheck, try not to spend it all and invest the leftovers wisely.
Now, when it’s time to PIVOT, the desired outcome is … income!
A sharp businessperson knows that when they make decisions, there is an opportunity cost involved. The opportunity cost exists in retirement as well. For example, if you are trying to mitigate the risk of outliving your money by purchasing an annuity, you will likely find yourself struggling to keep up with inflation long-term. There isn’t a perfect scenario with retirement decisions, and we’ll be faced with give and takes. When presented with reasonable choices, we must make unemotional fact-based decisions designed to increase the probability of having a paycheck for your entire life, whether you live to be 85 or 105.
By setting up a series of “buckets,” you are putting yourself in a more advantageous PIVOT position.
Here are the 5 buckets:
1. A Comfortable Cash Operating Bucket
This money is the amount of money needed to cover regular monthly bills. It also includes the cash you prefer to keep on hand.
2. A Supersized Emergency Fund Bucket
This money will be equal to 12 times total monthly expenses. There are three unique uses for this money:
- Acute health care needs
- Household and car repairs
- Market risk
Let’s unpack the market risk piece, as this is the most critical component of the supersized emergency fund. From 1825 to 2013, the market (on average) finished down 20 percent once every 20 years. So, if you live 20 to 30 years, you might experience one or two material market downturns. Most of the downturns, based on history, will be fear-driven fakes, causing most of your retired friends to make emotional decisions.
That won’t be you.
But, there is a number on your investment statement that will steal your sleep. Everyone has a number where they lose sleep over the stock market. If you get to that point, pause any withdrawals from your investments and live off your supersized emergency fund.
If you don’t do this, you could find yourself taking money from your investments while the investments are crashing. In this case, you are “eating your seed” and will be unable to reap the reward when it returns to normal. You could be taking out withdrawal checks at a low point, and no one wants to sell low. By taking money from your supersized emergency fund rather than your portfolio, you are giving your investments an opportunity to ride the stock market back up from where it fell.
The supersized emergency fund should be stored in a money market account at the bank or a six-month CD that only penalizes earnings (not principle) if the term is broken. The only criticism of this approach is, “Could I make more money by investing it, rather than having this much cash on hand?” Yes, but by keeping a little more cash on hand than normal, you are giving yourself permission to increase risk a notch more in your other investments. You are just doing it in a very intentional way.
3. A Needs Bucket
The next form of money is not so much held in an account, but rather is in the form of paychecks. We can call this the “needs bucket.” You must put pen to paper and identify all your needs in your monthly budget. This will include housing costs, food, utilities and other items needed to survive. “Needs” are expenses that would severely impact your quality of life if they couldn’t be paid. Frankly, you won’t find that your income needs will change much when you retire from when you were working, so creating the budget shouldn’t be too challenging. The goal is to have predicable and guaranteed resources such as Social Security and pensions covering 100 percent of your needs.
If your monthly needs are higher than your guaranteed resources, then you will need to fill in the gap. This is done with an annuity, which is like a private pension (annuities are discussed at age 54). Don’t be preconditioned to believe annuities are bad or good. Most people have an opinion because they are oversold and expensive. However, if used for a specific income purpose, they work well.
Annuities protect us against outliving our income. There is about a one-in-five chance that either the 65-year-old husband or, more likely, the wife, will live to 95. Modern medicine, safety and sanitation are consistently extending our lives. Annuity companies absolutely hate when they continue to pay an income to someone in their 90s. We must protect our family’s long-term needs by covering them completely with guaranteed income sources that will continue no matter how long we live.
4. A Wants Bucket
This account will be a diversified group of investments that has a minimum five- to 10-year track record. The group of investments will be built around your specific risk profile using modern risk assessment questionnaires. If possible, lean into a little more risk, knowing you have a supersized emergency fund account and you have your needs covered.
Then, you will withdraw a periodic check from these investments to cover the “wants” portion of your investments. Make sure you do not withdraw more than 4 percent of your portfolio annually. That is your boundary. For example, if your wants are $30,000 per year and you have $300,000, you have crossed your boundary and are now at a 10 percent withdrawal rate. This is danger zone and can cause you to run out of money. It’s recommended you maintain a withdrawal rate of 4 percent.
These accounts allow for pay increases over the years as food, gas and movie tickets go up in price, which helps combat and lessen the burden of inflation. But some of those inflation impacts are offset by declines in spending. Some research studies have concluded that the retirement inflation rate (apart from health care) is considerably less than for those in their working years. Additionally, your spending may decelerate as you get tired of traveling and the long flights become uncomfortable.
Rather than putting inflation increases on autopilot, like most people do without any real thought, re-examine annually. Update the budget, review the plan and decide if a pay increase is needed. If not, let the pay increase keep working for you in the investment portfolio.
5. An Inheritance Bucket
Let’s assume that you have put together a cash flow model and evaluated all your projected income checks from now until the day you die and there is money left over. This is a blessing known as a margin of safety.
Let’s pick at the margin of safety a bit. What if we set aside a little money and invested it differently? For example, imagine you calculated a $250,000 margin of safety in your plan and were pleasantly surprised. What if we took $50,000 out and called it “inheritance”? Because you are more likely to live 20 more years than die next week, you have a longtime horizon with this money. When someone has a longtime horizon with money, they are given an opportunity to be slightly more aggressive.
In this example, consider taking the $50,000 out of the plan, placing it into a liquid, diversified portfolio with slightly more risk tolerance than your other investments and labeling it inheritance. If setting aside the inheritance money doesn’t have a material impact on your retirement cash flow, then you have the opportunity to make the money work harder for you over the years.
How can you have confidence while PIVOTing into retirement? The answer to that question is: Plan. It’s simple to say but takes effort to do.
Insurance giant Genworth completed a study and concluded that pre-retirees who have developed a plan are 74 percent more confident that their money will last a lifetime, whereas only 44 percent of plan-less people had the same confidence.
Building a plan lays a foundation of confidence and reduces the odds of making emotional financial decisions. Our team at PAX Financial Group believes this is so important that we will not engage new clients without developing a plan.
With a concrete strategy, you are given the opportunity to enjoy the next chapter in your life with Peace, Imagination, Vigor, Opportunity and Time (PIVOT).
This material is provided by PAX Financial Group, LLC. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The information herein has been derived from sources believed to be accurate. Please note: Investing involves risk, and past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All market indices discussed are unmanaged and are not illustrative of any particular investment. Indices do not incur management fees, costs and expenses, and cannot be invested into directly. All economic and performance data is historical and not indicative of future results.