One of the biggest risks you absolutely need to get right in the coming decade is your income strategy. The issues we are currently facing in the near term are low interest rates, and potential volatile markets. We also have a risk of inflation coming out of the Covid pandemic. Once we clear 2022 and 2023, we potentially may have to be concerned about deflation.
The strategy I am going to outline below will be an especially important strategy to have in place to be able to plan around a number of these risks you can face in designing your income strategy.
Social Security Analysis
The first step that we need to take in preparing to retire is to do a very thorough analysis of how to claim your Social Security. Why is this important? The biggest reason is this is the one income source almost everyone has available to them in retirement. The second is it is a guaranteed source of income that in the past has done a decent job of staying ahead of inflation. The third is if you do not do an excellent job of planning out your social security it can leave the oldest living spouse in a potentially exceedingly difficult situation, because when one spouse dies the other spouse loses one of the social security benefits. This means maximizing the higher wage earners social security benefit is incredibly important.
One powerful way to maximize your social security benefit is to defer claiming it until age 70. Your social security benefit will increase at a rate of 8% if you defer it until age 70, and you will still get the normal social security cost of living benefits added into the income as well. When we are in a time of exceptionally low interest rates, an 8% rate of return is a fairly good deal to take advantage of. The other benefit many single retirees will want to explore is whose benefit to claim from. If you were married for at least 10 years and went through a divorce in most situations you will be able to claim off your benefit or your ex-spouse’s benefit. If your spouse passed away, you could also claim off their full benefit or yours. It is critical to talk to someone that is an expert in the social security rules to get this decision right. Earlier in my career, I had a chance to attend a weeklong social security training session by Elaine Floyd, who was the person primarily responsible for making financial advisors aware of how critical this planning step is. The difference between the right decision and the wrong decision with your social security could mean up to a $100,000 or more in additional income to your and your family in retirement. Do not get this decision wrong.
Once we have your social security planning strategy developed, we then need to look at the gaps in income needed vs what you have coming in. This will tell us how to invest your retirement nest egg to allow it to generate the income you need. One of the biggest risks many retires will face over the next 30 years is the sequence of returns. For example, if an individual retired in the year of 2000, they faced a number of challenges in taking their income in the first years of their retirement. The reason is in the first 3 years of their retirement 2000, 2001 and 2002, we saw negative returns in the stock market. The problem is if you are taking an income off an account that is getting a negative return you are liquidating more and more shares to do this. At which point your nest egg would not have been able to recover. In this example, if someone were taking 6% distribution off their nest egg, their nest egg would have been depleted by 2016.
Many retirees understand this concept, and it has really given rise to index annuities being a catch all investment for retirement. You need to be careful here too. With advances in technology and especially in health care you may be living a lot longer in retirement than you may think. This could mean you are exposed to inflation much longer than you are anticipating. So, it is critical to have a growth in your portfolio as well. We use a bucket strategy to alleviate both problems. By breaking your retirement into buckets of income you need through out retirement we can generate income from conservative accounts for the early years of retirement and invest for growth for the later years of retirement. This is the right balance of having a feeling of safety and security, so you do not stay awake at night, and also comfort knowing you have the later years of your retirement taken care of.
If you have questions about the risks of your retirement income strategy or how to create one, please click the button below and I would be happy to answer any of your questions and educate you on your options.