Wherever you are on your path to retirement, it is important to take time today to think of what your income sources will be. When you are in your working career, it is pretty easy and predictable to know where your next paycheck is coming from and in what amount. This allows you to live month to month without much thought of how the bills will be paid and how much you need to save up for the future retirement.
However, in transitioning to retirement, that paycheck from your employer is no more. You will now need to balance a few different income streams, which takes more planning than simply seeing your paycheck hit your savings account each month.
In planning out your retirement income streams today, you will feel that much more relaxed and confident that you are fully prepared for a successful retirement when the day comes. Here are a few thoughts to consider for your future years:
Basic Living Expenses
I believe it is always important to understand what your basic living expenses are, but it is even more important when entering retirement. One reason for this is because in order to retire you need to know how much money you need to have saved up, and this is dependent on the amount of your living expenses. Another reason is because you now need to withdraw a specific amount from your investment accounts on a monthly basis in order to replace your old paycheck. Unnecessarily withdrawing too much money from your investment accounts will have negative income tax consequences. It is important that you track your spending regularly both in the few years leading up to retirement and the first few years after you retire. You may be surprised to see how your spending shifts once you are done working on a daily basis.
Big Expenses or Fun Money
Along with your basic living expenses, you should have an idea of what big expenses you will encounter during retirement. This could include purchasing a new vehicle, retirement home, extended vacations, or gifting to family members. It may be wise to set up a “fun money” account that is separate from your basic living expenses investment account. This way, if the money runs dry, you will still be able to keep the lights on and cover your basic needs with your main retirement account.
Fixed Income Streams
As I stated earlier, transitioning from a regular paycheck to living off of your investment accounts takes a little more planning. I believe you should be able to cover your basic living expenses with a fixed income stream, which can come in a number of different forms. The first form everyone thinks of is Social Security. With Social Security, you will have a consistent income to hit your bank account every month, just like a regular paycheck. You can decide when to begin receiving this income, between the ages of 62 and 70, based on your specific needs.
Other forms of fixed income streams can come in the form of business ownership assets, rental real estate, stock dividends, bond interest, or even annuities. If you are the owner of a business, structuring the sale to last a period of 7 to 10 years can really help bridge the gap between your retirement start date and when you begin receiving Social Security or other forms of retirement income.
When thinking of retirement income, it is important to remember that your retirement will most likely last at least 25-30 years. With that comes the issue of inflation. As a rule of thumb, historical inflation will double the cost of living expenses every 25 years. So for example, if your annual living expenses are $100,000 today, they can easily be $200,000 in your later years. It is crucial that your investments continue to grow in retirement.
To help offset this increase in expenses, you need to continue to hold assets that will outpace inflation over time, like stocks. By balancing out the amount of assets you hold for current day expenses (fixed income focus), and those for future expenses (growth assets), you will be able to see your investment accounts grow well into retirement.
Leaving Money Behind
What do you want to have happen to your assets when you pass away? Some people wish to leave behind some money either for family members or charity, while others want to spend as much of their hard earned money as possible. It is important to think of this prior to retirement, as your wishes will greatly determine how much (or little) you need to have saved up prior to retiring. If you wish to leave assets behind, it is critical that you have your will up to date and all assets (both investment and insurance) with proper beneficiary designations. This will ensure your assets pass along how you wish. Your family members will thank you for not making them go through the probate process, which can be both frustrating and expensive.