Retirement is an exciting milestone that many would-be retirees wait for with great anticipation. However, only one in five Americans feel "very confident" that their savings will allow them to retire comfortably, according to the Employee Benefit Research Institute's 2023 Retirement Confidence Survey. So, it makes sense that many entering their retirement years are experiencing uncertainty, especially regarding money.
The good news is that there are ways to mitigate the risks of running out of money in retirement and strategies to ensure your nest egg stretches a little further. This guide will walk you through some retirement income strategies and budgeting tips to help you maximize your retirement savings.
Key Takeaways
- Protecting retirement income is crucial for financial security during retirement.
- Diversification and asset allocation are key factors in safeguarding retirement income.
- Insurance products, such as annuities and long-term care insurance, can help mitigate risks.
- Budgeting is essential for effective retirement planning and managing expenses.
- Regular reviews and adjustments to retirement income strategies are important for long-term success.
Understanding Your Retirement Income
The first step in protecting your retirement income is fully understanding your income sources, how they work together, and what strategies can make them last even longer. Retirement income will vary from person to person, but here are a few common ones:
Social Security Benefits
Social Security benefits provide a monthly income based on your earnings over your working life and are periodically adjusted for inflation. With a few exceptions, most people will qualify for benefits, so it's almost a guaranteed source of income.
Though it's a relatively secure source of income for most, the downside is that it's typically not enough money to sustain retirees on its own. Another issue is that the Social Security Administration projects that the fund will soon be depleted, with the latest forecast predicting that the fund will not have money as soon as 2034.
Pension
Your employer contributes funds to an account for your benefit once you retire. Payout amounts are usually predetermined and based on factors such as salary history and years of service. Some employers may offer a lump-sum payout as opposed to monthly payments.
Pensions can be great sources of retirement income because your employer mainly funds them, and they're mostly a reliable, consistent source of income. Risks include the growing trend of public and private sector entities with underfunded pension obligations. Market fluctuations, mismanagement, and demographic changes are reasons pensions may be reduced or eliminated altogether.
Retirement Savings Accounts
These include retirement accounts like 401(k)s, Thrift Savings Plans (TSPs), 403(b)s, IRAs, and Roth IRAs. These offer tax-advantaged savings options with the potential for growth through investments in stocks, bonds, and other assets. In some cases, an employer may also offer a match, which can increase your returns substantially.
Risks related to these accounts are that returns and related income are subject to market conditions. Plus, there are some disadvantages like contribution limits, early withdrawal penalties, and minimum distribution requirements, which can trigger tax liabilities.
Annuities
An annuity is a fixed-income product that can provide a guaranteed income stream for a defined period of time. Some retirees may use annuities to turn a lump sum payment, perhaps from the sale of a business, lawsuit settlement, or property, into a consistent monthly payment.
As an insurance product, the idea is that you are transferring the risk of running out of money from yourself to the insurance company that guarantees against the loss of principle. The disadvantages of annuities are that they can be complex, loaded with fees, somewhat illiquid, and the fixed income may not keep pace with inflation. Plus, you'll typically earn less of a return on your money than if you were investing in the stock market.
General Investment Income
You may have other assets that provide income, such as a business, real estate income, or even a taxable brokerage account. These income sources often require more active management and carry higher risk but offer the potential for higher returns.
Factors To Consider When Protecting Retirement Income
To make your retirement income last, keep the following factors in mind:
Diversification and Asset Allocation
"One essential strategy is diversification and asset allocation, which involves spreading investments across various asset classes to reduce risk," says Tyler Meyer, a certified financial planner and owner of QED Wealth Solutions. This strategy may include moving assets into more stable investments like bonds or cash when retirement is imminent.
Risk Management
Certain risks can bust your retirement budget. For instance, if the market drops substantially, you run the risk of prematurely depleting your retirement savings. Adding inflation to the mix only compounds the risk of running out of money.
Meyer also mentions how products like annuities can provide a hedge when volatile markets and inflation threaten retirement savings. He says, "In addition to diversifying investment portfolios across various asset classes and regularly rebalancing them, individuals can also consider allocating a portion of their assets to inflation-protected securities, exploring annuities with guaranteed income features, and maintaining a flexible withdrawal strategy aligned with their financial goals."
The Cost of Long-Term Care
Developing health problems can be another risk for retirees. If those health problems require elevated levels of care, such as assisted living, memory care, home healthcare services, or any form of long-term care (LTC), basic living expenses will increase substantially.
Warning
Contrary to what most people believe, Medicare doesn't cover LTC, so you will need a plan to handle these expenses should they arise. This may involve setting aside more money for retirement or opting for long-term care insurance.
Strategies for Budgeting for Retirement
One of the most powerful practices you can implement in retirement is budgeting. A budget is simply a plan stating how you will use your money.
If you are planning for a specific withdrawal rate, a budget can keep you on track so that your expenses don't exceed your income. Here are some steps to start the process of budgeting:
- Identify your expenses in retirement.
- Create benchmarks for where you'd like them to be if they are too high.
- Adjust spending habits accordingly.
- Track spending to ensure you are staying within your budget.
- Review the budget regularly to make adjustments based on your financial circ*mstances.
Your budget can help you stay focused on your long-term financial goals and avoid overspending during retirement. However, it's also important to budget during retirement and in your working years to prepare for retirement.
Dan Milan, a managing partner at Cornerstone Financial Services, says that the budgeting process "includes budgeting both during your accumulation years so that you can save appropriately, as well as budgeting in your retirement years so that you can maximize your distribution years."
He adds, "If planned correctly, you should be able to create a roadmap that allows for your retirement income to be reliant on income-producing assets that produce dividends, interest, and/or guaranteed income streams."
Strategies for Protecting Retirement Income
Although there are many variables when it comes to planning your retirement cash flow, there are plenty of things that remain within your control. Here are some examples of financial planning strategies that you can be extremely intentional about and will make a big difference in your finances as a retiree.
Create an Emergency Fund
An emergency fund helps you cover unexpected expenses so that you don't have to go into debt or dip into your retirement savings accounts. Keeping enough cash on hand means that you can continue to pay for your living expenses and earn interest on your money in the bank.
Manage Cash Flow Effectively
Essentially, you can manage your cash flow by spending less than you earn. People commonly overspend when they begin to use credit cards and regularly carry a balance on them.
Although it may be tempting to use credit in an attempt to keep your cash reserves intact, it will eventually catch up with you as you have to pay interest on borrowed money. As monthly payments accrue, you risk spending more money than you bring in with this habit.
Minimize Debt
As mentioned, avoiding debt is a great strategy to ensure your money lasts in retirement. If you've got enough high-interest debt, it can negate the returns you're earning on the money that you're saving and investing.
Consider making a plan to pay off debt, especially high-interest debt aggressively. This may mean cutting back in other areas until you're done, but eliminating interest payments from your budget will be worth it.
Be Flexible With Withdrawals
A common obstacle faced by retirees is the sequence of returns risk. This refers to timing withdrawals in a way that hurts the overall rate of return of your retirement portfolio. Essentially, selling investments to fund retirement expenses during a "market low" can deplete your cash faster than if the same amount were withdrawn during "market highs."
The sequence of returns risk means retirees should have a flexible withdrawal strategy and possibly a buffer of more stable investments to draw from during periods of market volatility.
If you think you might be retiring during a bear market and want to avoid drawing down your principal, it's also a good idea to have backup plans. These plans include reducing your withdrawal rate, selling an asset (like real estate) to increase liquidity or to reduce monthly debt payments, adjusting the timeline for receiving Social Security benefits, delaying retirement, or even working part-time to reduce the strain on your finances.
Even if you're not retiring in a volatile market, it's a good idea to have options in case your original retirement plans become unviable for one reason or another.
Engage a Professional
Navigating the landscape of retirement planning can be incredibly complex and overwhelming. That's why it's a good idea to seek professional financial advice to help you develop a comprehensive retirement income protection plan.
Government Programs and Policies for Retirement Income Protection
You should also understand the benefits of social safety net programs the U.S. government provides. These programs, though typically not enough to sustain a retirement lifestyle on their own, can complement your other retirement income sources.
Social Security
Social Security is available to most Americans who've earned enough credits based on their (or their spouse's) work history. Fortunately, there are some strategies to get the most out of your Social Security earnings.
- Delay taking retirement benefits: Wait to claim your Social Security benefits after your full retirement age (FRA). Every year you delay, up until age 70, your benefit increases by about 8%.
- Lower your taxable income: Reduce the taxable amount of your Social Security earnings by keeping your adjusted gross income (AGI) under the IRS taxable thresholds. This retirement tax strategy may include one or more of the following: diversifying your income sources, strategizing your withdrawals, or taking advantage of a Roth conversion strategy.
Medicare
Medicare acts like health insurance and covers a range of medical services to individuals over the age of 65. This coverage can significantly reduce out-of-pocket healthcare costs for many American retirees. The disadvantage of this coverage is that it may not cover all of your healthcare needs in retirement, including one of the most likely and costly needs for many retirees—long-term healthcare.
Though both programs can assist in your retirement years, it's important to understand their limitations. As mentioned, the benefits may not cover all of your needs in retirement, plus many changes to the programs mean the availability and eligibility requirements could change at any time.
Common Mistakes To Avoid When Retirement Income Planning
Most people have only planned for retirement and then actually retired once in their lives, so it's inevitable that people will make mistakes in this process. Common missteps include:
- Underestimating the amount of money needed in retirement
- Not adequately accounting for additional costs like inflation and healthcare
- Relying solely on Social Security income
- Not planning adequately for tax liabilities, especially those who'll end up in a higher tax bracket in retirement
Even if you make these mistakes, know that you can always learn and adjust as you go. It may take some creativity, but it's not impossible to reposition yourself for a better quality of life in retirement if you didn't plan as thoroughly as you might have.
If you're focused on future-proofing your finances, there are more resources here to help protect your assets.
What is the 4% Rule for Retirement Income?
The 4% rule for retirement income suggests that you withdraw no more than 4% of your portfolio in the first year of retirement, with adjustments for inflation thereafter, to ensure the longevity of your retirement portfolio.
What Is the Biggest Financial Risk in Retirement?
The biggest financial risk in retirement is outliving your retirement savings. This can happen due to inflation, increased living expenses, or not having enough money saved up to begin with.
What Age Should You Get Out of the Stock Market?
There's no recommended age to stop investing in stocks. Most financial professionals suggest retirees rebalance their portfolio from riskier investments, like some stocks, to more stable investments, like bonds or annuities, to avoid loss of principal.
The Bottom Line
Planning for retirement can present some challenges. These challenges come from unknowns, ranging from life expectancy and inflation to market conditions and even the viability of the Social Security trust fund and tax legislation. The key is to focus on what you can control while remaining creative and adaptable should you need to adjust your retirement plans before or during retirement.
