Planning for Lifetime Income in Retirement

A three decade, two-person baby boomer retirement is a problem of income, as opposed to principal.?

What do I mean by that? You don't bring your account statements to the supermarket every week--you bring your income.

To review the nature of this income problem, we need to evaluate two essential retirement questions:

1.?????Will your income outlive you?

OR

2.?????Will you outlive your income?

The whole point of retirement income planning is to design a system with the intention of providing an income that outlives us.?

In order for it to outlive us, our income must grow at the rate our cost of living grows.? The challenge is to create an income that is dynamic, and it must rise through time to offset inflation.? As it turns out, the critical issue is not so much the level of your income but the trajectory of your income.?

As an example, if you start into retirement with a fixed income that is 150% of your cost of living, with three percent inflation, your cost of living will exceed your income in year 14.

(The graph is for illustrative purposes. In the 14th year, the cost of living equals $75,629.49 when using a $75,000 annual fixed income in year one with a $50,000 cost of living of and a 3% annualized inflation rate increase)

For many folks, their cost-of-living increases over time while their income stays the same in a fixed income solution.?When and where those lines cross is not the issue; the issue is, if they cross, you are running out of money.? You will have begun dipping into your principal and, to make up the income shortfall, you are entering a downward spiral of lower future income due to lower principal account values to generate future income.

Even if you aren't preparing for a thirty-year retirement, it is preparing for you.?

The joint life expectancy (which in English means the point at which the second person passes) of a non-smoking couple retiring at age 62 is 30 years.

That is the top of the bell curve (i.e. average)!

(According to the Annuity 2000 Mortality Table adopted by the National?Association of Insurance Commissioners, for a 62 year old couple, there is a 50% chance one of the partners is alive at age 92)

You likely had better education and health care, worked in more fulfilling jobs, and generated a higher income; we don't want to count on you being average… those dots to the right, that could be you!

To offset the trend line of 3% inflation, your income (or more accurately your ability to withdraw from the portfolio) must rise about two and a half times over 30 years.

For example, if you need $8,000 a month on top of Social Security in year one, at the end of 30 years, you will need $19,000 per month.

(Graph depicts the impact of 3% inflation on a $8,000/month income over 30 years)

Here’s a question for you:

Historically, where do we find that kind of rising income?

The answer is by owning companies and not lending to them.? Fixed income securities, by definition, do not produce a rising income.? Mainstream equities, for example the S&P 500, historically have produced a rising income and they most notably have done so in the form of cash dividends.

Let's look at what has happened over the lives of people heading into retirement now.? We will look at the Consumer Price Index (CPI), which is a basket of consumer goods and services that we purchase day-to-day, and the cash dividend of the S&P 500.

Take a moment to yourself and guess, how many times has the CPI and cash dividend of the S&P 500 increased since 1960?

This may be shocking to some of you....?

(Source for Consumer Price Index: U.S. Bureau of Labor Statistics, as reported on rateinflation.com. Source for S&P 500 Earnings History: NYU Stern School of Business, Aswath Damodaran. Raw data from Bloomberg and S&P.)

The CPI has risen 10 times while the cash dividend of the S&P 500 has risen 30 times.

The S&P 500's cash dividends have historically compounded at around twice the long-term inflation rate.

That is only looking at the cash dividend.?What about the value of the index itself…

The index has risen 71 times since 1960!

Rising equity values over long periods of time have done two things:

1. Given you even more room to increase withdrawals, and
2. Built wealth that you can leave to the people you love.

As the famous investment disclosure goes, past performance is no guarantee of future results.? My recommendation is to meet with a financial advisor to begin refining your personal retirement income needs to your goals. ?When you sit down with a financial advisor, they can show you the numbers associated with your personal circumstances.

By starting the discussion now, you can look at ways to be more efficient in managing your portfolio over time.?The earlier you begin planning, the more flexibility you have in designing ways to create confidence in your stream of income during retirement.