One of the most stressful aspects of retirement can be transitioning from earning income to relying upon investments and other possible income sources to meet income needs.
You have put years of hard work into your medical school and training, given most of your life to caring for your patients, and may now find yourself contemplating, or already in, retirement.
Transitioning from earning income to relying on your investments and other possible income sources to meet your income needs can be one of the most stressful aspects of retirement.
Below are 10 steps that may assist you in gaining a level of confidence and clarity around cash flow planning in retirement:
- Know what your expenses will be in retirement. If you do not have a clear picture of what your monthly spending will be in retirement it is difficult to know if you have the assets and income sources to meet them. We utilize a detailed retirement expense worksheet with our clients, but you can also use an excel spreadsheet or the old yellow pad to list all of your expenses
- Divide your expenses into essential expenses and non-essential expenses. Essential expenses would include property taxes, food, health care, utilities, etc. The non-essential expenses would include travel, hobbies, gifting, entertainment.
- Include taxes, both federal and state. Social security, rental income, and withdrawals from retirement accounts all create taxable income that will need to be addressed.
- Include an inflation factor. This is to account for the increased cost of goods and services so you are not surprised by the additional income needs in the future.
- List all guaranteed income sources during retirement. One way to reduce the potential anxiety caused by retirement cash flow is to have a high percentage of your essential expenses covered by guaranteed income sources. By having a level of predictable monthly income not tied to your investment portfolio you can ride out possible market volatility and periods of lower returns by decreasing the amount needed from your investments. Social Security, rental income, annuity income, and part-time earned income are all reliable and predictable sources of income that can be used to cover a portion of your retirement expenses.
- Determine your retirement income gap. The income gap is the difference between your total expenses, including taxes, and your guaranteed income sources.
- Calculate your withdrawal rate. Once you know the amount you will need to create after guaranteed income sources you can calculate your withdrawal rate. The exact withdrawal percentage that is recommended varies but, ideally, we like to see a withdrawal rate no greater than 4%.
- Create a monthly withdrawal strategy from the portfolio. Once the amount is determined you can structure monthly withdrawals using dividends, interest payments, and if applicable guaranteed annuity payments.
- Make sure to withhold adequate taxes from the retirement accounts. For some income sources, like social security and retirement account withdrawals, you could determine a percentage that will be directed to the IRS and/or state to cover taxes. For other sources of income, you will want to make estimated payments to make sure you are not surprised by a large tax liability at tax time.
- Have all income sources deposited into a designated account. Most of our clients have their social security and portfolio withdrawals directly deposited into an account that is used to pay bills and cover expenses. This gives the feel of still receiving a paycheck and helps to smoothly transition from earned income to retirement income.
Case Study
Dr. and Mrs. Smith are about to retire and are planning their retirement cash flow strategy. Below are the 10 steps that were utilized to transition into retirement.
1. Dr. and Mrs. Smith used a retirement expense sheet to list their overall expenses in retirement and determined what they would need to cover all of their needs and wants.
- Net annual expenses: $160,000
2. Next, they divided their expenses into essential and non-essential.
- Essential Expenses: $110,000
- Non-essential expenses: $50,000
3. They estimated total taxes to be 20%.
- Total Taxes: $40,000.
- Gross Annual Expenses: $200,000
4. An inflation factor was used to plan for the future increase of goods and services.
- Inflation: 3.5%
5. Once they determined their gross and net income needs, they listed all of their guaranteed income sources:
- Dr. Smith’s Annual Social Security: $40,140
- Mrs. Smith’s Annual Social Security: $24,000
- Annual Surgical Center Income: $30,000
- Total Guaranteed Annual Income: $94,140
6. With the expenses and taxes listed, along with the income sources, the income gap could be calculated for the Smiths.
- Total Expenses: $200,000
- Guaranteed Income Sources: $94,140
- Total Income Gap = $105,860
- Essential Expenses: $110,000
- Guaranteed Income Sources: $94,140
- Essential Expense Income Gap = $15,860
7. With the income gap calculated the Smiths reviewed their investment portfolio and calculated the withdrawal rate.
- Total Investment Portfolio: $4,250,000
- Total Income Gap: $105,860
- Withdrawal Rate: $105,860/$4,250,000 = 2.49%
8. The Smiths would then work with their financial advisor to determine a strategy to withdraw the 2.49% utilizing dividends, interest payments, and if applicable annuity payments.
9. Once the specific dollar amounts are determined for the various investment accounts the Smiths would instruct their advisor to withhold federal and state tax on any accounts that would produce ordinary income, retirement accounts and annuities.
10. The last step for the Smiths to put their retirement cash flow plan in motion would be to choose a bank or brokerage account to have all of their guaranteed income sources and portfolio withdrawals deposited into so they can concentrate on enjoying retirement and not how they will pay for their monthly expenses.
Like the Smiths you can enter retirement feeling confident by following the retirement cash flow steps above.
This case study is for illustrative purposes only. Individual cases will vary. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Prior to making any investment decision, you should consult with your financial advisor about your individual situation.
