Know Where Your Money Is Coming From
As you move to a time when your income is not based on what you earn, your well-being will be very dependent on your sources of income. This blog will highlight some of the things to think about and perhaps enable you to identify your potential sources of income and then compare this to your expenses.
When you start analyzing your financial conditions, some people will look from the bottom up –your projected expenses and then what income is needed to support them, other will look top down – what income are you likely to have, and then adjust your expenses so you can live within your means. There is no right or wrong way of looking at this, you need to examine both. We’ll start with the Top-Down approach.
Sources for Projected Income
There are several sources of income. These are:
1. Social security – if you have paid into Social Security, contact them to determine the specific amount you will be eligible to receive and when you will receive this. There is an opportunity to delay this income till you reach age 70, and if you can, do so. The income you will receive will increase by an average of 8% per year.
2. Pension income – many employers have terminated their pension plans. If you are one of the lucky ones who have these, your only risk is the solvency of the organization that manages this program. Check to see if you are eligible to receive this income from your current or past employers.
3. Earned income – this in income you may receive from your employer if you start working part time, from another employer who is using your services, or a similar source for income. This could also include consulting fees, fees paid if you participate on a Board of Directors for a company, or income from previous work such as royalties, licensing rights, etc. This could also be rental income from property you have that can be rented. Finding sources for earning income after you have left the official workforce may be challenging and will require you to adjust your lifestyle.
4. Sale of assets – This is income you may receive when you sell something. While one’s home is the most apparent, you will need someplace to live so the sale of your home may mean you will need to add rent to your expense budget or just live on the net between your previous home to your new home assuming you can downsize. We will discuss the use of a reverse mortgage separately but this is a source of income using the equity that has been developed in your primary residence.
5. Investment income – This is income you generate off of the financial assets you have received through an inheritance or generated during your working career. This is perhaps the most important source for the income you will need for your life style. The question here is whether you intend to gradually spend this down over the rest of your life, and leave only what is remaining to your children and desired charities, or you will seek to preserve these assets for your children and next generations.
What You Can Expected From Investment Income
While many Americans have very little stashed away in savings, others that have been saving through a 401k, 403b or similar programs through their working career. The conventional wisdom is that if you withdraw 4% of these funds after you reach the age of 65 or 70, then you should have sufficient assets to last your lifetime. However, you cannot do this if your assets are in fixed income, savings accounts or certificates of deposits. They don’t generate enough income to fund this cash flow to you. This conventional wisdom was developed and then reviewed by economists. (Pfau, Wade and David Blanchett, “Can Retirees Still Use a 4% Withdrawal Rate?, Advisor Perspectives, September 2, 2014.).
Consider if you invest your assets and generate an average of 6% per year (The average rate of growth in the stock market from 1950 to 2016 has been 7.47%), then when you withdraw 4%, you assets will continue to grow by 2% per year. To achieve this most investment advisors base this 6% growth on invested assets that are 60% in equities and 40% in fixed income or bonds. If you assets are in cash or bonds, then you will not be able to generate the 6% needed to support a 4% withdrawal rate. Also, this extra 2% will enable you to weather most inflationary pressure.
Finally, if you have put money away into a 401(k) or 403(b) savings account, the IRS requires you to start withdrawing a certain percent of their assets that are included in a qualified defined contribution plan, such as your 401k or 403b accounts, after you achieve age 70½. To find out what you need to do, visit the IRS website: (www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds
Know Your Numbers
The conclusion is to total this annually and project this income over the next 10 to 30 years, or more. Perhaps the worst case scenario is to not know where you are financially as you enter this next stage of life. While the news may not be good, knowing your situation will enable you to take the actions now that will prevent problems when you are at the point in your life where you will be least able to address them. We are creatures that are more influenced by immediate consequences than long-term consequences. Given the experience you have had to this point in your life, now is the time to know. This will help you sleep and live the life you deserve. Be wise and be careful out there.
By Tom Wilson