Creating retirement income for today’s investor

Doug Horn

How retirement income is created can make a significant difference in the retirement lifestyle. While this is not a new topic, I felt revisiting this may make a difference for those soon-to-be. The adage implies the investments should be repositioned in order to create the income that will be needed. For those early in their retirement, this is almost a sure way to fail.

If during retirement the income from Social Security and pensions leave a shortfall from the income amount needed to maintain a certain lifestyle, then reliance on personal investments to fill the gap will be required. Let me use an example to illustrate my point. If $40,000 is needed and social security and pensions provide $29,000, then $11,000 will be needed from personal assets such as IRA accounts. Couple A has $250,000 in retirement accounts. They found some bonds paying 4.5 percent, thus when purchased would create $11,250 of annual income. They would be able to meet their income needs but would only increase their investments by $250 per year.

After ten years Couple A’s social security and pension income is now $32,950. Their pension was not adjusted for inflation so only the social security income increased. Their income needs are now $53,500 due to a modest inflation rate. Interest rates have only risen slightly, so the income from their investments is now $15,150, leaving them short by more than $5,000 per year. To avoid dipping into the principal, expenses are trimmed and the quality of life is lessened due to the lack of income. This example rings true all too often and now retirements are lasting far longer than ten years. Couple A would be in worse shape if interest rates had fallen rather than risen slightly.

Relying upon investments that generate interest may appear reasonable, but over time may fail to provide the income needed to meet the spending needs. Certificates of deposit and bonds are excellent at creating income, but their future values are rarely higher than the initial investment. Thus, these investments alone are not a great match against long-term inflation. Since the principal does not grow, either the future interest rates will have to be higher to meet higher expenses, or part of current income will have to be reinvested in order to grow the principal. To purchase $5,000 of goods and services today will require $7,790 in fifteen years; $9,030 in twenty years; and $12,136 in thirty years if inflation is only three percent. Since investors have no control over future interest rates, and their personal inflation rate may be higher due to medical costs or other items, their financial security can be at significant risk.

Rather than create a portfolio to create income, I believe it is better to design a portfolio for personal risk and the current market. Couple B has the some income needs and assets as Couple A, but allocates their portfolio blending bond funds, individual securities, real estate investment trusts (REIT) and equity funds. They determine they need to withdraw $11,000, thus an initial withdrawal rate of 4.4 percent ($11,000/$250,000). Their investment’s return during the ten years was slightly above 8 percent and less their withdrawals, their investments were now worth approximately $382,000. Since a withdrawal rate is set by the investor, Couple B could elect to increase their withdrawal rate to 5.4 percent, in order to meet their now higher spending needs.

Withdrawal rates are not a cure-all. Setting a withdrawal rate too high for either the market or the expected investment return on the allocation of the portfolio can lead to trouble. Expecting to be able to withdraw ten percent per year may work for a few years, but eventually the market’s performance will cause the portfolio to go down in value. Even a withdrawal rate of four percent is too high if the underlying investments are in money market accounts creating only one percent income.

Generally, withdrawal rates of six percent or less can be sustained when the underlying portfolio is properly allocated and the investor is willing to maintain their distribution amount by reducing the withdrawal rate for those years when the portfolio is growing in value.

For assistance with portfolio allocations, insurance, estate planning, or investment management contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our learning center on our website, There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other free tools.

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