Determining an appropriate strategy for converting assets into income is a crucial piece to any retirement plan. An income strategy should not only provide a regular stream of income but should do it tax-efficiently for as long as required. A successful plan requires a comprehensive analysis to come up with appropriate strategies best suited to sustain spending power through retirement. While no one strategy is right for everyone or better than others, each strategy should be tailored to the needs and challenges of each person.
Let's take a few minutes to review the key components of a strategy for converting assets into income.
Frame The Issue
Converting assets to income begins with choosing the appropriate way to frame the issue. For some, it's more helpful to think in terms of creating an income floor for essential expenses. And for others, it starts with the question, “How much can I afford to withdraw from the portfolio each year and still make my money last?” Whatever approach is taken, it's important to be familiar with the different ways of framing the issue and be able to pick solutions appropriate for your situation.
Build Out The Details
Once the strategy is framed, you can begin to build out the details about how it will meet your income goals while managing the risks facing those goals. To bring your retirement income strategy needs into focus, here are a few questions to consider:
- Do you prefer income stability or wealth accumulation?
- What minimal level of income is needed to fund essential expenses?
- Do you prefer a constant or fluctuating rate of spending?
- Are you comfortable spending from a volatile investment portfolio?
- Do you know how much you spend each year without running out of money?
- Is running out of money in retirement a concern?
- How do you plan to fund a longer than expected life?
- Is there spending flexibility?
- Is lifetime spending more important than leaving assets to others and having funds on standby?
- What are your other sources of income?
- Do options exist within qualified plans to annuitize assets?
- Would you consider home wealth a retirement funding source?
Identify Available Assets
Next up you'll need to identify all sources of income and assets that can be turned into income. Obvious sources include Social Security benefits, employer-sponsored defined-benefit and defined-contribution plans, and other taxable/tax-qualified plans. Other sources of income could include supplemental non-qualified employer-sponsored benefits, income from rental properties or renting out part of the home, part-time employment, commissions and income from selling a business. Include other less obvious assets such as cash-value life insurance, home equity, collectibles, and downsizing into a smaller home by selling the primary residence.
A successful plan requires a comprehensive analysis to come up with appropriate strategies. For example, converting a 401(k) account into a life annuity can be an excellent solution for someone with little other guaranteed lifetime income, but less so for someone with a significant pension benefit. Increasing lifetime income is not only about converting assets into income. It can also be about figuring ways to maximize Social Security benefits, using a reverse mortgage to tap home equity, and making better tax decisions to increase after-tax income. No one strategy is perfect. And trade-offs will be required. For example, strategies that improve income security in retirement may have a negative effect on wealth accumulation for legacy goals.
Finally, the selected strategy must address the various risks and contingencies that will be faced in retirement such as the possibility of a longer lived life than expected, a sustained market down period in the first few years of retirement, or the death of a spouse/partner at an early age. Before selecting a strategy it's critical to think through how the strategy will address these and many other retirement risks that could derail retirement.
The wealth accumulation (saving for retirement) side of retirement planning gets most of the attention. That's unfortunate because wealth deaccumulation (spending in retirement) is arguably the more complicated and consequential part of retirement. Very few save and invest for the fun of it. They do these things because someday they hope to have done them well enough to be able to comfortably retire. Whether this goal is achieved begins with having a well-thought-out strategy for converting assets into enduring income.
Is your strategy for converting assets to income up to the task?