For most of your working life, you’ve had paychecks deposited into your bank account on a regular basis to cover your living expenses, creating a 40+ year history of handling your finances in this manner.
However, those regular paychecks from your employer suddenly stop when retirement begins. This brings up one of the most common questions from people nearing retirement: “Where will my paycheck actually come from when I’m retired?”
Why People Don’t Think About This Beforehand
It’s perfectly understandable that most people haven’t given retirement paychecks a second thought. For most, the focus for years, decades even, has been on building and accumulating wealth.
You put your head down and give your attention to your career and investments. There’s nothing wrong with having a growth mentality. In one of our previous articles, we likened climbing a mountain to wealth building and management.
And the interesting part is that not much thought goes into what happens when you get to the top. In other words, how will you get down after reaching the summit? This is where the anxiety kicks in with some common concerns:
- Where will I get the money to live after retirement?
- How much will I need?
- What about medical costs?
- Will I outlive my funds?
Fortunately, the right plan can help you answer these questions and allay any fears.
Why Do You Need a “Paycheck” in Retirement?
There are a lot of moving parts in a comprehensive retirement plan, which we will go over more in a minute. But, you certainly don’t want to worry day to day whether you’ll have enough in the bank to pay the next day’s bills. While you’re not required to set up a monthly automatic withdrawal, or “paycheck” from your retirement account, we generally encourage this practice because it creates consistency and reliability. It also helps prevent spending down your assets too quickly.
If you’ve worked with your advisor to build a retirement income strategy, you can set the paycheck plan for that year and go back to living like you have for decades – on a monthly paycheck.
Structuring Your Portfolio for Retirement
Now that you know having a paycheck in retirement is a possibility, where is that money going to come from? Ideally, it will originate from several places.
The first is your fixed-income sources. Some baby boomers and workers in certain industries still have access to pensions. Then there is Social Security, which brings forth questions related to timing. “Is it better to take it earlier with a lesser benefit and not take as much from your portfolio? Or take it later while accessing your investments now?” The answer to these questions can be complex and will vary based on each person’s situation.
The second source is what we refer to as the “Golden Goose.” For those who remember the Aesop’s Fable of the goose that laid the golden eggs for the farmer, these are your portfolio assets. They can be stock portfolios, real estate holdings, or any other assets that create passive income for you.
The idea is to figure out, on top of your fixed-income source, how much income you can take from your Golden Goose. We determine this through a comprehensive financial planning process, while others think about rules of thumb like roughly 3% to 4% of your portfolio. Guidelines have their own challenges when not customized to each client and situation.
When you look at your Golden Goose, the proceeds you’ll generate come from two primary sources – growth and income.
Growth refers to the appreciation of the assets in your portfolio – buying Company A at $10 per share and watching those shares grow to $20. A well-designed and diversified portfolio will help you scale that mountain. To spend the growth, you’d need to sell shares.
Income refers to dividends paid by your stocks or interest paid by bonds. If Stock A pays a $2 quarterly dividend per share, that can be part of your paycheck or reinvested if you don’t need the income right away.
An ideal retirement paycheck stays within the income generated by your portfolio to preserve the principal. This helps maintain steady income through good times and bad. But, when that’s not possible, it might be better to look at a buckets strategy.
The Bucket Approach to Your Retirement Withdrawals
If the income alone doesn’t fully meet a client’s need, another approach we use to help our clients envision their “paycheck” after retirement is to visually structure your portfolio into three buckets.
When you reach retirement age, you’ll want a target of six-to-twelve months of reserves in a high-interest savings account. This is your short-term bucket that provides security through bad times. It isn’t for drawing down, but rather to use as a rainy day fund.
Next, you’ll have a midterm bucket to send your monthly paycheck. This one will hold a lump sum of your golden goose funds, and it is designed to provide your income for the next 5 to 7 years. This bucket will have a lot of yield and interest-generating investments that can deliver ongoing income.
The third bucket is your long-term bucket. Your growth investments for 7+ years will be in this bucket. They are meant to outpace inflation and continue growing your portfolio over time. You won’t need to focus on this money since it is working for the future you in the background, even during economic downturns, as we saw just a decade ago.
When Do You Shift from a Portfolio Growth to a Retirement Structure?
These concepts might make sense and provide reassurance, but when do you need to start taking some action on them? While you should begin planning for retirement at the earliest age possible, worrying about your paychecks can come a bit later.
Typically, you and your advisor should start preparing the retirement runway about five years before you plan to stop working. This provides plenty of time to prepare your buckets, reduce risk in your portfolio as needed and make sure you thoroughly understand where your paycheck will come from.
When you are within a year of retiring, you can nail down the details for full cash flow generation. With some deliberate planning and the right guidance, you’ll be ready to seamlessly step away from the workforce and into retirement.
When you retire, your next “job” should be enjoying the coming days and years instead of worrying about your finances. There is a significant amount of work involved in turning all the various moving parts into a series of steady retirement paychecks, but a relationship with a trusted financial advisor will help you achieve that goal.
Contact us now to learn more or reach out with any questions.