6 Key Steps to Creating a Retirement Income Plan

The thought of retirement can be scary because it can be hard to know if you’ve done enough to be prepared. But there are some specific steps you can take before retiring that can help make the transition easier. Let’s review some tips, techniques and products that may help you feel more prepared for this major life event.

We are all affected by the fear of the unknown. We yearn for safety in our lives. In fact, safety is so important that it is the second tier of Maslow’s Hierarchy of Needs. This fear as it pertains to income is often warranted.

As you near retirement age, you may feel pressure to make sure you will be able to generate the cash flow to cover expenses after you leave full time employment.

That’s why it's important to establish a detailed plan that identifies what sources of retirement income you will have to pay for living expenses in retirement, long before you’re ready to retire. Let’s review some financial planning steps you can take to create a savings and spending plan in retirement.

1. Determine Your Long-Term Income Needs

First, think about what your life will be after you retire. Similar to Maslow’s Hierarchy, Forbes discusses a hierarchy of financial needs that prioritizes the types of expenses you may have in retirement.

Using this philosophy, lower needs must be satisfied before the higher needs can be addressed. These lower needs include basic sustaining living expenses like food, housing, taxes and transportation. Then come safety expenses which can include insurance, including health care insurance to pay for medical expenses, home insurance and life insurance.

Finally, there is freedom income, money set aside to do all of the things that bring enjoyment and fulfillment, including travel, dinners out, and maybe a new car. To be able to fund this level, you’ll need to understand the exact cost of the activities that bring you the pleasure and relaxation you’ve earned!

But first, let’s review the sources of this income available to fund your lifestyle, no matter what it is!

2. List Sources of Retirement Income

If you’ve been able to do even a basic level of pre-retirement planning, you will likely be funding your retirement from one or more of these possible sources. Even though some of your retirement accounts, like annuities, may have been allowing you to defer the payment of income taxes on gains, you’ll need to pay when you take distributions during retirement.

We’ll provide more detail on each of these vehicles in the sections below:

• High yield savings accounts
• Mutual funds
• Annuities
• Defined benefit plans (Pensions)
• Defined contribution plans (401k, 403b)
• Traditional and Roth Individual Retirement accounts (IRAs)
• Social security benefits

3. Calculate Income from those Sources

As you enter retirement, you will be faced with the reality that you are moving from one income source (a paycheck) to multiple income sources. There are many factors that come into play when determining the annual income you will need to extract from these investment accounts, including the rule of thumb for calculating needs in retirement.

This rule states that, in general, 80% is a good starting point to consider for your income replacement rate. This means that if you make $100,000 shortly before retirement, you can start to plan using the rough estimate that you’ll need about $80,000 a year to live on in retirement.

To calculate your retirement income, look at all of your retirement accounts. Do you have a 401(k) or 403(b) with your employer? How much will you receive from Social Security? What about annuities?

Look at how much income these accounts will generate. Do the same with any IRAs, investment accounts, and savings accounts you plan to use to fund your retirement. A financial planner can help you with these numbers. Also, a skilled financial professional can help you consolidate some of these accounts into a more simple foundation to support your retirement investment strategy.

4. Subtract Expenses and Taxes From the Expected Income

Next, your retirement income plan should calculate the gap, which is the difference between income from fixed, or guaranteed sources, like Social Security, pension retirement benefits, income annuities, and your estimated expenses such as housing, living expenses, mortgage, and estimated taxes in retirement.

Add up these total expenses and you will know approximately what you will need to cover with the guaranteed portion of your retirement nest egg. Subtract the total expenses from your total income and:

• If this gap is a negative number, this is what you would need to withdraw from savings and investments to meet the needs of your retirement lifestyle.
• If the gap is positive (good for you!) then you have enough fixed sources of income to meet your desired retirement lifestyle and could either add to your savings or enhance your lifestyle and spend more.

A retirement calculator or financial planner can help you with these numbers.

5. Adjust Your Portfolio

If you have a significant deficit after doing this gap analysis, you may want to make some adjustments to your portfolio. If you haven’t already, you may consider purchasing an annuity, the only product that can guarantee you income for life.

You may also want to plan to get a part time job or consulting gig in retirement if that works with your available time and skillset. It will also keep your mind challenged, which is important in retirement.

Even if you don't have a deficit, you will likely be making changes to your retirement portfolio as your focus changes. Where your focus was formerly on accumulating money, it is now on the intelligent distribution of money to meet your needs in retirement. Overall, as you get older, your retirement portfolio should be adjusted to reduce the impact of potential market volatility in your portfolio.

Consider moving a portion of your portfolio into products that are guaranteed or subject to minimal fluctuation. Think of these assets as setting a foundation to meet your income needs for the next 10 years or so. The remainder of your portfolio can be invested to generate additional growth to help meet future income needs or to pass on to your heirs

Matching specific assets to various types of accounts (taxable, tax-deferred and tax-free) can help improve the efficiency of your portfolio.

6. Determine Your Withdrawal Strategy

Experts recommend several methods to review to help determine your income in retirement. Here are a few of the top choices:

The 4% Rule

The 4% rule says you withdraw 4% of your retirement savings in your first year of retirement, then adjust that dollar amount by 2% each year thereafter to adjust for inflation.

For example, if you have $1 million saved under this strategy, you would withdraw $40,000 during your first year in retirement. The second year, you would take out $40,800 (the original amount plus 2%). The third year, you would withdraw $41,616 (the previous year’s amount, plus 2%), and so on. You always have the ability to increase or decrease these amounts based on your actual lifestyle and expenses.

A Systematic Withdrawal Plan

With systematic withdrawals, you only withdraw the income that is driven by dividends and/or interest created by your investments. Because your principal remains intact, the theory is that you will likely not run out of money and you will grow your allocation of investments over time.

However, the amount of income you receive in any given year will vary, since it depends on market performance. There’s also the risk that the amount you’re able to withdraw won’t keep pace with the cost of living.

The Bucket Strategy

This strategy consists of allocating your savings into different accounts based on your expenses. For example, you might keep a few months worth of emergency savings in a fixed return account like savings. You could keep another portion of your money in an immediate, or income annuity that provides guaranteed payments for life or for a specific period of time selected by you based on your life expectancy.

These annuities can cover everyday expenses like food, housing, taxes, health care costs and transportation. Finally, you could keep some of your nest egg invested for the long term in stock market mutual funds or individual stocks. Long-term savings in your retirement or investment accounts.

No matter what strategy, or combination of strategies you consider, it’s always a good idea to sit down with an investment company (preferably one that charges you a flat annual fee for helping you manage your money) or an experienced financial advisor.

Common Sources of Retirement Income

Let's take a more in-depth look at the most common retirement income options:

Social Security benefits

The foundation of most investor's retirement plans are Social Security payments provided by the Social Security administration. This is a comprehensive federal government program designed to provide partial replacement income for retirees and their spouses, those whose spouse or qualifying ex-spouse has died, and the disabled. However social security can be affected by supplemental income, so this is something you should factor for. Your social security benefits are not affected by annuities though.

Defined Benefit Plans (Pensions)

If you are lucky enough to have a defined benefit plan, or pension, congratulations! As defined contribution plans, like 401(k)s, have become the mainstream employer-offered benefit, defined benefit plans have become less common, despite the retirement certainty and security they offer.

A pension plan offers guaranteed retirement benefits for employees. They are largely funded by employers, with retirement payouts based on a set formula that considers an employee’s salary, age and tenure with the company.

Defined Contribution Plans (401k/403b)

Defined contribution plans allow an employee to make contributions from his or her paycheck either before or after tax, depending on the options offered in the plan. The contributions go into an investment account, with the employee often choosing investment options from a selection provided under the plan. In some plans, the employer makes contributions, with or without employee participation.

A 403(b) plan is actually a tax-sheltered annuity offered by public schools and certain tax-exempt organizations to their employees. Generally, these annuities are funded by an employee's salary deferrals and employer contributions.

Related reading: Annuity vs. 401(k)

High Yield Saving Accounts

These are low-risk investments that can provide liquidity for emergency and other short-term needs. Some online savings accounts offer interest rates much higher than traditional brick and mortar banks.

Mutual Funds

General income mutual funds, which are focused on bond and fixed income assets are not specifically designed to provide retirement income, but they can fill a fairly conservative role as part of an overall portfolio. Retirement income mutual funds are a version of mutual funds that provide retirees with a stable source of income plus the potential for growth. These unique funds focus on dividends and interest as a way to drive income.

Traditional IRAs

A traditional IRA is an Individual Retirement Account into which you can contribute pre-tax money. With a traditional IRA, your money grows tax-deferred, but you’ll pay ordinary income tax on your withdrawals when you retire. Also, like most retirement accounts, the government forces you to take minimum distributions from these accounts after age 72. Unlike with a Roth IRA, there are no income limitations to open a traditional IRA.

Roth IRAs

A Roth IRA allows you to contribute after-tax dollars to your retirement plan. While buying a Roth provides no tax benefits in the year that you buy it, your contributions and earnings can grow tax free. Even better, because you already paid taxes on the money used to buy the product, you can withdraw money tax and penalty free after age 59.5, and once the account has been open for five years. Other advantages of having a Roth IRA:

• You can contribute at any age as long as you have income that falls within the income guidelines.
• Unlike traditional IRAs, you don't have to make mandatory withdrawals at age 72, allowing you to grow savings even during retirement.
• If you pass your Roth IRA onto your someone, their withdrawals will also be income tax free.

However, there are income limitations to open a Roth IRA, so not everyone is eligible for this type of retirement account.

Annuities

Annuities are products offered by insurance companies.

You can buy annuities through life insurance agents, financial advisors, or even direct online from companies like Canvas Annuity. You provide the funds to the insurer now (either in a lump sum or through monthly payments), the money gains interest, and you receive payouts as dictated by your contract.

Annuities can give you a fixed stream of income that lasts the rest of your life. This distinguishes annuities from other types of savings products mentioned in this section. That is why this product can be a good choice for retirement.

There are generally two ways to think of annuities, by risk profile and by reason for purchase.

Risk Profile

Annuities are available in three risk categories, namely fixed, fixed-indexed, and variable. Fixed annuities are the most conservative and least risky choice, and – with social security benefits – can provide a solid, guaranteed foundation for your retirement. Fixed-indexed annuities are a hybrid of fixed and variable, with guaranteed minimum returns, but more upside potential than fixed annuities.

Finally, there are variable annuities. These products offer an upside linked to the stock market and other funds, but they can also lose money.

Reason for Purchase

When you are looking to accumulate money prior to retirement, you can purchase a deferred annuity. When you are ready to begin receiving guaranteed payments, you can purchase an immediate, or income, annuity.

Annuities are taxed based on the type of annuity you own (qualified or non-qualified).

Understanding the different types of annuities, along with consulting with a financial and tax advisor can help you make good investment decisions and determine where an annuity might fit as part of your overall retirement plan.

Adding Canvas Annuity to Your Retirement Income Plan

When assembling your plan for retirement, there are a myriad of product choices, each capable of filling a role in your plan. For the most conservative bucket of your plan, fixed annuities are an excellent, guaranteed way to grow and distribute money. When buying an annuity to grow assets before retiring, a deferred annuity from Canvas Annuity can fit the bill. Canvas features some of the highest rates in the nation and offers the added benefit of purchasing directly online in just a few easy steps, or via a sales consultant over the phone. Visit Canvas today at www.canvasannuity.com.

Citations:

Forbes – Determine Your Hierarchy Of Needs For Retirement (Next Avenue 2004)

US Bank – Retirement income planning: 4 steps to take (2022)

TRowePrice -- How to Determine the Amount of Income You Will Need at Retirement (Young)

Money Rates – When Is Tax on A CD Due? – (Barrington 2021)

Safemoney.com – What Are Major Sources of Retirement Income for Americans? – (Retirement Planning 2021)

Calculator.net - https://www.calculator.net/retirement-calculator.html

IRS.gov -- Retirement plans, definitions

Charles Schwab -- What is a traditional IRA?

Charles Schwab -- What is a Roth IRA?