Managing Income Streams for Retirement

When approaching retirement, many families focus on their ability to reach financial independence based solely upon their investment holdings and savings.  While their investments are, of course, an important part of their overall financial picture, they are not the only factor in the retirement equation.  What families often miss is the contribution of the various income streams that they will expect to receive in retirement.  Social Security benefits, a pension, annuity payments and rental real estate can all play a significant role in securing financial independence—especially for wealthy families. A common rule of thumb in financial planning is that a 4% withdrawal rate from investment accounts is generally a prudent limit, in order to assure ongoing sustainability of the underlying assets.  In other words, if a family withdraws much more than 4% per year from their investment accounts, the chances begin to increase that their account values will draw down over time. With prudent withdrawal rates in mind, let’s think about a practical example.  For a family with investment accounts of $5 million who are just beginning retirement, a 4% withdrawal rate would equate to $200,000 per year that they could reasonably expect to take from their portfolio.  But let’s also consider that this family would like to budget for $300,000 of annual spending in retirement.  How might they get to their higher spending number without taking too much risk?  The answer lies in the other streams of income that will be available. Social Security Social Security payments will provide a significant benefit for retirement planning, even for high net worth families.  According to the Social Security Administration, the maximum benefit paid to those who reach full retirement age in 2019 is $2,861.  Also consider that a spousal benefit is one half of the earning spouse’s benefit.  Thus, a married couple retiring in 2019 with a full Social Security benefit and a spousal benefit would be collecting a combined $4,291.50 per month, or $51,498 annually. For a retired couple with an annual spending goal of $300,000, an annual Social Security benefit of $51,498 would comprise more than 17% of their annual budgetary need.  In addition, Social Security benefits are indexed for inflation.  Benefits go up over time, concurrent with the rising cost of goods and services.  Each year, the government assesses the US inflation rate and gives Social Security benefits a cost of living adjustment, otherwise known as COLA. Pension and Annuities High net worth families will often have other income streams in retirement that are distinct from Social Security.  While not as common as in the past, private pensions still exist for the former employees of larger US companies.  Annuity payments are another form of cashflow.  While annuities come in many different forms, a guaranteed monthly or annual cash payment from a private insurance company is often the end result in retirement.  Supposing the family with a $300,000 annual spending goal had an extra $2,000 per month coming in from a pension or annuity payment, this would comprise an additional 8% of their need. Rental Real Estate and Royalties It is common for high net worth families to own real estate that is not their primary residence.  Whether it be a house on the beach, a ski condo or a rental apartment, these assets are often very useful in providing cashflow in retirement.  Suppose that a family owns a rental condo in the city where they live.  Also suppose that net of insurance and HOA dues, they earn $25,000 in annual rental income. It is also fairly common for families to own interests in energy or minerals, such as a partial interest in a producing oil well.  Much like rental real estate, the passive income from royalty payments is a monthly or annual addition to a family’s income stream in retirement. Putting it All Together The family in our example could safely withdraw about $200,000 per year from their investment accounts.  In order to meet their annual spending goal of $300,000, the combination of Social Security benefits, annuity payments and rental real estate income provides an additional $117,000 per year of income.  By factoring in these income streams external to their investment portfolio, the family can reasonably achieve their spending goals without taking on excess risk. When creating your own plan for financial independence, it’s critical to work with an advisor that is taking a comprehensive view of your wealth.  The difference could be the projected sustainability, or instability, of your retirement plan.   Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.