Early in my career, I quickly learned that fear can motivate but only on a short-term basis. Sustainability of fear-based results had limits and drawbacks. However, a little bit of fear can motivate but lots of it can paralyze.
Fear in retirement planning is the same way. A little fear can motivate to change and take action. Lots of it can numb you into believing there is no hope.
In 2012, I was 48 years old and my net worth was $155,000. I had debt and two kids nearing college age. I don’t have a precise recollection of what caused me to wake up. It was probably a multitude of things but I do remember one event vividly.
My company changed some retiree healthcare rules in which I was not grandfathered. At the time, I had enough years with the company to earn the benefit but then the curve ball. Thankfully, I have since earned the benefit and feel good about it sticking this time.
That event woke me up to the concept that nothing is sacred and the game can change. I felt that the only person I could rely on was me and not my company, the government, or any possibility of an inheritance. Even the best of employee-focused companies (like mine) can/will change the rules.
That was my moment and it woke me up. Nine years later my net worth has gone from $155,000 to nearly $900,000 today. And that’s with putting two kids through college debt-free and having a stay-at-home wife.
That’s all great but what really matters when it comes to retirement is cashflow. The income you produce from assets or other methods to make sure you can live the kind of lifestyle that makes you happy. Gathering assets in pre-retirement is one thing but turning them into income is where many struggle.
Income Approaches
There are multiple approaches to providing retirement income. These 3 are the more popular ones that get most of the press:
- Income Floor (my approach)
- Bucket System
- Systematic Withdrawal
These all have their pros/cons. I’m not here to convince, sell, or even educate on any of the three. There are plenty of resources available to do your research. Let’s at least touch on them for basic understanding.
The income floor (or essential vs discretionary) approach focuses on expenses and trying to provide secure, low-risk ways to meet those costs. Pensions, social security, annuities, and bond ladders are typical ways to provide a secure income floor.
The basic premise of the bucket system is to create a diversified portfolio with three time horizons: (1) first 5-10 years of retirement, (2) next 5-10 years, and (3) the remaining years. The investments in each bucket are appropriate for your time horizon. The first bucket is more focused on low risk assets while the other two buckets have more of a growth focus.
The systematic withdrawal approach is probably the most popular way people convert assets to living income. Basically, a diversified portfolio sold off systematically to generate your income. It takes a total return approach and it’s critical you follow an asset allocation and strict portfolio withdrawal percentage. Many follow the “4% rule” type of approach to determine the withdrawal amount.
My Plan (Income Floor)
There are several ways to create an income floor but the greatest way of all is with a pension. The only part of this “way” is to identify a company that has a pension and stick with them for several years. So far, after 22 years, I’ve been lucky that the pension is still accruing and funded.
Many people start with a company and then see their pension freeze or they leave the company. If my plan continues to play out, in 5 more years I will have created an income floor that will be the basis in providing a comfortable retirement.
My $1.1M portfolio (not including the NQ 401k) will become at least $2.5M by the time I’m 90 years old. Also important, I should only have to withdraw from the portfolio less than 1% (on average) annually over the 28 years of retirement.
My NQ 401k will pay out over 5 years to combine with my pension. This combination will take me to social security, which I show in this example to be taken at 67 years old. I’ll run more scenarios to see if waiting until 70 to take social security is best (and I’m betting it will be).
In the exercise, estimate your expenses so that you know how much of an income floor you need to cover spending. My retirement expenses are about 60% essential and 40% discretionary. The income floor enables my wife and I to splurge on occasion because all our forecasted expenses are met at a 99%+ level.
If I didn’t have the pension, I’d likely use a combination of approaches (floor, systematic, bucket) to create a steady retirement income. And please, I’m well aware that my last article called pensions a time bomb. But now, the biggest question I face over the next 5 years is what if my company freezes my pension?
What if My Pension Freezes?
My biggest fear, the fear I’ve had the past 10 years, is will the pension freeze before I retire? Last week, I had a colleague at work (who is my age) say she’d probably work another 10 years. Her reason was that she didn’t have as many years in the pension (she has 14) as I have. After our discussion, I found she has more fear of a pension freeze than I do.
I’ve got 22 years in my company pension today and hope to retire with 27 years. If the pension froze today, my 22 years would mean a significant cost to my portfolio. As I calculate, it would cost me nearly $866,000 ($2.559M – $1.693M) over 28 years.
Now this is only 1 scenario but the big hit is the first 3 years. During the first 3 years of retirement, I’ll be pulling a withdrawal rate averaging 6% over those years. That’s a lot of compounding that I’d miss over the next 25 years.
Of course, we could minimize our expenses those first 3 years and try to keep the withdrawal rate at 4% or less. Like I said earlier, 40% of my expenses are discretionary so it could be done. I’m not sure we’d be willing to significantly reduce travel those first few years though.
Summary
So, do I have a fear of running out of money in retirement? The closer I get to retirement and run scenarios like these I’d say no. I’m fairly conservative with my income projections and my expenses are 40% discretionary … it shows I’m in pretty good shape. My income floor should keep us afloat during the worst of times and our portfolio will smooth out the rough moments.
What I’m happy to see is that even if the pension is frozen today then we’d be ok. That is a big relief and takes some of the fear out of the equation. If I didn’t have such a great income floor, then I’d likely use a combination of approaches to providing income. Though annuities won’t be in my future, they could work for others based on their circumstances.
The charts in this article are probably the most important charts I’ve produced so far. Just one picture tells me my cashflow will be good, the source of that cashflow, how much of my portfolio I’ll be withdrawing, and what my balance will look like near the end of my life.
Thanks for reading!
Mr. TLR