Why You Should Solve for Retirement Cash Flow, Not Income

Other Income Sources

For many people, retirement funding does not rely on a single source of income. Instead, their cash flow comes from a combination of sources, which may include a pension, Social Security benefits, an inheritance, real estate, or other income-generating investments.

Having multiple sources of income—including a portfolio structured to include an immediate annuity, a systematic withdrawal program, a bond ladder, a CD ladder, or a combination of these investments—can help safeguard your income if interest rates fall or one of your investments delivers less-than-expected returns.


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Match your essential expenses to guaranteed sources of income.

Answering the Question: Do I Have Enough?

Making the change from saver to spender is a financial and mental hurdle, especially after 30 or 40 years of working hard and choosing to pay yourself first. There is no magic switch to flip to make this transition easy. However, creating a spend-down plan and paycheck replacement strategy will help you map out your path.

The spend-down plan is a piece of your overall financial plan designed to help you spend your assets in retirement and leave a legacy as tax efficiently as possible. Spend-down is the equivalent of the two-minute drill in football – where you have the lead and the ball. It outlines how you keep the ball in your possession, not run out of money while running out the clock, and win the game. Your paycheck replacement strategy is more like the plays you decide to call – that is, which source of income you use to cover your expenses in retirement.

The first question to answer before officially jumping into retirement is whether you have enough. What does your lifestyle cost? What are your sources of income? An unbiased financial advisor with an emphasis on planning can help run the numbers and discuss outcomes. If your probability of success is below your comfort level, you can reduce planned spending in retirement, work a few more years, or take on a passion project. Time is your friend in investing. The more you can delay taking money out of your portfolio, the more time it has to grow.

While more time in the workforce might not exactly line up with your initial retirement dreams, setting yourself up for a secure retirement you can enjoy remains a more than worthy goal. If, on the other hand, your probability of a successful retirement is high enough, you could look at your stretch goals and see if adding one or two of those is in the cards.

Once you are comfortable with your overall plan, the next step is to maximize your outcomes by minimizing taxes over your lifetime.

Balancing act: cash flow vs. liquidity

When it comes to managing cash flow in retirement, there are 2 key concepts to understand: cash flow and liquidity.

Cash flow simply means the amount of cash you have coming in and going out each month (see chart below). Think about it as mapping your income versus your expenses. If you anticipate risk factors that can often come with retirement (health care expense, a downturn in the market, or a family emergency) then consider increasing your position in cash (or cash equivalents like Treasury bills, CDs, and money market accounts).

Liquidity refers to the ease of turning an asset to cash—and how quickly you can access that cash. The easier an asset can be converted to cash, the more “liquid” it is. For example, your cash holdings in your brokerage account are more liquid than your house. Similarly, you can sell shares in a mutual fund to pay for expenses. However, you can’t immediately convert certain insurance policies into cash (without generally paying penalties or surrender fees) or quickly sell valuables such as art or coin collections.

Like many challenges in retirement, this is also a balancing act. If you have too much money in cash, you can be missing out on potential growth. At the same time, you’ll want to consider which assets will be available to you over the next few years to help pay ongoing expenses in retirement.

Your Cash Flow Needs

The amount of income you report on your tax return may be quite different than your annual cash flow needs. For example, in early retirement, you may report less income on your tax return, and in later retirement, you may report more income—yet your cash flow could remain the same. How could this be?

Suppose you retire at 65, but you make a plan and start Social Security at age 70. To meet your cash flow needs from 65 to 70, you buy an immediate annuity with a five-year payout, and you buy it with non-retirement money.

Note The monthly annuity payment you receive will provide cash flow, as each payment you receive is a combination of principal and interest. However, only the interest portion is considered taxable income on your tax return. In this situation, you have more cash flow than income.

Now, fast forward seven years. At age 72, you are required to take annual distributions from your retirement accounts. These withdrawals are reported as taxable income on your tax return. Each year you get older, you must withdraw a larger portion of your remaining retirement account. You may not need to spend it all. In this case, you have more income than your cash flow needs require.

Do Your Best, But Be Ready for Updates

By this point in the process, you’ll realize that financial planning is an art, not a science. You can’t predict your exact income or expenses. You may not get that part-time job. You may incur unexpected medical expenses. You may receive an inheritance. Start with your best guess, with the idea that you will review your plan annually, if not two to three times a year.

Once you have your best guesstimates laid out year by year, you’ll probably find that your planned cash flow is not consistent. The money you’ll spend on that long-awaited European vacation the year you retire will take your cash flow down a notch, while the proceeds from the lake house you plan to sell when you’re 70 will bump up the flow.

As you can see, at its core, cash flow analysis is a simple exercise. It’s also an incredibly important one that helps you recognize your cash flow needs and their timing. Once you know what costs you’ll need to cover when, you can plan to set money aside or use money from your investments to carry you through any lean times.

Planning can help you achieve a positive cash flow, which can help you attain happiness in retirement.

Regular monitoring

Plans and projections are always subject to change. Even with reasonable assumptions about investment returns, inflation, and retirement living costs, it’s likely you will encounter numerous changes to your cash flow over time. Frequent monitoring of your income and expenses will detect changes that you can address in a timely fashion to prevent significant problems down the road. Experts often recommend a monthly review of your budget, as well as a comprehensive annual review of your financial situation and goals. While you can keep track of your situation with paper and pen, specialized software may make the task easier, especially if your finances are relatively complex.

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