Like most Boomers who are either already retired or planning for the day your paycheck stops, you have probably saved some amount of money to be available for the years you are not earning a salary. And you may be quite knowledgeable about retirement savings accounts like the 401(k) or IRA, or investment products like mutual funds, stocks and bonds.
The next stage of your financial life – converting your savings into the maximum amount of dependable, spendable income – is often more complex and confusing. It also comes with a whole new set of terms.
In the spirit of national Financial Literacy Month, I will provide short explanations of these important terms. While the meanings of the terms are important to understand, it is more important to know what they mean for you and your family as you create a plan for retirement income.
Planning for retirement income
First, recognize the distinction between spending down your accumulated savings — what some planners call decumulation — and creating a plan to provide retirement income. Although it’s basic, you need to know the definition of income, which is an amount of money received without any other financial effect. In other words, the income doesn’t reduce savings you have in the bank or elsewhere; income comes from Social Security, an income annuity, dividends on stocks, and traditional pensions.
Income is not a withdrawal. When you sell investments to pay for your monthly expenses, for instance, you face the problem of possibly running out of money before you run out of retirement. That could be a risky strategy.
Planners often rely on retirement calculators to measure the amount of that risk by using so-called Monte Carlo simulations that, just as the name implies, estimate the gamble you are taking when investment returns vary above or below the long-term “average” rate of return in the market.
The flaw in that approach is that most people do not achieve the average returns, in part because when the market inevitably takes a severe downturn, individual investors often sell their stocks or mutual funds and then can’t earn back their money when the market recovers.
The best approach is to focus on creating spendable (money after taxes paid) and dependable (money you can count on) income, while reducing your risks.
Products that provide income
Social Security payments are immune from market highs and lows. So are traditional company pensions. They can both provide true retirement income.
Another product that provides the same type of income for the rest of your life is an income annuity. There are several forms. You can purchase an immediate annuity that provides guaranteed lifetime income starting within 13 months. Like all other income annuities it can be customized to your personal circumstances.
You can also buy a deferred income annuity by paying an insurance company to provide a guaranteed amount to you at an age you set in the future.
A specialized deferred income annuity is called a QLAC, or Qualifying Longevity Annuity Contract, purchased from your IRA or 401(k) account to provide income late in retirement – usually when you are 80 or 85. A QLAC will help you pay for expenses that typically arise later in life, and also reduce your required minimum distributions.
Another source of income early in retirement can be a reverse mortgage, sometimes called a Home Equity Conversion Mortgage (HECM). This can be designed to pay you a monthly amount based on the equity you have built in your home. It is important to use this source in moderation. If not, there could be a financial impact on the long-term value of your home if you plan to leave it as a legacy.
Products that supplement your income late in retirement
While spendable, dependable income can be created to pay for your essential costs of living, there are often needs for additional sums, particularly late in retirement.
Because most people who live long into retirement will need the services of a caregiver, you might also consider Long Term Care (LTC) insurance, which depending on the terms of the policy, will pay for in-home or nursing home care for between three to six years.
Your home can be a source of liquidity for late-in-retirement expenses as well. A HECM described above can create liquidity that can be accessed when these expenses occur.
Properly designed and integrated into your retirement income plan, a HECM allows you to stay in your home and the loan is repaid only upon your death, or that of your spouse, when the house can be sold.
Taken together, some of these products offer a unique solution to your retirement income plan.
LTC insures against caregiver and related expenses that can quickly deplete savings. LTC and QLAC combined can provide you with confidence in your ability to avoid becoming a financial burden to your children late in life.
A HECM combined with QLAC (quite a mouthful) could also boost financial security over the life of your retirement. HECM provides cash payments that you could take early in retirement; QLAC would provide additional income late in retirement.
People and providers
Planners often offer investment advice to Boomers and specialize only in predicting how long your savings will last. If you plan to live longer than the number they provide, you will be advised to cut down your spending. To protect yourself, you need to research your prospective planner’s background and licensing credentials before you hire, and to see if they can offer all the income products listed above. The term “financial planner” doesn’t necessarily explain the licenses a financial advisor holds.
An annuity carrier is an insurance company that backs the guarantees of the income annuity you buy. Make sure you are working with a highly rated company. There are many that have been in business for a century or more.
A provider of reverse mortgages is a specialized mortgage company that will help you access the liquidity in your house. Make sure your reverse mortgage has FHA insurance.
Remember that you are responsible for your own financial decisions. You can educate yourself on available options to provide dependable, spendable income and then find an advisor who understands how a reverse mortgage, an income annuity or long term care insurance might address your unique needs.
The next step in planning for retirement, which many people don’t consider, involves the technical aspects associated with taxes, risk management and benefit claiming decisions so that you can plan your retirement with certainty. As you become more confident in your financial literacy, you will also gain peace of mind about your future.
You don’t have to wait until the next installment to get a better understanding of how your savings can best serve you in retirement. Visit Go2Income to learn more.