Friday, February 6, 2015

Financial Planning – Part 5 – Income management

Pension

After 30+ years with the same company, my defined contribution pension plan was about 40% of my pre-retirement salary.  The only decision to make here was to take a slightly lesser amount but with a 50% continuation for my wife if I pass away before her.  Since women usually outlive men, this is a good decision to make.

Social Security

It was a question in our email group about social security that started the whole discussion.  You have probably seen many articles in the online news or other Internet sources about financial advisors suggesting that you delay taking withdrawals from social security for as long as possible.  However, while it is true that the longer you delay (up to age 70), the higher your payments will be, the truth is that that does not factor in the number of payments you are likely to get.  The truth is that the system is designed so that the average person will get the same amount of total from social security no matter whether they begin taking payments at age 62, age 66, or age 70.  The totals from all those starting points will be about the same by about age 80.  So, if you die before age 80, then you will have more income by starting earlier, and if you live longer than age 80, you will have more income in your later years.

But that’s just the financial side of things.  I considered two factors in making my decision to start social security at age 62.  First, I considered my own life expectancy.  My parents and all their siblings, except my mother’s youngest sister who is still living, passed away at an average age of 84.  My own life expectancy, given that I had a major heart attack at age 56, is about the same.  So the financial equation is not significant to me.  What is more significant is that I’d rather have the money now, when I can use it, than later when it would just be more money available to pay a nursing home.  My grandchildren are young enough now that we can spend time with them.  My wife and I are healthy enough that we can do things now.  But neither of these may be true when we’re in our 80’s.

IRA

I initially just rolled my 401K into an IRA, since it was going to be a year before I could take any withdrawals without a substantial penalty.  Then I considered what I wanted to do with it.  I don’t believe the goal in life is to just have a lot of money left around to leave to your children/grandchildren.  Certainly they will be the recipients of at least some of our assets when my wife and I are gone, but that was probably a couple of decades away at that point. 

In the end I decided to split it into two pieces.  One third I put into a mixed basket of mutual funds, some stock-based and others bond-based, with a portion in cash-equivalents.  I balanced the risk of the entire pool of funds to be about 60% stocks, 30% bonds, and 10% cash.  That is just sitting there, not being touched in the short-term.  While the percentage split changed during the recent economic downturn, the whole basket weathered it nicely and it’s continuing to build in value.  If I never have to touch it, that’s fine, but otherwise it will be the place I turn to in my later years.  The fact that this is a long-term asset is why I can be somewhat more aggressive in the stock-to-bond ratio than if it was my primary source of near-term income.

The other part of my IRA was used to purchase a variable annuity that generated a continuous stream of income that was guaranteed for as long as either my wife or I were still living.  Since I purchased it at a relatively young age, and before the recent market turndown, I have a guaranteed withdrawal rate higher than I might otherwise.

Expenses

I also put some thought into my expenses during retirement.  While many of them would not change such as food, others such as gasoline would be reduced since I was no longer commuting to work every day.  And some, such as home maintenance would probably increase as our house got older.

In the end, I had a budget with sufficient income to meet all our expected expenses.  While I did not have income from my IRA until age 59-1/2 and income from social security until age 62, those few years of reduced income and having to use some of our accumulated savings were not a major factor.

Chief Learnings

There are a lot of things to consider when you retire – getting professional advice is useful

Balance the level of risk you are willing to take to match your circumstances

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