(This article appeared previously on MarketWatch.com.)
When planning for a major event, financial or otherwise, the key to success is starting with the right question. If you don't do this, it's easy to get sidetracked and not accomplish what you set out to do.
The looming question in every person's mind contemplating retirement
is: “Will I have enough assets to last for the rest of my life?” This is a natural question, since asset accumulation is the name of the game for virtually every financial planning goal. This is the wrong question to ask, however, when it comes to retirement income planning. The primary issue with using the traditional asset accumulation approach for retirement planning is that we don't know how long we're going to live
The Right Question
So what is
the right question to ask when planning for retirement? Ask yourself the following question on a regular basis: “What is the amount of sustainable income that I will need during different phases of my retirement years?”
(MORE: 7 Secrets of Highly Effective Retirement Savers)
Asking this question frames retirement planning in a totally different light than the traditional “Will I have enough assets to last for the rest of my life?” While asset accumulation is the name of the game for most other financial planning goals, sustainable lifetime income is the cornerstone of retirement income planning
Purpose of Sustainable Income
We all have nondiscretionary expenses that must be paid which, by definition, aren't optional. These include rent or mortgage payments, real estate taxes, homeowners' dues, utilities, food, and income taxes. The primary purpose of sustainable income is to create a known floor of income to cover nondiscretionary expenses throughout retirement.
Sustainable income can also be used to cover quasi nondiscretionary expenses, including autos, clothing, insurance and repairs. As a general rule, the more conservative you are, the greater your need for sustainable income will be.
While it's important to have sustainable income, a fixed monthly income for the duration of retirement generally won't meet your financial needs. It's also essential to recognize that retirement has distinct phases with different types and amounts of expenses.
(MORE: Lifestyle Investing for a Successful Retirement)
Three phases of retirement are described in Michael Stein's book, The Prosperous Retirement: Guide to the New Reality. They are the Go-Go, the Slow-Go and the No-Go. You need to identify and project your inflation-adjusted, nondiscretionary and quasi nondiscretionary expenses in each of these three phases and design a sustainable income plan to meet your needs during each phase.
Sources of Sustainable Income
Let's say you've identified your projected inflation-adjusted nondiscretionary and quasi nondiscretionary needs during your various phases of retirement. Where do you turn for sustainable income?
is the most prevalent and best example of sustainable lifetime income. While everyone knows that there are issues with the Social Security system in its present form that must be addressed and that will likely result in less favorable benefits for younger individuals compared with current recipients, the fact remains that you can plan for sustainable lifetime Social Security benefits.
(MORE: Social Security's Real Retirement Age is 70)
Sustainable lifetime income sources aren't as readily available in the private sector with the widespread elimination of traditional defined benefit pension plans. The good news is that there's a long-established reliable source of sustainable lifetime income that's competitively priced and offers creative solutions in the commercial sector. It's known as a fixed income annuity
and is offered by life insurance companies. For more on fixed-income annuities read my blog post, Sustainable Lifetime Income When You Need It
Fixed-income annuities have been available in the U.S. for over 250 years. They come in three flavors: single-premium immediate annuities (“SPIA”), deferred-income annuities (“DIA”) and fixed-index annuities (“FIA”) with income riders. While there are significant differences between each type, the basic purpose of each one is identical, i.e., provide sustainable income for a defined period of time. The income is generally for life; however, DIA's can be purchased for a specified term of years or months.
Sustainable Income Plan
When analyzing fixed-income annuities, the goal is to use the least amount of assets to purchase the amount and timing of income to match your projected financial need in each phase of retirement, taking into consideration existing sources of sustainable income such as Social Security. This requires the design of a sustainable income plan by an experienced retirement income planner who will identify and optimize a customized blend of the appropriate fixed income annuity types, products, and current and future investment amounts and the timing required to meet your retirement income planning needs.
What is the amount of sustainable income that you will need during different phases of your retirement years? If you ask this question when planning your retirement, the likelihood of developing a plan to experience a financially successful retirement will be much greater than if you simply ask, “Will I have enough assets to last for the rest of my life?”
Robert Klein is a contributor to MarketWatch's RetireMentors. He is the founder and president of Retirement Income Center, a retirement income planning firm in Newport Beach, Calif.
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