Most retirees transitioning away from work have spent the better part of 40 years paying their bills with a steady stream of paychecks. Yet when retirement begins, the paychecks stop. This leads to one of the most natural—and pressing—questions for retirees: How will I replace these steady wages so I can fund expenses for the next 30–40 years?
The most straightforward way to facilitate retirement cash flow is to recreate ongoing paychecks. In the early days of retirement planning (the late 1940s through the 1960s), the solution was relatively simple: Retirees bought bonds, which generated periodic interest payments (to the retiree) in the form of coupons. People merely had to make sure they had enough coupons to cash in as retirement “paychecks.”
Then, inflation in the 1970s ravaged the purchasing power of bonds by 57% in the span of a decade. Retirees in the 1980s shifted to the alternative income vehicle of dividend paying stocks, which could better keep up with inflation. The paycheck replacement strategy was essentially the same, though: Buy enough dividend-paying stocks (as opposed to interest-paying bonds) to cover regular expenses.
Yet one complication with dividend-paying stocks is that they also incur capital gains and losses. Unfortunately, capital gains are not nearly as stable as dividends or interest, often producing large distributions in some years and little to no (or even negative) distributions in other years. This makes them less conducive for generating regular payments to retirees.
The good news is retirees can balance these three sources—interest, dividends, and capital gains—to create retirement income and wealth. When combined with ordinary income and the other two “legs” of our New Three-Legged Stool™ approach (tax-deferred accounts and tax-free Roth IRA distributions), all these tools create a tax-efficient strategy.
The bad news is that it can be challenging to figure out where the cash to generate regular retirement paychecks should come from.
This is where a financial adviser who is trained as a retirement specialist can help. At Rodgers & Associates, we can set up monthly electronic transfers directly from a client’s investment account into their checking account. Our process helps ensure there’s available cash to transfer. We work throughout the year to determine that it is coming from the most tax-efficient source.
So how do you plan a retirement paycheck?
Begin with any outside sources of income. An employee covered by a pension will be required to make a payout election (which is often irreversible). The decision typically includes whether to cover a spouse over joint life expectancy with all or some portion of the benefit. Generally, the option based on a single life expectancy offers a higher monthly benefit. The option based on joint life expectancy is smaller but provides lifetime income and greater security for the employee and spouse.
Another important source of outside income is Social Security. One of the most important decisions for retirees is when to begin taking Social Security benefits. Eligible workers can start drawing benefits at age 62, but benefits increase every month they wait to draw until age 70. People who use other retirement accounts and personal savings may be able to delay benefits as they continue to grow.
Where pension income and Social Security benefits are used to create regular, predictable income, investment and retirement accounts can help adjust for shortfalls and inflation.
The bottom line is to recognize that generating “income” in retirement is not merely an investment issue. In some cases, it is a straightforward mechanical problem—figuring out how cash will show up in your bank account every month.
Generating a regular paycheck for our retired clients is a matter we take seriously. We believe that combining income, dividends, capital gains, and IRAs succeeds in both good times and bad. We continue to review our policies and strategies to fine-tune our approach.
Rick’s Insights:
- Capital gains can be substantial yet unpredictable, making them far less conducive to a steady retirement paycheck.
- Planning a retirement paycheck begins with outside sources of income like pensions and Social Security benefits.
- Tax efficiencies can be achieved when ordinary income, qualified dividends, and long-term capital gains are combined with distributions from tax-deferred accounts and Roth IRAs.
