Your Retirement Income:
Determine How Much Per Year You Will Be Able To Make in Retirement
In order to do this, you will need a handle on what sort of investments you will
ultimately make. Even if you’re fortunate enough to be receiving substantial
retirement income from the sale of a business, a settlement, or something else,
it’s reasonable to assume that at least a portion of your income will be
acquired by putting your money to work for you.
Let's look at two different kinds of investments, managed
funds, and municipal bonds. You MUST invest in something, so that you will have
as much money as possible in your retirement. Your aim should be to outstrip
inflation, AND increase your wealth, so that as the years go on (even if you
live much longer than you think you will) you're assured of an income sufficient
to live in the way you want to live.
Putting your knowledge to work: managed funds
When you're ready to retire, you've spent years working, so
you have more than enough experience to manage your money. There's plenty of
information available, from newspapers to books, and online resources. Trust
yourself, and explore the world of managed funds. There are so many different
funds available, that you will find one in which your own interest and
experience can come into play, and you can enjoy watching your money grow.
A managed fund is just what it sounds like – investors
have pooled their money, and managers put the money into various investments. All
managed funds are different, and their goals vary. Some are long-term
investments, others invest for short-term income, and some go for a combination.
Note: income funds usually invest in bonds (see the next section) and offer a
lower return because they generate income, so these income funds are favored by
many retirees. With any fund, your money investments are diversified, so you own
tiny portions of shares of stock or whatever the fund invests in.
There are various different kinds of funds: open-ended
funds, and close-ended funds.
Funds grow, and as they become successful, more and more
people want to invest in them. A fund that grows and takes in all the money that
people want to invest is called an open-ended fund.
Where open-ended funds are a kind of free-for-all,
close-ended funds set a limit on the number of shares which can be sold to the
public, and once the fund is fully subscribed, it's closed. At that time, no one
can buy into the fund unless someone sells out.
Entry and exit fees into managed funds
Since managed funds need people to manage the money, a
portion of the investment returns are used to pay the people who manage the
fund. That's an expense. You also incur another expense when you buy into a
managed funds: an entry fee, and later, when you want to leave the fund, you
incur an exit fee.
Entry fees are usually charged as a percentage of the money
that you're investing. If you intend to leave your money in the fund for years,
this won't concern you. However, if you think that you may want to withdraw your
money within a year, you'll lose that percentage minus or plus any loss or
profit the fund made during that time. You'll lose around the same percentage as
an exit fee when you leave the fund.
AAA-insured fixed-income municipal bonds as your primary source of income
That said, we recommend considering municipal bonds.
Municipal Bonds aren’t as hot as stocks because they’re simply not as
“exciting” nor are they as “flashy.” No one gets rich overnight holding
onto municipal bonds, but no one goes broke overnight either.
When you invest in fixed-income bonds you are guaranteed a
set amount of annual income from your investment. Assume, for example, that you
purchase $250,000 worth of bonds paying 6% and that those bonds mature in 16
years. You would then be guaranteed $15,000 worth of income from those bonds for
the next 16 year (note: many bonds also have “call” dates which provide the
issuer with the option to return your money to you and stop paying a few years
shy of the maturity date).
Municipal bond income is also be exempt from Federal taxes.
If you live in a state that has its own tax and you purchase out-of-state bonds,
expect to pay a small amount of state income tax on the money received from the
bond issuer. If your state has no income tax (i.e.
, etc;), you can purchase bonds issues by any town in any state and avoid paying
income tax on the money received from them altogether.
Municipal finds versus stocks
How does this compare with stocks? Even if you could safely
average 8% per year from your “low risk” portfolio, you’d be left with
barely 6% after taxes (or even much less depending on your bracket). And so what
if you can get 9 or 10 or even 11% per year...every year.. from stock
investments before taxes--- when you’re left with 7-8% after taxes, is it
REALLY worth the extra point or two to incur all that risk?
Stocks are NOT reliable in the short-term. When you’re
retired and you need to rely on your investments for income, what happens while
you’re waiting for the NASDAQ to recover one quarter so you can pay the bills?
At work, would you feel comfortable if your employer told
you “We’re going to pay you... It might be $100k this year.. but next year
it could be $10k...maybe even $5 k... some years it’ll be $50k ...but the
average will be 46k!? Of course you wouldn’t be comfortable! Well, that’s
how your life will probably be if you plan to live even partially off of
stocks/mutual funds, etc.
Yes, they may average X% per year and yes, you might be
able to live off on X%--- but what happens when you need money NOW… this
quarter? this year? --and you simply can’t wait for it to “average out”
Bonds represent an EXACT payment amount...a guaranteed
fixed income. No, they’re not as exciting as stocks...There’s no
“chance” of bonds surging dramatically and you getting rich in a year...
Instead, holding bonds is like holding a reliable steady job. You get a fair
income, you know how much it will be and you can depend on it.
Stocks may very well be the better alternative for you if
retirement is still ten or more years away (i.e. you can probably/ hopefully
average out a better return on your money over that many years without needing
to tap your investments for income), but bonds are usually the wiser alternative
for those who need to know exactly how much cash they’re going to have on-hand
each year for retirement.
If you’re really nervous about stability during
retirement, consider diverting all investment income into fixed-income vehicles
and avoid stocks and mutual funds altogether.
Of course, many
will argue that you “shouldn’t put your eggs all in one basket-” --but in
this case, consider just how little their definition of “diversification”
really has to offer.
If you have a $500,000 nest egg and want to put 90% of it
into fixed-income municipal bonds and 10% in the stock market to “make a
little more” or to “diversify” --what happens? Meanwhile, if you purchased
AAA-insured bonds, 90% of that money is super-safe and 10% is now at risk. If
you’re ‘super lucky’ and the stock market BOOMS way ahead of its
historical average to a whopping 14% a year, you’ll make $7,000 a year and,
depending on your bracket and how quickly you withdraw the cash, you’ll have
barely $5,000 left to pocket after taxes.
Simultaneously, you’ll have earned $27,000 from the
$450,000 you invested in fixed-income AAA municipal
bonds at 6% for a total of $34,000 worth of tax-free income per year.
But what if you had just left it ALL in bonds instead of
following the “wizardry” that pushed you to gamble 10% on stocks? You would
have earned 6% on $500,000 per year instead, and “only” made $30,000 worth
of tax-free income. So yes, you would have made $4,000 less BUT you would have
a) kept your money safe, and b) known in advance precisely how much you would
have earned and c) would have avoided all the complications and frustrations of
the stock market.
Remember that the above example only applies if the stock
market beats its historic average and consistently rakes in 14% growth for you
before taxes. What if it “only” yields 12% though?...10%?....8%...?
The difference between all bonds versus 90% bonds and 10% stocks becomes
smaller and smaller and smaller... Is it WORTH all that RISK to have an extra
few thousand dollars?
If the market “only” yields 10%/year before taxes
it’ll barely even be THAT much. Why add unnecessary stress, aggravation, and
risk by buying “just a few stocks” .. “to diversify.” If you know you
need X% to live on and bonds are offering that X% -- be wise and consider taking
it while it’s offered and not being greedy and putting even 10% of your money
at risk for the possibility that you might earn a little more by having some of
it in the stock market.
If you’re not familiar with municipal bonds, sites like http://www.investinginbonds.com/
provide some good introductory info but you certainly don’t need to be
a financial wizard to understand the basics of how they work.
When you purchase a municipal bond you’re not really
investing in a municipality in the same way that you’re investing in a company
when you purchase their stock. That is to say, you’re not giving them money.
Instead, you’re lending them money. The municipality is then obligated to pay
you the COUPON AMOUNT -- usually in two equal payments per year. For example, if
you purchase a $100,000 bond with a 6% coupon, the municipality that issued it
will pay you $3,000 every six months tax-free. When the bond expires or when it
is called, the issuer will repay you the original $100,000. As long as you hold
the bond to maturity [or until it is “called”], its worth to you remains the
same. You will always get that 6% for the life of the bond regardless of market
fluctuations and you will always get back your $100,000 at maturity.
Since you’re lending money to a town, county, or other
municipality, you’d probably like to know something about its credit rating
and ability to repay you. Bonds come with ratings from AAA down to D--sort of
like academic grades in school.
AAA bonds are the safest as they generally come with
INSURANCE-- Meaning that if for any reason the municipality is unable to make a
payment, the insurance kicks in and makes it for them. Of course, you “pay”
a small premium to have this insurance as the higher the bond’s credit rating
is, the lower its coupon rate will be.
Still, historically--- of all bonds rated BB and higher,
there have been only a tiny minuscule fraction of a percent worth of
municipalities that couldn’t make a payment and virtually EVERY case was
resolved (i.e. the municipals didn’t default on the bonds-- they just were
delayed in making a payment or two).
When it comes to AA and AAA bonds, there have been
virtually NO problems in HISTORY-- It is reasonable to argue that NO other
investment is as safe as a AAA-insured municipal bond--- You’re lending money
to an established, creditworthy local government and an insurance company is
backing up pledging that if they don’t make a payment, the insurance company
will step in and make it for them-- and in history, that’s virtually never
even had to happen.
Indeed, there are other variables to learn about when it
comes to bonds that are beyond the scope of this guide.
It is our intent to familiarize you with the basic
concepts, to encourage you to research it further, and to evaluate the
information your advisor gives you about them. Remember: It is often in the
advisors interest to sell you stocks instead--as the commissions and related
incentives for doing so are more advantageous to him or her.
But learn about
maturity dates...and call dates...Learn about the different prices you can
purchase bonds at and realize that if you purchase a $100,000 bond with a coupon
of 5.5% for only $98,000--then you’re really earning an annual yield of
approx. 5.61%. In contrast, a $100,000 bond with a coupon of 5.5% sold for
$102,000 is really only paying you an annual yield of about 5.39% sine you’re
only earning $5500/year on your $102,000 investment.
Finally, be sure to understand that if interest rates
increase while you’re holding your bond and your bond is still far from
maturity, the bond’s value is likely to decrease but only if you sell it
early. As long as you fully intend to hold your bond to maturity (or until
it’s “called” early), you will get back your investment plus all the
interest you earned as fixed-income over the years. There is no fluctuation:
Municipal bonds offer fixed, precise income: Precisely what a retiree generally
needs to live on.
That said, let’s move on to the second worksheet. Now
that you’ve already calculated how much it will cost you to live each year--
The next step is to calculate how much you will be able to make in income.
Print out this form and fill in the blanks.
Annual income expected from social security AFTER TAXES:
Income from investments AFTER TAX/ -- NOTE: This is where BONDS
come into play:
If you invest in stocks, this number is only a guess
whereas with fixed income AAA muni.bonds, it’s a virtual certainty.)
Income from tax refunds (figure out w/ your accountant if
necessary-- Remember that you’ll still probably be deducting property
tax payments, and some other annual expenses to reduce tax burden (if
any)-- possible resulting in annual refunds...)
Other sources of income /AFTER TAXES (i.e. from settlements,
lottery payouts, business sales, etc;)-- Remember to consider whether any
of these will CEASE after X# of years.
At this point, you may find
that the amount you will have each year is less than the amount you will need to
enjoy the lifestyle laid out in the previous step. You may have to slightly
(don’t make it difficult on yourself however) re-adjust SOME figures in your
For example, you might begin by
lowering gift expenditures, reducing vacation budget just a bit, etc. Try to
make the deductions count---by taking just a bit off of each one of several
items--without putting a negative impact on your lifestyle that you know you
won't like once retired--- Tweak your budget.
Factoring In Inflation
This is where your guesstimates com into play.
Even assuming that you’ve tweaked the first worksheet such that the amount you
require for comfortable living is equal to or less than the amount of income you
expect to earn while retired, you’re not in the “safe zone” yet.
Inflation is a VERY real variable.
The price of groceries, homes, cars, etc; certainly
aren’t what they were 20 years ago. In its simplest form,
inflation has historically averaged about 3.1% across-the-board.
Of course, there were periods such as portions of the
1980s-- where annual inflation approached double-digit ranges.
For purposes of example, we’ll use 3.1% as our inflation
plug-in variable throughout the rest of the guide. Does doing so mean that if
you require $100,000 to live this year, you’ll require $103,100 to live next
year? Not necessarily.
For one thing, some of your living expenses listed on the
first worksheet might not be subject to inflation (i.e. mortgage payments, etc).
For another thing, the 3.1% might not necessarily occur each year. It is, after
all, an average...over time. If you PLAN to spend 3.1% more each year than the
previous year though, you’ll probably be in good shape.
You might experience near zero inflation for a period of 5
years...and then possibly 8 or 9% in one year. There’s simply no way to tell
but you need to find a number (like 3.1%) that you feel comfortable with and
apply it to your inflated costs of living when planning your retirement. In
such, re-investment or “inflation allotment” becomes an additional expense.
Assuming you’ve calculated that based on today’s rates,
you’ll need $50,000 per year to retire comfortably.
Now figure out WHICH of those expenses are SUBJECT TO
INFLATION -- Figure -to be safe-- on ALL of them being subject to an average of
3.1% inflation EXCEPT your mortgage payments and anything uniquely along those
lines. If your raw mortgage payments (after considering property taxes etc;) are
$10,000/year..and your total needs were at $50,000, then you have $40,000
subject to annual inflation. This would mean you’d want to figure on needing
$51,240 during the second year of retirement, over $52,500 during the
third year etc.
It’s not logical to try to guesstimate your life
expectancy and add at least 10 years to it. If you’re 60 now-- you may very
well live to be 95 (or older)! Of course, the optimum situation would be to
figure out how much that $40,000 worth of pre-mortgage inflationary expenses
(hypothetical number) will become when you’re 95 years old and structure your
plan such that you’re earning that much already. More realistically, however,
you should prepare to purchase a new bond (or other investment) each year.
For example, if you purchase another $20,000 worth of
fixed-income AAA municipal bonds
each year with annual yields of 6% tax-free, you’ll earn another $1800 per
year which will cover you for a while until the numbers catch up with you
(Remember also that you may be buying some bonds at higher and/or lower rates
depending on the market each year as you continue to buy and build your bond
So you’ll need to budget to earn at least that much extra
to put aside from your annual income.
Thus, “saving for inflation” or
your “inflationary allotment” becomes another expense to add to your
list. Of course, you also have your core nest egg which you can withdraw
against; but preferably only as the bonds mature so you don’t lose anything on
your investment. To calculate this fairly requires the creation of an
appropriate spreadsheet as described in the following section.