Saving early is the best way to guarantee enough income in retirement

Financial advisors hear this question all the time: “How much do I need to save for retirement?”

They answer: “It depends.”

On what you want to do in retirement, whether your money will come from a pension, Social Security or your investments.

Then comes the follow-up question: “Can you guarantee I’ll have enough?”

“I think the guaranteed income term is one that’s probably used more than it should be, by both people and advisors because there’s very little that can be guaranteed,” said Bill Shaheen, president and chief executive officer of Whitney & Company.

A steady income may look attractive when that regular paycheck is no longer coming in, but depending on an individual’s investment history and risk tolerance, the vicissitudes of the market may create too much anxiety.

The greatest risk to retirement is inflation. Relying only on a pension or an annuity, which don’t offer cost of living adjustments, is like working at a job that never gives you a raise.

“Sometimes people will say, “I really want to be conservative. I’m not working anymore and I don’t want the market risk,” Shaheen said.

Retirement funding needs to cover essentials as well as discretionary spending, and many people also want to protect their lifestyle.

“You’ve probably seen some of these latest studies are saying people over 50 their average amount in their 401(k) or retirement account is about $50,000 and they think if they can accumulate $250,000, they’ll be able to retire on that plus their social security,” said Shaheen.

But the base withdrawal of 4% is not a lot when unexpected bills can take a chunk out of any income stream, let alone one that’s fixed.

“Maybe they’re living on after taxes $30,000 a year. I don’t know that many people can do that and maintain a lifestyle that they had when they were working and making $50,000,” he said.

Shaheen said a financial plan built around a conservative 5.9% average annual return and based on a 60/40 portfolio of stocks and bonds can provide comfort now and growth later.

“It shows them that they’re going to be OK,” he said. “They realize that, ‘If I really want to maintain my lifestyle, I guess I need more growth than I was thinking I did because otherwise I could run out of money.’”

Building a portfolio to finance retirement is similar to having resources to fund other major life events.

“People have accumulated resources during their working years for their retirement and now they are faced with the choice of converting that savings into income stream,” said Elizabeth Thorley, founder and chief executive officer of Thorley Wealth Management. “We want to look at it from a holistic standpoint before we start talking about guaranteed income stream.”

Thorley suggests making a budget that lays out the needs and the wants. If the cash flow from Social Security or pensions won’t cover what she calls must-haves, converting a portion of investment assets to guaranteed income may provide peace of mind. A starting point for a person with a low tolerance for risk is to determine how much they need to cover the essentials.

But there’s another consideration for soon-to-be retirees: What will retirement really be like and how will I spend my money and my time?

“I’m asking you to tell me how much you need, how much you want to spend in retirement and you’ve never retired before,” she said. “You haven’t had 40 hours a week to decide what you want to do with those hours. Some people give it a lot of consideration before they retire and others don’t.”

Guaranteed income streams aren’t very flexible, which some people don’t find out until too late.

“I would caution people to get used to what the changes are in your life when you retire,” Thorley said. “And then revisit these choice that you have. If you can, try to give yourself some flexibility on how you’re distributing your income in retirement. It doesn’t necessarily have to be all set up the day you retire. Give yourself some choices.”

Chris Van Buren also is a proponent of budgeting before retirement, but he suggests taking a conservative approach.

“There are always these things that you forget to put into your budget, and you always want to budget a little bit more than actual spending. That really lays the groundwork of determining how much maybe should be a guaranteed income strategy and how much can I actually take risk with some of my dollars for some appreciation potential?”

Van Buren, a certified financial planner with LVW Advisors, said that clients with robust Social Security and/or pension payments may not need another guaranteed stream.

He educates clients about potential risks with guaranteed income, such as how to protect the surviving spouse, illiquidity and lack of inflation protection.

“Let’s just say that you put $100,000 into an annuity and it pays out $500 a month,” Van Buren said. “The $500 a month will not go higher based on inflation. So if inflation is 5% … you are losing your purchasing power. … You’re behind the eight ball, which is a big deal. Maybe not in year one, but in year 10, 15, 20, it becomes a big problem.”

Much of the discussion on guaranteed income focuses on people close to or in retirement. But for people in their 30s and 40s, the risk of relying on one stream of income or a pension may be even higher. When building their financial plan, they may not be able to count on pensions or Social Security as did their grandparents or parents.

“I assume, for now, just to be conservative, that I’ll only get about 75% of what I might get from Social Security, or what I’m promised,” said Thomas Stedman, certified financial planner and wealth management consultant with Manning & Napier. “I’ll make up for it by saving more, maybe working longer or spending less.”

Stedman, 34 and with a wife and two children, said that for years he has paid himself first by saving 25% of his paycheck. “You live off the rest, whatever that is, and make it work. You don’t spend money and then figure out how to cover it.”

Stedman said friends ask him about annuities, and he tells them they make sense in specific situations. He wouldn’t tell his friends that an annuity would never work for them, but he suggests other ways to build wealth.

“I usually tell my friends to just save 20%; that’s a great starting point. You could jack it up if you want, lower it if you’re struggling, but if you’re not doing that, you’re probably not on a good path right now. Younger people should be maximizing their retirement accounts first, their HSAs, 401(k)s, IRAs. If they have money left over, I would recommend a taxable account.”

A financial plan with a cash-flow projection reinforces the message that saving early pays off later.

“Some will see it and be like, ‘Oh, wow. I didn’t know I was doing that well’ or ‘Wow, I need to need to buckle down and start saving more.’ If not, at least they know that they’re choosing to continue down the wrong path if they spend more than they make or live outside of their means.”

Patti Singer is a freelance writer in Rochester. Contact her at pattisingermedia@gmailcom.