Sources of retirement cash flow
The purpose of attaining financial security should be to be able to have sufficient cash flow to meet spending needs for the rest of your life. The planning to have everything worked out exactly right so that the check for the funeral bounces is not realistic since we never know when we would be passing on. Rather, we need to accumulate a sufficient amount of assets that will provide the needed cash flow no matter how long you live. This could require leaving some funds untouched, forever, so the cash flow stream won’t cease. Here is a look at a reasonable picture of cash flow sources in retirement.
Retirement income: Retirement means you are no longer earning a pay check. If you are still working, there is a high likelihood that your cash flow needs will be filled from your salary, so this discussion should not apply to you.
Part time income: If you retire from your primary job, but either feel the need to continue doing some work, or are concerned that there will be a short fall of your retirement cash flow, then you might want to continue with some sort of job providing a pay check. This would then be your first level of retirement cash flow – the take home pay from this job.
Social Security: If you are old enough, Social Security benefits can be paid to you. From a big picture, long term plan, plenty of people would be best served by delaying their benefits until age 70, and spouses until a younger age depending upon their circumstances. By waiting until age 70 you can assure a guaranteed cash flow that you can never out live and that will be increased periodically based on inflation. See a blog I wrote on July 23, 2015. Link: https://partners-network.com/2015/07/23/social-security-as-an-asset-class/
Employer pension income: The next source that you likely will not be able to outlive will be pension payments from an employer’s plan. Caution: Make sure you understand the election and withdrawal choices prior to making decisions on what to do. Every plan has different ways of handling what looks like the same things.
IRA, 401k and many employer retirement plans: These require mandatory withdrawals at age 70 ½. Make sure you understand the rules and starting and deadline dates. If not planned correctly, the withdrawals can exceed the plan’s income hastening a depletion of the fund. With right planning it could take up to 10 years until the withdrawals exceed the income lengthening the payout period and sustainable cash flow.
Roth IRA and 401k: If you have these, they can be a reliable last case withdrawal source as the income with accumulated tax free and the distributions will likewise be tax free. This should be considered a fall back safety net.
Annuities: Many people make investments in various types of annuities that provide either guaranteed or nonguaranteed cash flow for the duration of the annuitant’s life. This is a source that needs careful analysis and understanding when the decision to annuitize is made as many of these decisions are irrevocable or carry huge penalties if changed. To the extent there is a cash flow stream, it would need to be factored into your modeling.
Investment sources: The cash flow in the form of interest and dividends withdrawals will provide for a freezing of the account values since the income will be withdrawn. There will be growth if there are stock market investments that go up, but to the extent of asset withdrawals, investment management fees or stock market losses there will be a reduction of the asset base. Any asset reductions or withdrawals will set in place a process of eventual elimination of that source. Depending upon the asset withdrawal amounts this could occur over relatively short or very long periods. This is another instance where planning is essential. As to losses in your fixed income portion, these losses can occur when a fixed income mutual or index fund decreases in value (usually caused by rising interest rates, but can also be caused by risky fund investments that drop in value).
Rainy day funds: These are cash amounts that are set aside from your investments that are kept in money market funds or short term bank certificates of deposit that “guarantee” a source of cash for periods up to 18 months (depending on your circumstances). I do not suggest including these amounts in your asset allocation as the purpose of these funds is to provide a safety net and not asset growth or be exposed to potential loss.
Cash flow needs: This is what you spend. Some of this cannot be cut, such as food, health care, insurance and shelter, but some can, such as entertainment, cable and cell phone charges, the types of cars you drive and eating out. To the extent your cash flow needs are greater than your income, you can consider cutting some of your spending. That is your choice, but keep in mind that spending drives the need for cash flow and that many expenditures are behavioral, optional, possibly habitual and can be reduced.
Inflation: This is a stealth cost. It is rarely obvious and creeps up until one day it hits you that your costs have gotten out of control, while nothing major has changed in your life. This should be factored into your long term planning.
Income taxes: Income taxes is a major cost and must be considered in determining your spending needs.
Nonliquid or income producing assets: This includes residences, art, antiques, collectibles, jewelry and similar assets and cash value life insurance that are part of a person’s wealth, but which do not provide cash flow, so these are not considered in a spending analysis.
Closely held businesses: This is another category of assets that might not be liquid, and that may or may not provide cash flow. If there is cash flow, it should certainly be considered in the analysis.
The above covers the major categories of investment and sources of cash flow and is not directed toward the many people who do not spend all of their cash flow. However, for those that do, hopefully this will help you reassess your situation and have you put your total asset situation into full perspective. Good luck!
