Income in Retirement

Published On: January 15, 2021

Written by: Ben Atwater and Matt Malick

A Frank & Ernest comic depicts a financial advisor at his desk with a client sitting across from him.  In the cartoon, the client says to the financial advisor “I can stick to a budget.  It’s sticking to an income that’s the problem.” 

Ideally, a healthy retirement portfolio will provide most mass affluent retirees with the comfortable retirement they desire.  But rarely is retirement that simple.  For some, income can come from part-time work, especially in the early years of retirement.  Others will look to rental properties, business buyouts, pensions, deferred compensation, etc.  And many more will rely on Social Security as the bedrock of their retirement. 

Since we are investment managers, we will focus on investment income first.  Then, we will look at Social Security because for most it is an important piece of the puzzle.  Although in this essay we are not focusing on the myriad varieties of retirement income, we are always available to discuss your specific situation and further explore all options. 

Investment Income – For retired clients, we build portfolios that provide retirement income.  These planned systematic withdrawals from retirement funds supply clients with a consistent “paycheck” to replace their working income.  In a low interest rate world, we look to “total return” investing – generating payouts from dividends, interest and long-term price appreciation (capital gains).

A sustainable spending rate from retirement funds is approximately 3% to 5% of your principal, depending on your timeframe and whether your goals include leaving a legacy to heirs.

There are some vital factors to total return investing that are an integral part of our investment philosophy.  The first is to have an allocation of enough “safe” assets to support distributions during times when the market is depressed (like March of 2020). 

Another is to manage – to the extent possible – realized capital gains when raising money for distributions.  This works particularly well with an individual stock and bond portfolio where we can harvest losses and pick and choose which gains to realize.

We believe that, over market cycles, it is important to own stocks that pay dividends, but it is unwise to chase high yielding stocks regardless of other fundamental considerations.  Said another way, you should never select an investment simply because its yield meets your spending requirement. 

Higher yielding stocks tend to be highly correlated.  During some market cycles they do well, while during other cycles (like the current bull market) they perform poorly.  Investors hunting yield have been largely disappointed of late.  That said, your portfolio should generate a reasonable level of income for times when the market is depressed and price appreciation is nonexistent.

In our low yielding world, embracing the idea of total return investing is incredibly important.  Not only can you not chase yield, but when executing a total return strategy, you must pull funds from stocks when the equity market is high and from bonds when the equity market faces a pullback or bear market. 

This sounds easy enough, but it is emotionally taxing.  In the face of a depressed market people look for reasons to sell stocks and what better reason than for living expenses.  However, this is how you lock-in losses.  As active investment managers, one of the best ways we can add value is by liquidating the right investments when clients need cash.  It is difficult to overstate the importance of this level of individual client customization. 

Social Security Income –Even for mass affluent investors, Social Security plays an important role in retirement income planning and typically combines with total return payouts from your investment portfolio to finance your retirement.  Due to the importance of Social Security benefits, please do not make any Social Security decisions without contacting us to perform an analysis of your best options.

With Social Security, we will address benefits anecdotally, based on the many analyses we have completed.  But, to start, here is some basic background information on maximum benefits and full retirement age.

In 2021, the Social Security wage base is $142,800 (it is adjusted for inflation most years).  Above this wage, employees and employers no longer pay Social Security tax.  As there is a maximum Social Security contribution, there is also a maximum Social Security benefit.  The benefit maximum for 2021 is $3,113 per month ($37,356 / year) at full retirement age (FRA).  The maximum benefit at age 70 is $3,895 ($46,740 / year).  To receive the maximum Social Security benefit at FRA, a person needs to have earned at least the Social Security wage base during 35 individual working years.   

The FRA for those born in 1957 is 66 and six months, up from 66 and four months for people born in 1956, 66 and two months for those with a birth year of 1955 and 66 for everyone born between 1943 and 1954.

For those born later, in 1958 the age is 66 and 8 months, in 1959 it is 66 and 10 months, and from 1960 and after, FRA is 67. 

Beneficiaries are still eligible to take Social Security at 62.  In the many analyses that we have performed this rarely makes mathematical sense.  Given average lifespans and the penalties involved (you receive 30% less than your FRA amount at 62), taking Social Security early can rob you of tens or even hundreds of thousands in lifetime benefits.  However, if you need Social Security at 62 to get by, obviously, you have no choice but to take it.  Another reason to take early Social Security could be health-related, whether a specific diagnosis or a grim family history.

Otherwise, it is best to wait until at least your FRA to take Social Security.  And, again, mathematically, given life expectancy today, it makes sense for most people to wait until 70 to take Social Security.  To “breakeven” by waiting until your FRA (we will use 67 as the FRA to be conservative) you need to live until about 74.  In other words, if you claim Social Security at your FRA, you will need to live until age 74 to earn a greater lifetime benefit than you would have by claiming at age 62.  For those who wait until 70, your breakeven will be about age 77. 

The math of waiting is compelling because your Social Security benefit from your FRA until 70 compounds at 8% plus the cost-of-living adjustment (Social Security calls this “delayed retirement credits”), which makes waiting an excellent investment, especially if you live into your 80s or beyond. 

The only way to make a perfect Social Security projection is to know when you are going to die.  For this reason, the decision should be based on probabilities and personal circumstances.

Many mass affluent couples decide to have the higher earning spouse (the one with the larger Social Security benefit) wait until age 70, while the other spouse takes Social Security at FRA.  This can be a sound strategy because the survivor benefit for Social Security is the higher of the couple’s Social Security benefits including delayed retirement credits.  Our projections usually show the lifetime benefit difference between this strategy and both spouses waiting until 70 to be relatively minimal.  As we have said before, everyone’s situation is different.  There are the mathematical and the practical considerations.  Please do not hesitate to discuss your Social Security situation with us.

Other Income – In addition to portfolio income and Social Security, some clients have other sources of retirement income like pensions, rental properties, etc.  These are solid assets to bring into retirement.

Most pensions are not adjusted for inflation, so the purchasing power of the pension deteriorates each year at the rate of inflation.  Over a twenty- or thirty-year period this proves problematic.  Conducting inflation-adjusted retirement projections allows us to address this issue head-on.

Established rental properties can be a boon to your retirement plan.  But do not buy a rental property just before retirement.  Too often this can backfire as the untested property fails to meet your expectations.

For those who plan well and take a disciplined approach to investing and spending, providing an appropriate level of income in retirement is quite achievable.  We are here to help.