Comparing Retirement Income Strategies

by Drew Snider, CFP®

Director, Financial Planning, Coastal Credit Union, Financial Advisor, CUSO Financial Services, L.P.

5.6.2021
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Articles
This infographic is explained below

Comparing Retirement Income Strategies: Which Is Right For You? - Infographic

So, you’ve been saving like crazy for your retirement and it’s time to think about how to turn your nest egg into retirement income. What’s the best strategy to live off of your retirement savings? In this video and blog post we compare two popular options: the 4% Rule, and Retirement Income Bucket Strategy.

Before considering which retirement income strategy to use, it’s important to complete a comprehensive financial plan that outlines not just your retirement income but also your insurance needs and estate planning documents. It should answer how much you can spend and maintain for a 30 year (or more) retirement.

Knowing what spending level is appropriate for you will help you develop a retirement budget that works for your household. If you’re like most retirees, there will be a gap between your guaranteed income sources (like Social Security) and your spending. The nest egg you’ve saved for retirement will fill this gap. Some retirees choose to close the gap with another stable income source like an annuity while others are comfortable drawing down their investment portfolio. 

Ok, we can finally work on that retirement income strategy. There is no one best way to create retirement income but whatever you choose, be sure you and your spouse/partner understand how it will work and the risks involved.

The 4% Rule

The 4% Rule got its foothold in retirement planning in 1994 when William Bengen, a professional in the financial planning field, published his research that answered the question: What is a sustainable distribution rate over a 30 year retirement period? After running models using different rates of return and inflation scenarios, he settled on 4% as a conservative number.

So how does the 4% Rule work? Simply, take your retirement portfolio and calculate 4% at the beginning of your retirement, this is your retirement income. Your portfolio should, over time, earn more than 4% and continue to grow allowing for increasing distributions to account for inflation.

Advantages: The greatest advantage to the 4% rule strategy is it’s simple and easy to follow. Plus, it has been successfully used for 25 years by many retirees.

Disadvantages: The 4% Rule assumes constant spending throughout retirement. However, after decades of retirement research we find that most retires go through three phases:

  1. Go-Go years – Early retirement is when most folks have more energy and a list of things they want to see and accomplish. As a result, a retiree’s expenses tend to be higher in these years.
  2. Slow-Go years – You’ve checked off the buck list items and settled into a less active period of retirement and spending tends to decrease.
  3. No-Go years – The last stage tends to bring more expenses because retirees are paying more for services they used to do for themselves. As an example, yard maintenance and house cleaning can become new expenses in the later years. 

Another disadvantage: The 4% Rule is based on a retiree investing their nest egg in stocks and bonds. If you are not comfortable with investing, your portfolio will likely not achieve the rate of return required for the strategy to work and you could run out of money. Along those same lines, the original research was done during a period of higher interest rates when retirees were getting better yields from their bonds and savings than we earn today. If interest rates don’t increase over your retirement, the bond and cash portion of your portfolio may not provide the returns required.

The Retirement Income Bucket Strategy

In comparison, the Retirement Income Bucket Strategy is more dynamic than using the simple 4% Rule.  Here’s how it works:

At retirement, you will allocate your portfolio into 3 buckets: short-term, usually years 1-3; medium-term, usually years 4-7; and long-term, 8 plus years. In the short-term bucket, you will allocate the amount of money from your portfolio needed in the first three years. Typically, you will keep this money in low-risk accounts like savings, money market or certificates of deposit. The medium-term bucket will be invested in moderate risk assets like annuities, bonds and perhaps divided stocks. Over time as you earn dividends and interest in these accounts, they will refill the short-term bucket. The long-term bucket should be invested for growth to help you out-pace inflation. Over time you will need to sell some growth assets and allocate your gains to the medium-term bucket.

Advantages: This retirement income strategy is more dynamic than the 4% Rule allowing you to adjust your allocation to the buckets as your spending needs change. Also, for many retirees, it gives them comfort to invest a portion of their nest egg in growth investment knowing they have their income needs covered for the first 7 years. 

Disadvantages: The primary disadvantage to the Bucket Strategy is the time and attention required to implement and manage the buckets over time. Partnering with a financial advisor at Coastal Wealth Management, available through CFS, can help you over come this hurdle.

Key Takeaways

Planning for retirement doesn’t have to be complicated. Coastal members can connect with a CFS* Financial Advisor to schedule your free retirement plan review. We can assess your current retirement income strategies to see if you are on track to meeting your financial goals.

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*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. ("CFS"), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. Coastal Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.

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