Retirement income match game

This content is categorized as:

There's no straight line to follow when it comes to crafting a solid retirement plan. But the final destination is the same for everyone: making sure your needs are covered from your first day of retirement and well into the future—perhaps 30 years or more.

Balancing short‑term and long‑term needs requires successfully matching your sources of income with expenses throughout retirement, says Mike Kastler, MSF, a fee‑only financial advisor based in Ortonville, Michigan.

The advantage to linking different retirement assets to different types of retirement expenses is peace of mind, says Kastler. Rather than hoping one pool of retirement money will cover everything—needs and wants‑for all time, he explains, you're actively earmarking different types of income for different retirement costs. That can make a real difference for your security and comfort in retirement.

Kastler advocates a "bucket approach" to retirement planning, where assets are put in different buckets depending on when and how you plan to use them.

Bucket One: Monthly Essentials.
The costs associated with your housing, food, and healthcare are top priorities. Fill this bucket with your most dependable sources of income in retirement, such as Social Security or pension payments. Other sources of income for this bucket could include dividends from investments, Required Minimum Distributions from a retirement portfolio, or income from a rental property you own.

What if your basic expenses can't be covered by your existing sources of dependable income? That's when Kastler looks into adding a reliable source by purchasing an immediate annuity to fund essential expenses throughout your lifetime. It can reduce the risk of losing assets due to either a market decline or outliving your assets.

Bucket Two: Discretionary Expenses.
The whole point of retirement is to have some fun, right? This bucket of money and assets is for things like travel, entertainment, or gifts for family. It also covers unexpected emergency needs. Kastler recommends retirees have at least two years' worth of expenses in cash in this bucket, to reduce the chances they'll need to withdraw from their stock portfolio when the market is down. This bucket could also contain income from a bond ladder, proceeds from a home equity line of credit, or the cash value of a permanent life insurance policy, Kastler says.

Bucket Three: Anticipated Future Needs.
The third and final bucket will fund your expenses years down the road, including long‑term care, if needed. Research shows that Americans are living longer and about half outlive the average life expectancy of their age group, so it's important to have a long‑term plan. Stocks, high‑yield bonds, real estate investment trusts, and other investments with higher risk and higher potential return belong in this bucket.

Over the years, you'll sell the investments in this third bucket and move them into the first and second buckets‑but you'll want to be careful about how quickly you do it. Here's where it makes sense to work closely with a trusted financial professional. Kastler does financial modeling with clients to estimate the impact of withdrawing from an investment portfolio to cover rising expenses or big purchases. A modest change—like increasing monthly expenses by $100 or $200—may have a big impact on the likelihood that a nest egg will last up to 30 years, he says.