How to Make Your Money Last in Retirement

Saving for retirement seems so easy, right? You save to a certain number and if you hit that number you’ll be ok. Let’s say you decide your number is $3 million. And let’s say you get that much saved into your 401(k) by the time you’re 65. Now what? How do you use that savings to create income in retirement? And are you sure that you’ll be able to make it last?

How to make your money last in retirement

Making your money last in retirement is a little more complicated than simply accumulating a savings number in a 401(k). Generating retirement income that will last as long as you live takes a financial engine that have a number of moving parts. It’s important to start to understand today what that engine will look like in the future. That’s because building the right parts today will put you in a position to assemble a precision engine when you retire.

What might a precision engine look like in retirement? Well, it might include cogs and gears such as an IRA, Roth IRA, 401(k) (or Roth), a pension or annuity, social security, cash value life insurance and more. Where you stash retirement savings today is arguably just as important as how much you end up saving. That’s because annuities, pensions, Roths, IRAs and other options have different features, benefits, limitations and tax treatments. Income from your 401(k) will be subject to income taxes in retirement, while income from a Roth typically will not be if withdrawn after the age of 59 1/2. Some options require you to begin taking minimum distributions at a certain age, while others do not. Some options (like annuities, pensions and Social Security) will provide guaranteed, stable income for life while the value of others will rise and fall with the markets—allowing you to keep up with inflation but putting you at risk of losing money if you have to make an ill-timed withdrawal.

To really understand why it’s important to build an engine with so many pieces, let’s fast forward to retirement, the point where you’ll turn the keys and start that income engine.

When that time comes, your task becomes twofold: minimize the impact of taxes and ensure your ability to generate stable income that will last through retirement. Accomplishing both tasks in concert takes a little know-how or a financial pro. But, if you’re pulling all the right levers on your income engine, the effect is akin to a Formula-1 driver nailing a hairpin turn at the perfect angle and speed. You’re getting every ounce of performance from that well diversified income engine that took decades to build.

Financial strategies to create stable income in retirement

You don’t want to wake up each morning wondering how changes in the stock market will affect your ability to pay the bills or fill the fridge. Fortunately, a well-built retirement engine can insulate your income from market volatility. And although you might see the same amount of income rolling in every month or year, it won’t always come from the same sources—if you’re able to pull the right levers at the right time.

A stable cash reserve

Building an ample cash reserve is one key to stabilizing your income. As a rough benchmark, you want to hold about two years’ worth of your short-term cash needs in a savings account (or something similar). Holding two years of funds here gives you a financial buffer to help cover unexpected expenses or drastic changes in the market.

Guaranteed income sources

How you fill the bucket, and when, will be key to pushing your retirement engine performance to the max. In retirement, income from guaranteed sources like income annuities, Social Security and pensions will continually flow into your cash reserve. These income sources typically provide stable income for the rest of your life. While these likely will not cover all your expenses in retirement, they will provide a floor for your income.

Investments

Income from investments isn’t as predictable. Therefore, it’s best to sell investments in these accounts when the price is right. If the market is rising, for example, it might be a good time to sell a few investments to replenish your cash reserve before the next correction. Contrarily, if the stock market takes a deep dive and the value of investments has fallen significantly, you do not want to sell at depressed prices. Liquidating investments at low prices means you’ll need to sell more shares to fund your lifestyle, and that reduces the number of shares that will benefit during a recovery. Instead, during a deep market correction, it might make sense to dip further into your cash reserve or access cash value in a life insurance policy to fill your reserve bucket until the market rebounds.

Life insurance

Permanent life insurance is an often-overlooked asset for retirement. But it’s unique attributes can make it a critical part of your retirement plan. In addition to the death benefit, permanent life insurance will accumulate cash value. With most permanent policies, that cash value is guaranteed to grow and is unaffected by the markets. That makes the cash value of life insurance a stable source of income that you could tap during down markets.

The key to creating stable income that lasts through retirement is diversity of assets (and thinking beyond just investments). With a diverse portfolio, each month you’ll have what you need to enjoy time with the grandkids or travel the world, even if that income comes from different sources at any given time.

Financial strategies to minimize the impact of taxes you’ll owe

The sequence in which you draw from your accounts and the ways you combine that income will significantly impact how much money ultimately lands in your wallet. If you take too much out of taxable accounts in a given year in retirement, for example, you may push your marginal rate higher, which means a larger percentage of each additional dollar you withdraw goes straight to the IRS. If your income level is straddling the line between the 24 percent and 32 percent tax bracket, you could see a significant impact on the bottom line as the amount you withdraw rises.

Or, say you have an unexpected medical expense. Rather than paying for it by selling investments in a 401(k), which would increase your taxable income that year, you could withdraw your Roth funds tax-free. This is also another area where the cash value of permanent life insurance can help. You are able to access the basis you have paid into a policy tax free. And you can typically borrow against the value of any gain without owing tax (so long as the policy stays in place). While accessing your cash value will reduce your death benefit, it can be a great way to preserve the value of your investments and minimize taxes in retirement.

Ultimately, the idea is to ladder your income in a way that minimizes the impact of taxes you’ll owe over time. As you can see strategically pulling money from taxable and non-taxable savings each year allows you to control when and how much you pay in taxes. That’s important because your taxable income can also impact Medicare premiums and the amount you pay in capital gains on investments outside your retirement accounts. Having a tax-diverse retirement portfolio is like playing a game of Tetris with all five pieces, rather than just one or two. With more options, it’s far easier to efficiently fill in gaps as they arise. 

Turning on your retirement income engine

On the surface, using multiple assets in retirement is simple: keep taxes low, generate stable income. However, with all those moving pieces it can be challenging to get the timing right. Fortunately, you can hand keys to your income-generating engine to a trained financial professional who will work with you to develop a plan tailored to your expectations in retirement. Your advisor can help you ensure that you’re building the right pieces of your engine today so that you’re ready for retirement. Then, when you get to retirement, they can be your Formula-1 driver navigating the twists and turns of a rewarding, and financially sound, retirement.

All investments carry some level of risk including the potential loss of principal invested. This publication is not intended as legal or tax advice.  Financial Representatives do not give legal or tax advice. Taxpayers should seek advice based on their particular circumstances from an independent tax advisor. 

Utilizing the cash value through policy loans, surrenders, or cash withdrawals will reduce the death benefit; and may necessitate greater outlay than anticipated and/or result in an unexpected taxable event.