How To Best Plan for Retirement Income Gap Years

Our topic on this episode of the Ready for Retirement podcast is about how to best plan for the retirement income gap years.

Questions answered: What is the best strategy to prepare for years without income? What can I do to increase income before I can access my retirement accounts? What is the best strategy for your individual situation? 

Are you ready to start focusing on the things that truly matter when it comes to your financial future?

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Key Points

• What are the “retirement income gap years”?
  • Some people view the gap years as the years leading up to age 59.5 where they can’t access retirement funds without incurring a penalty.
  • Others view the gap years as the years before any outside income source begins.
    • (i.e. You may be able to access your IRA, but unable to access a Pension or Social Security).
• Retirement Smile
  • As a reminder, most people tend to spend much more in the early years of retirement, less in the middle, and more in the end as medical expenses rise as opposed to having a constant withdrawal rate throughout retirement.
• Retirement Income Gap Years
  • The listener has 3 years before retirement funds are accessible penalty-free.
  • Example
    • If you have $100,000 you would like to withdraw from your portfolio to meet your living expenses and three years of “gap years”, you have $300,000 of funds you need.
    • If you have $600,000 total, $300,000 of this needs to be in conservative investments to ensure you can meet your living expenses.
  • Once you have bridged your “gap years”, you can spend as much as you’d like during the early years of retirement where expenses may be relatively higher in retirement.
• Retirement Considerations
  • How confident are you in your budget?
    • Does your Social Security & Pension cover all of your expenses?
    • It’s not uncommon for retirement expenses to be higher than what your current expenses are.
    • If you’re confident in your budget and feel comfortable Social Security & Pension can cover all of your expenses, I would want you to feel comfortable spending more from your portfolio than you may even need, assuming you’re confident in your expenses.
    • The risk of spending too much in the early years of retirement is that you don’t have as much of your portfolio in the latter years of retirement.
• Windfall Elimination Provision
  • Are you subject to WEP?
    • If you have a non-covered pension where you receive pension benefits for years of service where you aren’t paying into Social Security, your pension amount will reduce the amount you receive in Social Security.
    • Confirm the amount of Social Security you’re planning for is accurate once determining if the WEP applies to your situation.
• Margin for Error
  • Many people have a clear sense of their monthly expenses, but one-off things can throw a curveball in your budget.
    • Ensure to plan for one-time expenses like property taxes, cars in retirement, etc.
    • Leave margin for error if you haven’t planned your expenses in depth.
• Legacy Goals
  • If your goal is to leave funds for children, grandchildren, charity, etc., you’ll want to ensure this is planned for in your retirement plan.
• Home Equity
  • Equity in the home can give you flexibility to spend more because you can always use your equity to spend more and as a backup plan.
• Inflation Concerns
  • Is your portfolio positioned to outpace inflation?
  • If you have a pension that historically underperforms inflation, you’ll want to position your retirement portfolio to ensure you preserve the purchasing power of your portfolio.
  • If your pension has a COLA (Cost of Living Adjustment) that is smaller than income, you’ll want to ensure you have other investments outpacing inflation.
  • Example:
    • Assume your living expenses are $100,000/year and your Pension/Social Security increase by 1.5%/year.
    • Let’s also assume the combination of your Pension & Social Security total $100,000/year (excluding taxes).
    • In the first year of retirement, there’s no need for additional income from your retirement portfolio.
    • In the second year of retirement, if expenses grow by 3%, you can expect to have living expenses of $103,000 and your income is $101,500, which creates a gap of $1,500.
    • In the 10th year of retirement, if expenses grow by 3%, you can expect to have living expenses of $134,000, with income of $116,000 coming in assuming 1.5% growth, which creates a gap of $18,000.
    • In the 20th year of retirement, if expenses grow by 3% you can expect to have living expenses of $181,000 and income of $135,000, creating a gap of $46,000 needed from your retirement portfolio.
  • There is no general rule of thumb because it depends on your situation.
    • I have software to assist with this, but here’s another way to look at this.
    • Check out Episode 68: How Much Do People Actually Spend in Retirement?
  • If your Pension makes up 50% of outside income and Social Security makes up 50% of outside income, your blended inflation rate is ~2% (1.5% from Pension & 2.5% from Social Security).
    • If inflation is 3%, you may be able to not worry about inflation rising at a different pace than income when looking at average expenses throughout retirement. 
• LTC (Long-Term Care)
  • Does your insurance premium fit in your budget? If so, I would feel confident spending more in the early years of retirement.
  • If you don’t have LTC insurance, you’ll want to ensure leaving a portion of your portfolio alone that you don’t plan on touching that will continue to grow for you as a form of self-insuring.
• Income Survivor Options
  • What are the survivor options and how does that impact income for both you and your spouse?
    • Ensure to have a plan in place in case your spouse passes if the following occur if your spouse passes:
      • Standard Deduction is cut by 50%.
      • Ex-Spouse’s Social Security Income is no longer available.
      • Ex-Spouse’s Pension income is no longer available.
• Social Security
  • The surviving spouse can collect the larger of the spouse’s Social Security benefits.
• Roth Conversions
  • Roth Conversions are about understanding what your income will look like when RMDs (Required Minimum Distributions) begin.
  • Roth Conversions are most beneficial if you’ll be forced to take out much more than you need in retirement.

Timestamps

1:31 – Podcast Review!

3:57 – Social Security

7:00 – Covering Gap Years

10:52 – When It Makes Sense To Be Cautious

14:15 – Additional Legacy Considerations

18:19 – Survivor Options

21:44 – Retirement Example (Inflation)

25:27 – Planning for Non-Portfolio Income

28:46 – Aligning Your Investments With Your Financial Goals

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