Let’s assume that you and your spouse are ready to retire at age 67 with $1.2 million of investable assets. Your monthly expenses are $10,000, and your combined monthly Social Security benefits are $6,000. This means you have a monthly “income gap” of $4,000. How will you generate annual cash flow of $48,000 ($4,000 x 12 months) over the next 25 to 30 years of retirement?
Here are three ways to generate cash flow in retirement: Portfolio Yield, Lifetime Income and Spend Down.
Portfolio Yield is a measure of the earnings generated by an investment over a certain period of time. Earnings may include interest, dividends, and/or other income. Using a 3% assumed rate of return, you would need to allocate $1.6 million of your investable assets to generate annual cash flow of $48,000 ($1,600,000 x 3% = $48,000). This strategy is not a viable option, since you only have $1.2 million of investable assets.
Lifetime Income involves investing a portion of your retirement savings with an insurance company to create a predictable lifetime income stream. Using a 7.5% assumed joint lifetime payout rate, you would need to allocate $640,000 of your investable assets to generate annual cash flow of $48,000 ($640,000 x 7.5% = $48,000). This strategy leaves you with $560,000 in remaining investable assets ($1,200,000 – $640,000 = $560,000).
Spend Down simply means withdrawing a fixed payout rate from a portion of your investable assets. Using a 10% fixed payout rate, you would need to allocate $480,000 of your investable assets to generate annual cash flow of $48,000 ($480,000 x 10% = $48,000). Assuming a 3% annual rate of return, you will need to replenish this $480,000 account in approximately 12 years.
It may be wise to allocate a portion of your investments to each strategy based on your financial resources. Here is an example using a 10% Portfolio Yield, 60% Lifetime Income, 30% Spend Down allocation:
Portfolio Yield $160,000 x 3.0% = $4,800 (10%)
Lifetime Income $384,000 x 7.50% = $28,800 (60%)
Spend Down $144,000 x 10.0R = $14,400 (30%)
Total $48,000 (100%)
There is no right or wrong allocation. Since all money is not taxed the same, tax diversification also becomes an important factor in generating tax-efficient cash flow in retirement.
