Last week we began exploring the need to “begin with the end in mind” when it comes to retirement planning.
If you’re just stuffing dollars into a 401(k), you have a retirement account, but don’t have a retirement plan.
A retirement plan is not only a tactic of funding a future retirement, but also a strategy of how those funds will be spent. In fact, the strategy of how funds will be spent will determine both how and where money should be saved on the journey to retirement.
So, here are the four strategic functions of money in retirement. The functions are the “end” you should have in mind as you begin. Knowing them will help you know what to do with the money you are saving now.
Income. When works stops, so does the income you receive from work. Unless you’re one of the few Americans retiring with a pension, you’ll have to figure out how to translate your retirement assets into retirement income.
If your first thought is, “I’ll just take a little out each year and live off that,” you’ll run smack into two hard questions: (1) will that be enough to live on, and (2) will it last?
Until you answer these questions, the remaining three will go unaddressed. Retirement income planning has become a specialty in the advising world, with good reason. This is the uncomfortable and difficult-to-predict intersection of money and life… how much income will your assets be able to produce and how long will you live?
Liquidity. This is cash or things that can be turned into cash quickly. Money in a checking account is 100% liquid. Funds in investment accounts are fairly liquid, though not as much so as cash. You may be able to turn your investments into cash quickly, but what if the underlying value is down. Real estate is not very liquid. And that small business you own is very illiquid.
Also, there is a difference between “technical liquidity” and “practical liquidity.” If you are taking all the interest and dividend income off your investments (something many people do) and you decide you need $50,000, what happens if you take that $50,000 from your investments? The interest and dividends that were being generated by the $50,000 goes away.
You need liquid funds available to pay for anything you can’t fund with this month’s income: a new roof, a medical procedure, a vacation, a new car, a grandchild’s education, etc.
Contingency. Contingencies are the big, unexpected things. The big one most retirees face is long-term care. I see people grossly underestimate this one all the time. It isn’t just the cost of a nursing home…that’s the last resort for most folks.
If health should decline slowly, what will be the cost of a growing number of caregivers and care services each month? I regularly see this cost exceed $10,000 per month.
Legacy. Whom do you love? What cause are you passionate about? Is there someone or some cause you want to provide for at your death?
The Waterfall Effect. The four strategic functions of money in retirement act like a waterfall. If it takes all your money to provide for your income, you’ll have nothing left to flow over for liquidity, contingency or legacy. Conversely, whatever retirement assets are not required to meet your income needs, may be used for liquidity, contingency and legacy. Further, whatever assets that were not used in the liquidity or contingency functions then pass down to the legacy function.
My hope is that having identified these four strategic functions will help you think more clearly (and therefore more strategically) about what you are seeking to accomplish towards your retirement.
In short, I want you to have a true plan for your retirement.
One that begins with the end in mind.
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