Everyone approaching retirement needs a retirement income plan. Unless you’re Marissa Mayer, you’ll have to plan your finances in retirement. Where will your money come from? What expenses will you incur? When will some expenses drop off and others increase? You can lever technology to put together your retirement income plan by using Excel or an online software program.

A retirement income plan will show you the sources and uses of your money. It’s similar to a budget for retirees but it’s more high level. You’ll get down to pretty granular detail in a normal budget. You’ll have things like cell phone expense, water, electric, etc. Not with a retirement income plan. We’ll instead throw in like expenses into a category. You’ll lump all ongoing expenses into one number call “living expenses.” Expenses that may go away in the future, like a mortgage, will have a separate column so that you can drop them to zero after a certain date. Some people may carry a big long-term mortgage forever in which case this wouldn’t matter.

The steps listed below will get you on the right track to first understand your retirement income picture and then help you accelerate achieving your objectives. If you’re reading this, you’re probably interested in retiring as soon as possible. You may be normal retirement age or even debating early retirement. Either way, you’ll want to follow the steps to see if retirement is possible or a pipe dream.

1) Download the below spreadsheet or build your own template.

Retirement Income Plan Spreadsheet

This spreadsheet (which you can also access here as a Google Sheet) is used to create your retirement income plan based on what you input below for retirement income and expenses. When you fill in the first data point in each column, the formulas will drag that value down. If you want to make some adjustments, go in and hard key over the numbers you wish to replace. You could also create your own income plan or adjust the one I provided to fit your needs. All we’re doing here is figuring out a pretty simple equation:

retirement income equation

A = Your Retirement Income

B = Your Retirement Expense

C = The Difference

2) List your retirement income by year and the sources of that income.

retirement income sources

A) Social Security – What age do you plan on pulling Social Security? There are benefits to waiting until 70 and there’s an upside to claiming at 62. Based on which age you plan on pulling will determine the amount you receive. There are other variables here to consider like your spouse’s age, your children’s needs, your desire to work, your other income sources. I like to run a simulation for people who need to figure out the best strategy to maximize their Social Security. This way you can compare what you’d get by claiming at one age versus another age.

B) Pension & Annuities – Those who receive pension income and Social Security get $36,000 annually, while those who only receive Social Security get $16,000 (median figures), according to Pension Rights. If you’re receiving a pension or are going to receive a pension, congratulations! You’ll likely have more money in retirement than your peers.

You may also be receiving annuity income in retirement. If so, input that amount in the pension column as well. I consider pension and annuity income similar, unless you have some crazy multi-tiered triple fee clown annuity. Sorry if that’s the case.

C) Portfolio Income 

Portfolio income includes stocks, bonds, real estate, etc. My suggestion is to put in the spreadsheet your dividends, bond income, and net income on your real estate investments. Leave out any capital gains or appreciate on your rental properties. That’s the balance sheet side of your money. This column in the spreadsheet is for income, not changes in net worth.

My FAVORITE type of income is portfolio income. There are many reasons why portfolio income is my favorite but let’s just talk about tax. Portfolio income is tax favored. For example, you’ll pay 0% tax on dividends if you’re in the bottom two tax brackets. Muni-bond income is tax free at the federal level and tax free at the state level if you live in the state you buy the municipal bond from. For real estate, it’s almost impossible to be taxed. You’ll have a ton of deductions from income on your Schedule E.

D) Employment Income

Do you plan to work in retirement? Many people do. Some because they have to. Others because they want to. If you make an earned income and pull Social Security at the same time, you may have to account for the earnings limit. There are two thresholds that you’ll have to take into consideration for the earnings test.

  1. early retirement age 62 through the year before your full retirement age
  2. year in which you reach full retirement age (between 66 and 67 for most readers)

The first threshold is around $17,000. If you make more than this in earned income and you also draw Social Security prior to full retirement age, the Social Security Administration will withhold some of your Social Security. The second threshold is around $45,000. If you make more than this amount the year in which you hit your full retirement age, the SSA will withhold some of your Social Security. Make sure you tell the SSA if you plan to make more than the limit

E) Lump Sum

You’ll also want to input any expected lump sum payments to you. These could be insurance payouts, inheritances, or payments received from the sale of a property. You can put these payments in any of the columns that works for you.

3) List your expenses by year including living expenses, mortgage, taxes, etc.

Next up is to input your expenses in your retirement income plan. Your expenses will likely change each year. Some expenses will increase, like health care spending. Some will decrease, like a mortgage payoff.

A) Living Expenses

I would look at your budget here and list everything. It also may be a good time to see what you can cut out in retirement. I don’t really believe in cutting expenses per se. I’m more interested in expanding income, reducing high-impact expenses, and cutting unnecessary expenses.

Most people will list food, transportation, utilities, entertainment, etc. in the living expenses column. Healthcare is also listed here but it’s something that may change drastically as you age. You’ll likely have Medicare premiums once you hit 65. You may also have prescription drug costs. You’ll have to revisit this retirement income plan every year to update it based on your expected annual expenses.

B) Mortgage

I think most people should carry a mortgage going into retirement in order to optimize their finances. The chart below shows the cost of a mortgage versus the benefit of investing. I think people should carry a mortgage if they use the proceeds to invest. This is similar to the way companies leverage their balance sheets. You have the same opportunity to leverage your personal balance sheet to take advantage of cheap money.

retirement income arbitrage

C) Taxes

Your taxes will always change. The largest factor here is your employment income and the deductions you carry. But wait, tax rates can change based on the whims of government bureaucrats. Tax rates may be lower in the near future, but could go much higher in the long term. Do your best to estimate your taxes but this can get utterly complex. When it comes to taxes, I like to say that the best way to predict the future is to just look at the recent past. This may not apply if your going from mostly earned income to Social Security income. Up to 85% of your Social Security income may be taxed but for most people it’s much lower.

4) Calculate the difference and figure out shortcomings.

Column J in the retirement income plan spreadsheet shows you the difference between your planned income and expenses. A positive means you have more income than expenses. A negative means we either have to go back to the drawing board or we conduct principal drawdowns in order to meet your expenses. Retirement is really a simple equation. What makes it complicated is that we have different rules for different income and expenses. Did you pay for your healthcare with cash from a checking account or a health savings account? Did the money you earn come from work or investing? We make things difficult. And you don’t even want to get into the tax code. The deductions, exemptions, tiered rates, and on and on.

If you’re getting a negative number here, don’t worry too much. There are likely many ways in which you can get to a positive number or at least breakeven. Most people who are creating their retirement income plan will want buffer amount in case there are unforeseen expenses. A buffer of at least 10% of their total annual expenses is great. In the template spreadsheet, there’s a total of $45,000 in annual expenses and the buffer this hypothetical retiree has is $7,000 so it meets the requirement. This way you won’t have to dip into your principal in order to meet potential unforeseen expenses.

What we’re not calculating in this spreadsheet is inflation. Inflation is a hidden tax that slowly erodes your wealth. You have to make sure you’re staying ahead of inflation by earning at least the risk free rate of return and hopefully more. You can check inflation numbers here in order to get a good idea of how the value of your cash is being eroded.

5) Create an Investment Plan and THRIVE.

What we’ve created with the spreadsheet above is a retirement income plan. What we haven’t done yet is created an investment plan. A plan that considers your goals and risk profile in order achieve an objective. With an investment plan, you’ll figure out the specific steps you’ll need to take to make your retirement a reality. An investment plan can be compiled by looking at four different aspects as listed below.

Goal

When do you want to retire? Do you want to work part-time during retirement? When do you want to draw Social Security? These are just some of the questions you’ll need to ask yourself in order to figure out your retirement goal.

Risk Profile

The amount you can stand losing and your age will determine your risk profile (risk budget). I like to use a scale of 100 where 100 means high risk and 0 means absolutely no risk. Most people approaching retirement will still be above 50 on the risk budget scale. This scale is important because it will determine, along with your investable time frame, which investments are appropriate for you.

Time Frame

“Our favorite holding period is forever.” ~ Warren Buffett

The best way to make an above-average return is to lock your money up in longer term investments. It’s not always the case, but is a general rule of thumb and one that I’ve seen to be true. People who constantly trade in and out of different types of investments will lose. For those investing in the stock market, this means buying with a really long view. I’m talking ten years PLUS. The reason for this is if you go into the market thinking you’re going to make money in the short run, even 3 years, you could be very wrong. The market has a way of making idiots out of short term investors.

Let me pose this philosophical question: If you bought into the stock market in year 1 and your investment went down by year 2, was it a mistake to buy stocks? Most people would say yes, you shouldn’t have bought stocks because they went down. I would instead argue that if you have a ten year investment horizon, then it doesn’t matter what the stock market did in year 2. Therefore you made the right decision. (A note on this should be to consider your risk profile. The worst thing that can happen is for you to buy into the stock market, the market subsequently decreases, and then you get scared and sell your investments.)

Investments

Now that you’ve figured out your risk profile and investment time horizon, you can figure out your actual investments. There are a slew of investments to choose from and it seems like more and more pop up each day. I’ve developed the Triad Portfolio for a way to allocate your investments between risk-free assets, core assets, and alternative investments. You’ll want to have a well-diversified portfolio that maximizes your return given your risk profile and objectives.

Retirement Investments

 

Let me know how you are building your retirement income plan. Put your email in below and reply to my introductory email with any questions or feel free to comment below.