retirement income

When Your Paycheck Stops

How to Build Retirement Income

It is a paralyzing feeling to stare at a lump sum payout of cash and think about investing it. If you’re like me, at some point you have received a bonus or a windfall in some form or size and thought, “I should invest this in something that will grow more than cash.” And then you wait and wait because of fear or uncertainty that the time isn’t right. I am reminded of The Waiting Place in Dr. Seuss’ “Oh, The Places You’ll Go” where everyone is just waiting.  Waiting for the market to drop, rates to go up, the right opportunity, or the absence of risk. We become paralyzed and often end up doing nothing.

Now imagine that the lump sum payout is from your pension or Employee Stock Ownership Plan (ESOP).  Imagine it is the proceeds from the sale of your business or the 401(k) that you have spent a career accumulating.  What if that sum of cash is your life’s savings and now it needs to generate retirement income paychecks for the rest of your life? If your last paycheck is coming, you are about to make the most significant financial pivot of your life: Turning your savings into income. Thinking of how to do that can create a sense of paralysis but waiting is not an option for you now. The money needs to work for you, but how?

To begin, let’s talk about your mindset as an investor, what it was and what it needs to be.  This is a big transition in how to think about your savings and a change that should not be taken lightly.  As they say, what got you here isn’t going to get you there.  These are some of the advantages that you had when working that may now be gone:

  • Earning Power- You don’t have the time to make up for investing mistakes by taking a higher paying job
  • Saving- You can’t save more out of your paycheck to supplement retirement
  • Investing- Instead of contributing money and compounding, you are pulling out money

The financial tailwinds of your earning years now become the investing headwinds of retirement.  This is why your approach to investing should change if you are trying to replace your paycheck. Here are some steps you can take to plan and invest for retirement income:

Know the Returns You Need vs. The Returns You Want: The first step to your paycheck strategy is to determine your income gap. How much do you expect to spend annually in retirement? How much is covered by guaranteed streams of income like Social Security? What is the deficit you have to fill?  This information helps you focus on the amount you need to pay yourself and prevents you from just reaching for as much income as you can get (we’ll talk about the risks of that later).

How Much Income Can You Earn Safely?  The next step is to understand how much you can earn on your ‘safe’ money.  By ‘safe’, I mean the rates that are paid on cash in money market funds, CDs, and savings accounts.  If these accounts are paying very little, as they are now, then by being too safe with your investments, you run the risk of not earning enough income and not keeping up with rising expenses. It may feel comfortable to keep your lump sum pension in cash or your 401(k) in a stable value fund, but those dollars need to be working hard now that you have slowed down. Cash savings is important to keep for near-term needs and emergencies, but being too conservative can be dangerous, too.

Balance Growth and Income:  There should be two goals when you invest for income: Create a paycheck today and grow your assets for tomorrow’s paychecks.  It is tempting to look for a guaranteed stream of income that meets your needs now, but that often comes at the expense of the growth you need for later in retirement. If you are retiring today, you may live longer than you expected which increases the odds of running out of money.  We often recommend a ‘Total Return’ approach where interest, dividends, and growth all contribute to the distributions taken by a retiree.  This is especially helpful when interest alone is not enough to cover expenses.  Using a total return strategy takes discipline, but your advisor can help with creating a schedule for payment and a method for keeping your investments in balance.

You should also be mindful of some risks when you start to think about creating a paycheck from your lump sum payout or savings. As if investing was not hard enough, the financial industry can be predatory when it comes to working with retirees.  These are a few red flags in a retirement income conversation with an advisor:

  • Reaching for yield: There is no such thing as a ‘safe’ 8% income stream. If you are pitched safety and high income in the same investment you are likely getting into something unsavory. Make sure you know what you own and are not putting your savings at risk reaching for a few more dollars of income.
  • Be Wary of Guarantees: Annuities are worth a more robust discussion, and they can have their merits, but they are peddled by banks and brokers too often without doing the hard work of the planning described above.  If you are worried about the market and not sure how to invest, rest assured there is someone with ‘Financial Advisor’ written on his business card waiting to sell you a high-commission product that you don’t understand. Absent a financial plan, an annuity that locks up your money and limits your flexibility is rarely a good idea.

If you work with an advisor, the conversation about turning a lump sum payout into income is one of the most important discussions you will ever have.  It is the opportunity for a good professional to teach from experience and for you to understand the path forward for your family, financially.  If you do not work with an advisor, don’t be afraid to reach out and ask for the second opinion of a Certified Financial Planner™.  We often speak with people who have never worked with a professional but feel the weight of decision about retirement income and don’t know where to turn.  A true financial professional will guide, educate, and help instill confidence that your plan for a paycheck is both effective and sustainable.

Investing for income is a complex topic and this blog probably raises more questions than it answers.  If you have a specific question or have a topic that you think would be valuable for us to write about, contact us today.


Thinking about retirement? You may be interested in the following reads:

A Moving Target: Thoughts on Target Date Funds

An Offer You Can’t Refuse