"Don't put all of your eggs in one basket." This is a saying that's often tossed around when it comes to retirement income planning. Usually it's brought into the conversation to address different types of investments one should consider to generate retirement income.
While diversification is a fundamental principle when it comes to both pre- and post-retirement investment planning, income timing is just as important in retirement. The first thing that needs to be recognized is that retirement isn't a single financial event. It's a process that includes multiple stages, each with its own financial demands.
There are unique types of expenses associated with each stage. For example, there may be an emphasis on travel in the initial stage of retirement, potentially requiring a large initial budget for this item that may decline, and ultimately be eliminated, in later stages. Another example may be a mortgage that gets paid off during retirement. Finally, health and long-term care expenses tend to dominate the final stage. Nonrecurring, or infrequently recurring, expenses, such as car purchases and home improvements, need to also be considered.
Given the fact that income needs to cover expenses and there will be various types and amounts of expenses with different durations associated with each of the various stages, different streams, or ladders, of income need to be planned for to match one's needs. Several types of income need to be analyzed to determine which ones will be best suited to match the projected expense needs of each stage.
When considering income types, it must always be kept in mind that after-tax income is used to pay for expenses. If the income source to be used to pay for a particular expense is a retirement account such as a 401(k) plan, a larger distribution will generally need to be taken from the plan than would be required from a nonretirement money market fund or from a Roth IRA account. Income tax planning is essential when it comes to income ladder design.
Complicating the income ladder design process is the decision regarding when to begin receiving Social Security. While Social Security can provide a solid base, or floor, to meet income needs for the duration of retirement, the amount of income that you will receive is dependent upon the age when you begin to receive your income. Given the fact that the amount will increase by 8% per year plus cost of living adjustments between full retirement age and age 70, it may make sense to defer the start date depending upon one's retirement age, marital status, health condition, and other potential sources of income. The types, timing, and amounts of income ladders are directly affected by the Social Security start date decision.
Keeping in mind that successful retirement income planning includes planning, managing, and protecting income, an analysis of one's income protection plan is also essential to the income ladder design process. As an example, to the extent that long-term care insurance has been purchased, a large income stream won't be needed to pay for long-term care expenses. Funds will generally be needed, however, to pay for long-term care insurance premiums throughout retirement unless a claim arises.
As you can see, retirement isn't a smooth ride whereby you can plan for the same amount of expenses each year increased by an inflation factor. Given this fact, an analysis of different types of projected expenses, including amounts and timing of each, is critical, followed by the design of an after-tax income ladder plan to match your expense needs.