There is something interesting that happens when people get close to retirement. For most of their working lives, they have been taught to measure financial progress by looking at an account balance. How much is in the 401(k)? How much did the IRA grow this year? What is the investment account worth? Am I getting closer to $1 million, $2 million, or whatever number somebody told me I was supposed to have before I could retire?
That makes sense while you are accumulating money because the account is generally moving in one direction. You are contributing to it, hopefully it is growing, and a larger number feels like progress.
Yet eventually, you slow down, the paycheck stops, and the question changes. You are no longer asking how much money you have accumulated. You have to start asking how much of that money you can actually use.
Accumulation Isn’t Everything
I think that is a much harder question, and frankly, I don’t think the financial industry has done nearly as good a job answering it. We have gotten very sophisticated at accumulation. We have automatic contributions, target-date funds, employer matches, asset-allocation models, retirement projections and all sorts of ways to encourage people to put money away for 30 or 40 years.
What happens on the other side is considerably less clear. Now the person who has spent a lifetime being rewarded for watching an account balance go up is supposed to start watching it go down, and we’re surprised when that makes them uncomfortable.
Saving for retirement and spending in retirement are two very different problems. People can reach retirement with “enough” money and still have a difficult time giving themselves permission to use it.
When the money comes from a pension or Social Security, they tend to think of it as income. When it comes out of an investment account they spent decades building, it feels more like they are consuming something that may never come back.
I think there is something important in that distinction, but I would take the idea a little further. To me, the real issue isn’t simply figuring out how to turn a retirement account into a paycheck. The bigger issue is that we have spent too much time measuring wealth by the size of the pile and not enough time measuring what the pile can actually do.
A Million Dollars Isn’t a Retirement Income
Suppose you come into my office and tell me you have $1 million saved for retirement. My first reaction isn’t necessarily that you are in great shape or terrible shape, because I really don’t know much yet. I know you have $1 million. That’s useful information, but it doesn’t tell me how much income you need, what other income you have, how much tax you will pay, whether you have debt, what your lifestyle costs, how much liquidity you need, whether you want to leave money to your children, or how much risk you are willing to take with the money that is supposed to fund the rest of your life.
More importantly, the million dollars doesn’t tell me how much you can spend with certainty. Can you take $100,000 a year from it? Probably not for very long. What about $70,000? $50,000? $40,000? What if the market has a great first five years after you retire? What if it has a terrible first five years? What if inflation averages 2 percent, or 4 percent, or more? What happens if you live to 95? What happens if you die at 78 and your spouse lives another 20 years?
All of those possibilities are connected to the same million-dollar account balance, yet they can produce very different outcomes.
That is why I have always been much more interested in cash flow than in net worth. Net worth tells us something important, but cash flow tells us how your financial life actually works.
You don’t buy groceries with net worth. You don’t pay the electric bill with an account statement. You don’t take your grandchildren on vacation with a rate of return. Somewhere along the line, an asset has to produce, distribute, or release cash that you can actually spend.
Why a Paycheck Feels Different
Think about two couples who retire with roughly the same net worth. One couple has Social Security, perhaps a pension, some rental income and other assets producing enough dependable cash flow to cover most of what they spend each month.
The other couple has the same overall wealth, but most of it is sitting in investment accounts. Every month they have to decide how much to withdraw, and every withdrawal potentially reduces a balance they have spent their entire adult lives trying to increase.
On paper, those two couples may be in very similar financial positions. In real life, I suspect they may behave very differently.
This isn’t a surprise. It’s easier to spend a paycheck than it is to liquidate your assets. Most people spend their working years doing just that, it feels normal. We’re using to the cyclical nature of the paycheck, and much less used to watching a balance go down.
That doesn’t automatically mean pensions are better, investments are worse, or that everybody should convert their assets into an annuity. I think that conclusion is much too simplistic.
What it tells me is that assets and income as we typically think of them perform different functions. I believe we should be considering what dollars can do multiple jobs, and build an intentional framework around that.
What is the Purpose of Retirement Income?
This is where I think typical retirement planning sometimes starts with the wrong question. We ask people how much they want to accumulate, and then we spend the next 30 years trying to get them to that number. Maybe the better question is, what do you ultimately want the money to do?
Money can produce income. It can provide liquidity. It can protect against risk. It can create opportunities. It can be used to acquire other assets. It can be transferred to children and grandchildren. It can allow you to make decisions without worrying about where next month’s mortgage payment is coming from.
All of those things have value, yet if we try to designate five different pools of money to do five different things, we’re staring down failure. Similarly, if we judge every financial decision simply by which one produces the highest projected account balance, we are ignoring efficiency.
Truth Concepts calculators allow you to bust these “problems” wide open. A calculator doesn’t know what the market is going to do next year, and neither do I. That’s not really the point. The point is that a good calculator allows us to take assumptions that are usually hidden and put them on the screen where we can actually see them.
Identify the Purpose of Your “Retirement Income” Dollars
Instead of starting with, “I think I need $2 million to retire,” we can start with the lifestyle. How much income do you actually want? How much will Social Security provide? Is there pension income? Rental income? Business income? What other dependable cash flow exists? Once we know that, we can start identifying how to make the financial ecosystem work in your favor.
Truth Concepts calculators allow you to go even deeper, if you choose. What happens if the rate of return is lower? What happens if inflation is higher? What happens if withdrawals increase? What happens if retirement lasts longer than expected?
The value isn’t in pretending we can forecast those things precisely. The value is seeing how sensitive the outcome is to assumptions we may have been taking for granted.
That is a very different exercise from looking at an investment statement and saying, “I’ve got $1.8 million, so I think I’m okay.”
Average Returns Can Hide a Lot
There is another issue that becomes much more important once someone starts taking money out of an account. During your working years, a significant market decline is unpleasant, yet if you are still earning money and continuing to invest, you may have time to recover. You may even be buying more while prices are down. Once retirement begins and you are taking distributions, the order in which those returns occur becomes much more important.
Imagine two retirees who earn the exact same average return over a 20-year period. One experiences strong returns early and poor returns later. The other experiences the same returns in reverse order, with the bad years occurring right after retirement. If neither person is withdrawing money, the ending results may be relatively similar.
Once withdrawals are introduced, however, those two people can end up in very different places because the second retiree may have to realize significant losses just to pay the bills. Those assets are no longer there when the market eventually recovers.
This is one of those concepts that is much easier to understand when you actually run the numbers than when somebody explains it on a whiteboard. Change the timing of the returns in a calculator and suddenly “average rate of return” doesn’t look nearly as comforting as it did before.
There Is Another Kind of Retirement Risk
We talk a lot about the risk of running out of money, and we should. Longevity risk is real. Inflation is real. Taxes are real. Market volatility is real. Healthcare costs are real.
Yet I think there is another risk that doesn’t get discussed enough, and that is the possibility of doing such a good job protecting your retirement assets that you never really use them.
It’s not surprising that retirees are reluctant to spend the assets they’ve spent their lives accumulating. There is nothing inherently wrong with that. If someone wants to leave a large inheritance, wonderful. Yet I think there is a big difference between leaving wealth behind because that was your objective and leaving it behind because you spent the last 25 years afraid that you might need it.
If you spent 40 or more years working, saving and building wealth, there ought to come a point when the financial system you created gives you enough confidence to actually use some of it.
Create the Flexibility of a Paycheck with Life Insurance
What retirees want is confidence, or permission, to spend assets. For decades, I’ve used my calculators to prove that whole life insurance is the ideal asset to extend the life of your money and allow you the peace of mind to actually spend down assets.
When you have an increasing asset that is guaranteed to pass tax-free to your heirs, that you can use to access tax-advantaged funds, suddenly spending money doesn’t seem so intimidating. Additionally, life insurance enables you to sequence returns so that you don’t have to pull from investments in a down year. I call this strategy the Cash Flow Bridge.
Life insurance puts your dollars to work in multiple ways, rather than having separate buckets of cash for each “problem.” This makes for efficiency, and ultimately extends the life of all your dollars.
And, spending down other assets doesn’t seem as daunting when you know there will still be something left for your kids or grandkids.
In these terms, retirement is less about your dollar amount and more about having the flexibility to pivot no matter what life throws your way. And isn’t that a more enjoyable way to live?
The calculators can’t tell us exactly what is going to happen. Nobody has that power. They can show us what has to happen for a particular strategy to work. And that is an enormously important distinction.
Solving Retirement Income
For decades, typical financial talking heads have taught people that the goal of retirement planning is to accumulate a sufficiently large pile of money. I think accumulation is only half the job.
Eventually, that pile has to support a human being, a marriage, a family, a lifestyle, and perhaps a legacy. It has to survive things we cannot predict while still providing enough cash flow that the owner doesn’t spend retirement afraid to use the money.
The question is not simply how much have you accumulated? The question is, what can your money reliably do for you?
If you’re ready to help clients answer those questions and go even deeper than your average financial software, give Truth Concepts a try.
