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New Retirement Rescue Blog Post...Retirees Need to Focus on Cash Flow Not Income!

by Retirement Rescue Coaching on Nov 21, 2014

Retirement Rescue Coaching: For most of our adult lives, we sustain our standard of living by working and generating income from the fruits of our labor. As we receive a paycheck from our employer–or draw payments from a business we own–we report the income we generate to Uncle Sam, who takes a portion in the form of taxes, and the rest is used for some combination of consumption for our current needs, and saving to fund our spending in the future.

At the point of transition into retirement (or at least, “financial independence” from work), the basic goal is relatively straightforward: to replace the income we had during our working years, with income from the assets we have saved for retirement. Simply put, we aim to replace one income stream with another, thereby allowing us to maintain our lifestyle.

The problem, however, is that the word “income” does not mean the same thing in retirement that it does while we work. The first issue is simply that if all we do is spend the “income” from our assets in retirement, we leave over all the assets themselves; while some may wish to leave such a generous inheritance to their heirs, for many retirees, the reality is that they can’t afford to not use their principal at any point in their retirement. While it’s obviously dangerous to spend too much principal too soon, it’s an unnecessary constraint on lifestyle to avoid spending it ever.

The end result: At some point, retirement spending needs to include principal, too. Especially in low-yield environments where relying solely on “income” alone can severely (and potentially unnecessarily) constrain retirement spending. On the other hand, one of the most confusing problems in the world of investing is that sometimes payments are a combination of principal and income already, and investors don’t even realize it! For instance, one of the reasons that master limited partnerships (MLPs) have “tax preferences” is that they’re paying back a portion of the principal along the way (which is why those payments are “tax free”!).

The same is true of immediate lifetime “income” annuities, that also pay out what is actually a combination of income and principal. And in the case of many variable or equity-indexed annuities with “income” guarantees, all the annuity guarantees may do for most retirees is pay them back their own principal over time, without actually generating any “income” at all. In the context of retirement accounts, the matter is even more confusing. As an accumulated asset, the account balance of an IRA is “principal” in any normal accounting of investment results, yet it is treated as “income” for tax purposes–because the principal is actually a deferral of income back when it was wages during the working years! These confusing overlaps in what constitutes retirement “income” can lead to serious problems. Retirees may purchase “income” guarantees that are actually just a return of principal, or spend principal thinking that it’s income, or rely too heavily on income and unnecessarily constrain their spending by not tapping principal when it is appropriate to do so.

So what’s the resolution? It’s time to stop talking about retirement “income”, and instead focus on what really matters: generating after-tax retirement cash flows that can fund real-world retirement goals, not “income” as some investment product or the tax code inconsistently define it. And with a focus on cash flows, it’s easier to then talk about all the ways those cash flows can be effectively created, and retirees can more appropriately evaluate what sustainable cash flow can be withdrawn in the first place!


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