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Planning to live on retirement income from investments instead of earned income is a transition that can be a mysterious and scary thing for many soon-to-be retirees. After all, once that paycheck is no longer coming in, we’re living mainly off of dividends, interest and liquidated shares. But it doesn’t have to be intimidating!

For most individuals, a financial planner or wealth manager is an option to consider for effectively stewarding the resources currently within their grasp.

While some financial planners, like wealth managers, may have a minimum investment required for their services, there are many who do not require a minimum (or at least have a very low minimum in the thousands). These planners often specialize in topics such as:

• Budgeting
• Risk Management
• Investments
• Retirement Planning
• Education Planning
• Tax Strategy
• Estate Planning

Due to the Fiduciary Rule from the US Department of Labor, financial planners are required to clearly disclose in dollar amounts what is charged for financial planning. For this reason, many firms have chosen to separately charge for financial planning (comprehensive advice) as opposed to investment advice (stock picking, for example), so that one comprehensive fee does not get charged for both combined. This is intended to make the fee structure more transparent and, ultimately, serve the best interest of the client.

Depending on the complexity of your situation and the extent of financial knowledge that you possess, it may be beneficial to work with a financial planner to construct a blueprint going forward. While some clients prefer to pay annually to keep their plan updated and utilize ongoing planning conversations, some may choose to only pay once in a while for an updated plan and spend the next several years implementing it. When a life changing event occurs, it may be time to revise the plan.

Whether you use the services of a financial planner, or intend to tackle this subject on your own, having a well-constructed plan is essential if you intend to build wealth effectively over time.

Let’s take a look at a basic projection that can serve as a starting point. The importance of having this base line projection is so that you can be more intentional with your day-to-day decisions, understand how changes to your situation can affect the end result, and feel confident knowing that you have a basic plan with a strong likelihood of success.

Even on a small budget, the power of smart decisions and compounding interest can mean a world of difference in the years that follow.

What If I Have Nothing to Start With?

If you are starting from ground zero with little-to-no savings, it’s likely that you’re currently, or very recently, living paycheck to paycheck. That doesn’t disqualify you! A great first step would be to get in touch with a financial planner who specializes in budgeting, or even a financial coach (often unlicensed, meaning they will stick to budgeting advice without selling or recommending investments). A financial coach specifically helps others with balancing the budget.

Even if you have the willpower and know-how to cut expenses on your own, the benefit of engaging a third party is 1) it provides a level of accountability and 2) it can provide an outside viewpoint to help get all household members on the same page.

Budgeting is number one, the gateway to all other forms of wealth-building. Once the budget is under control, you can begin building an emergency fund and, eventually, earmarking a percentage of your income to investing in your future. Developing this plan with a financial planner or coach will have a cost upfront, but it is important to think of this in terms of any investment. The long-term value of developing a blueprint for your future wealth, and current lifestyle, will far outweigh the cost of laying the foundation.

Generating a positive surplus from the budget is like a fountain from which all else springs. The planner’s job then becomes that of protector (insurance), strategist (risk management and tax planning), builder (investments and retirement planning) and sustainer of the legacy (education and estate planner).

Because the planner has no power that is not given to him or her, it is extremely important for both of you to be on the same page. Plans work most efficiently when both parties understand one another, ask questions, share differing opinions, and are honest about their thoughts and feelings.

While adherence to the planner’s advice is not mandatory, and there may even be disagreements from time to time, being a good listener and understanding the “why” behind any piece of advice will improve your decision-making skills and your understanding of financial principles.

No planner is perfect, and without a perfect vision of the future, mistakes will inevitably be made. That is normal for everyone, part and parcel to navigating uncertainty. But the goal of putting two heads together is that you can see more clearly, and make better decisions in the present, with a fuller scope of information and education about the nature of building wealth.

Let’s Take An Example

So what might a basic retirement income projection look like? While this is an overly simplified version of what would be discussed (such as ignoring taxes), this will give you an idea of how to think about establishing the baseline plan.

If you’re proficient at math, you may enjoy the challenge of these numbers. If not, feel free to skim over this and leave the number crunching to a financial planner.

Here we go!

Martha is 25 years old earning a gross income of $50,000 per year. After working with a financial planner to construct a sustainable budget, she now has the potential to save away 5% of her earnings into a retirement account. While $2,500 doesn’t seem like much, she continues to save this away faithfully for 37 years until she reaches the age of 62. If she manages to earn a 7% average annual rate of return on this investment, her savings will have amassed to about $400,000 by that time*.

*Note that I have compounded the returns on an annual basis, rather than monthly, to be more conservative and (probably) realistic.

Assuming her income grows over the years, and she maintains a 5% savings rate, the number will be higher.

What if she saves a superstar level 10% of her income every year: $5,000? Of course, the end result at age 62 is double the former at $800,000.

Additionally, stocks and bonds are not the only choices she has for investing in her future. She may decide to invest in herself, improving her knowledge base and achieving promotions. She may invest in real estate, or even a business. These may significantly affect the end result.

Let’s make some very conservative assumptions.

• Martha gets a 2% inflationary raise each year.
• She continues saving 5% each year, which grows slightly with each increase in income.
• Martha qualifies at 62 for reduced Social Security (due to early retirement and possible reduced Social Security payments due to its unsustainability under current legislation).

Under these circumstances, she will have grown her invested assets to just over $500,000.

By using the Social Security Calculator, we might assume she qualifies for around $1400 in today’s dollars. To adjust for inflation, let’s manually assume this is adjusted upward at 2% per year (the Fed’s target average inflation rate), and she qualifies for $2900 at age 62.

But then, it’s important to remember that under current legislation, the Social Security fund is likely to be depleted by 2033. That means that any payments out would need to be covered by tax inflows alone, possibly leading to a 20%-25% reduction in benefits.

(It’s still possible to save the Social Security amounts for this generation, but action needs to be taken quickly either to change qualifying ages or increase the FICA tax.)

To be conservative, let’s say this doesn’t happen and that Martha only qualifies to receive 80% of this projected Social Security amount: $2,320/month.

Assuming a 5% withdrawal rate from her portfolio in retirement, we can put these numbers together:

• $25,000/year from her portfolio (5% of $500,000)
• $27,840/year from Social Security

Rounding up, this total is nearly $53,000 annually. Taking the present value of this amount (again assuming a 2% average inflation rate), this would be the equivalent buying power of $25,500 in today’s dollars.

While this may not sound like much, it’s a surprisingly decent income for such little investment over the years. If she has faithfully paid off debt over that same time, then this may be a livable income. Or she may choose to go part-time with something that she loves to do, using this income as a supplement.

Alternatively, if she had saved away the 10% instead of only 5%, the numbers could look like this:

• $50,000 from her portfolio (5% of $1 million)
• $27,840 from Social Security

The present value, using 2% inflation, of nearly $78,000 is about $37,500. In today’s dollars, could she live off of about $3,000/month assuming no house or car payment? For a single individual, this is quite possible. If she is sharing expenses with a friend, family member, or spouse, then of course the extra income from that situation would change the outlook significantly as well.

The goal is of course for Martha to have much more than this in retirement. But this establishes a baseline to say, even if nothing ever changes, and she simply stays faithful with little, she can still retire earlier than average and live a comfortable lifestyle.

This is the most basic situation, but from this she can plan and strategize to increase that savings rate and even growth rate as her knowledge of wealth-building strengthens over time!

Conclusion

The services of a financial planner can benefit in many ways. One way we have discussed here is by helping you define the track that you are on, projecting how much retirement income might be expected based on your present rate of savings.

In the way of investments, having an individual who has knowledge of financial markets, risks vs. rewards, psychological pitfalls of the common investor, and access to a range of strategies and products can also be an extremely useful benefit.

Getting the maximum return out of investments is not the primary goal. If we were looking for the greatest return potential, we would also be looking at the greatest risk. But we aren’t looking to gamble with our future, but rather apply certain principles that set the odds in our favor to capture as much upside as is reasonable for the level of risk with which we are comfortable and that we can afford to take. Finding this balance is one role of the financial planner. The value of such a plan becomes strikingly apparent as the power of its compounding nature manifests over the years.