Previous post:

Next post:

Planning Your Retirement? Think Income, Not Assets

by Melanie on April 25, 2014 · 37 comments

in early retirement, income, retirement

Get free update via email:
RB40 won't spam you

The following article is from Mike, our staff writer.

How will you know when you’re financially ready to retire?

Most people don’t give that question much thought at all, but as readers of RB40 I’m going to assume you’re a little more financially savvy than the average Joe on the street.  Perhaps you’ve already sat down and come up with an estimated amount you need to save in order to retire safely using the four percent rule.

If so, that’s great!  You’re already way ahead of most people and you’re at least beginning to map out your plans for retirement.

But today I’d like to introduce you to a different way of thinking about your retirement savings.  It’s an idea that was popularized by my fellow blogger Todd Tresidder in his book How Much Money Do I Need to Retire?  Reading Todd’s book made me rethink my own plans for retirement and it might just do the same for you.

You see, the problem with traditional retirement planning is the sheer number of unknown variables which can wreck havoc on even the best laid plans.

For example, let’s say you use a traditional retirement calculator to figure out how much money you need to retire and it says you need exactly one million dollars.  Your plan is to withdraw a certain percentage of your assets each year and according to your calculations that million dollars will last you exactly twenty years (I’m using round numbers here to make the example simple).

But despite your best planning, any number of things can go wrong.  The stock market could crash two months after you retire.  If your million dollar nest egg is suddenly only worth a half million dollars, you’d have to significantly reduce the amount you can safely withdraw each year.  Alternatively, you could live well past the twenty years you had estimated.  Outliving your money could mean spending your final years in poverty.

In his book, Todd lays out a blueprint that includes a new way of thinking about retirement, one that focuses on cash flow instead of asset values.  Rather than focusing on accumulating the most assets with the intention of slowly selling them off, you focus on creating new revenue streams that can support your retirement without requiring you to sell off any assets at all.

Ideally you’ll be able to develop multiple income streams to protect yourself in case one of them dries up.  You’ll also want to build income that will grow over time to keep up with inflation.  Here are a few suggestions for income streams you can build to support your own retirement:

Stocks that pay dividends.  Look for reliable stocks like the Dividend Aristocrats.  These companies have established a long history of not only consistently paying out dividends, but also increasing their dividend payout year after year.

Rental properties.  While being a landlord has its challenges, you’ll be able to raise rent to keep up with inflation.  Plus, with some luck rising real estate prices will increase the value of your property too.

Business ownership.  The key here would be to own a stake in a company that doesn’t require much oversight on your part.  Becoming a silent partner or owning a business where most tasks can be outsourced or managed by someone else will provide income without draining you of your precious time.

If you can manage to build enough income streams to live off and also have the ability to increase the payments those streams throw off to keep up with inflation, you’ll never have to worry about outliving your money.  You can retire with piece of mind knowing that your income-generating assets will support you indefinitely.

RB40′s take

I also think it’s better to focus on the cash flow rather than the lump sum. Personally, I became much more aware of how I spend our money when I track our monthly expenses. Part of that is tracking our various passive income and it’s great to see how much closer to true financial independence every month. However, it can take a very long time to create enough passive income to cover your monthly expenses. That’s why I’d like to add a couple more things to Mike’s list above.

Creative income. This is really important if you plan to retire early. Most of us won’t be satisfied with an idle retirement at such a young age. If you can make a little income doing something you enjoy, then you’ll be able to put off withdrawal. It’s more fun to create something than just lounging around all day anyway. The income generating assets in this case is your creativity.

Royalties. Of course, if your creations are well received, then you might be able to generate some residual income from them. You can write books, make music, shoot great photographs, or create great works of art.

Are you working on your income streams for retirement? 

Get free update via email:
Stay in touch with Joe and see how he handles Retiring by 40 and being a stay at home dad.
We hate spam just as much as you

{ 37 comments… read them below or add one }

Stefanie @ The Broke and Beautiful Life April 25, 2014 at 5:16 am

I don’t think I’ll ever step away from work entirely, though I would like to choose to work rather than having to work. I’m building my business now in hopes that it will support me not only through my prime income earning years but also in retirement, when I hope to still manage it, just a bit more from a distance.

Reply

retirebyforty April 26, 2014 at 3:17 pm

That sounds great. It would be nice to have a business where you don’t have to work a lot. Need a good team.

Reply

Mike Collins April 29, 2014 at 5:44 pm

If you can get to the point where much of the work can be managed by someone else you’ll be in a great situation. Takes quite a bit of work to get there though.

Reply

Petra April 25, 2014 at 6:43 am

The 4% safe withdrawal rate has been proven to have a high probability of success, even through the worst market downturns in history. The strategy that Todd promotes has not been tested that much, and I see a lot of potential problems with it. I guess it can’t hurt to have a 2nd or 3rd income stream next to having assets in savings and in the stock market, but I wouldn’t count on any income stream to not dry up or suffer over time.

Reply

retirebyforty April 26, 2014 at 3:19 pm

Living on passive income is much harder to achieve than just drawing down with the 4% safe withdrawal rate. I don’t think many people can get there. What are some problems that you see?

Reply

Mike Collins April 29, 2014 at 5:50 pm

It’s not a perfect strategy (a company could eliminate its dividend or your rental property could be left vacant in a bad economy) but its one I think is worth consideration. The 4 percent rule is not foolproof either and with life expectancies rising I worry it will become harder to make that nest egg last. Thanks for the feedback.

Reply

Justin @ Root of Good April 25, 2014 at 7:19 am

Looking at your retirement funding in terms of income instead of assets makes sense to some extent.

We sort of lucked into enough income from dividends and a little hobby income to mostly fund our early retirement. We may have to sell some of our investments occasionally, but there’s nothing wrong with that either.

Reply

Mike Collins April 29, 2014 at 5:50 pm

You’re in a good situation!

Reply

freebird April 25, 2014 at 7:20 am

Interest has been a popular source of retirement income, albeit maybe hard to get these days. That’s the “fixed income” part of your portfolio, like bonds held to maturity or a CD ladder. Riskier high-yield plays could include REITs or canroys.

My retired mother’s attitude is along these lines, she’s only willing to spend the income from her pensions, SS, and CD interest, she never touches the principal. My plan is completely different, I don’t see anything wrong with a scheduled depletion. Sure the stock market may crash, but most likely it’ll be temporary so you just have to adjust for awhile. I don’t think stock dividends are much safer. Bond interest should be more secure, and CD interest should be very solid.

One nice thing about these paper assets is that you don’t incur liability– unlike if you own a business or rental properties. Another is that these tend to be more liquid, so if for some reason a sudden disaster forces you to bug out, you can likely retain a fair portion of the value. Or if you think we’re in for an extended stable period, you can always buy an immediate annuity from a large insurer, in whatever lot size you want.

My background is a bit like yours, my parents immigrated from a part of the world where their substantial family real estate holdings were totally lost to a revolution. They escaped with the clothes on their back, and lived off some gold jewellery that turned out to be of far more practical value than great grandfather could have imagined.

Reply

retirebyforty April 26, 2014 at 3:21 pm

I don’t mind spending down our retirement fund either. I’ll wait until we’re in our 60s to do that, though. For the early part of our retirement, we’ll depend on only passive income and creative income. Gold is a great hedge. Everyone should have some gold jewelry in their arsenal.

Reply

Chattanooga Cheapster April 25, 2014 at 10:11 am

I agree with Stefanie on this one. The point of the 4% rule is that it will survive even drastic market turns. A retirement strategy utilizing a 4% withrawal from a fund that had 25Xliving expenses would have been just fine even through the Great Recession.

I do get the point, though.

Reply

Ravi April 25, 2014 at 10:42 am

I think one way to think about it is to “value” your income streams as if they were assets. If you are currently using the 4% rule (3%, 3.5%, whatever number you choose), then you can basically apply that to any income you currently have that is not from financial assets to get an “equivalent value”.

Ex: You have a hobby where you buy/sell art that nets you an average of $3,000/yr ($250/mo). If you tried to replicate this with financial investments, you would need approximately $75,000 (3,000 / .04). Meaning, you would need to invest around $75,000 to have access to $3,000 per yr indefinitely.

You can see how even a relatively small amount of income, few hundred dollars a month from a small side business, part time work, consulting, etc, can “replace” the need for a fairly large chunk of invested assets.

I think the point of the article was to pick whatever suits you, but to not be solely focused on the total $ amount invested.

Another example is if you plan to work part time at $10/hr for 15 hrs/week, that’s around $600/mo (7,200/yr). Again, divide by .04, and this part time job is equivalent to having an additional $180K in assets.

Interesting stuff. I do like the idea of taking the income approach for part of my assets. In an ideal world, I would have enough income to cover my regular expenses, and wouldn’t need to touch principal except for special situations.

Reply

retirebyforty April 26, 2014 at 3:29 pm

I like your approach. You can see how a small amount of income can help alleviate the pressure on your retirement fund. For me, blogging generates more income than a million dollar dividend portfolio. Most people really can’t save that much so they really need to look at some kind of work after retirement.

Reply

Mike Collins April 30, 2014 at 6:55 am

Thanks for the feedback Ravi. i like your example of a hobby that generates a few hundred dollars a month. A few revenue streams like that can really take the pressure off your investment portfolio by adding much needed income.

Reply

Evan April 25, 2014 at 11:44 am

Maybe I missed it but I didn’t see annuities as a way to solve a lot of the income problems for traditional retirement.

Reply

JayCeezy April 25, 2014 at 7:49 pm

Evan, do you have an example of an annuity that would provide a steady payout? Over what period? At what effective return?

I have been following annuity payouts for decades, and at this point in time I am seeing returns for the 30-40 year range at about 1.9%. I think I can beat that with a simple CD ladder, and still retain control of my money as well as being able to give the remaining estate to the person(s) or cause(s) of my choosing in the event of my demise. Annuities are essentially insurance products. If you do not need insurance, you do not need an annuity.

Reply

davidmichael April 27, 2014 at 11:59 am

Annuities could be another revenue stream. However, I recommend extreme caution. We lost our retirement annuity after the largest insurance company in California went bankrupt (in the 1990′s). In terms of anticipated income, that was $650,000 down the tubes. So…don’t believe all the hype and everything you read by the insurance or investment companies. Private companies can and do go bankrupt. Thus…the need for diversification. (Just thought I’d throw in a little dose of reality here.)

Reply

IWRN April 25, 2014 at 11:50 am

You have a really good point. I have been focusing on how much assets I have and want to have before my retirement. In the reality, it doesn’t really matter how much assets I have. I need to generate a stable and sustainable passive income stream instead.

I was planning to work for another 2 years but am completely sick of my current job and industry just like you were before. I am really worn out and am about to push a button to quit my job at this point. Last year I set up my goal to reach my asset worth of $1 million excluding my retirement accounts (401K and IRA). I am still a short of my goal and need to work another year or two.

I really need to find how I can come up with a stable passive income using my capital. I own a rental property but need to cash it out to put an expense nightmare behind me. I also cannot rely on the stock market to generate a stable passive income… This is where I struggle.

Reply

retirebyforty April 26, 2014 at 3:32 pm

That’s tough. I was pretty much a zombie the last 2 years at my job. Just going through the motion and it was still really stressful. Have you look at dividend stocks and REIT? That should generate some income for you. I would also try generating money from a part time job or just try to kick start your creative income. Even a thousand dollars a month can help you minimize withdrawal.

Reply

Mike Collins April 30, 2014 at 7:00 am

Being stuck in a job you can’t stand is tough, but at least you’re planning ahead so your escape will be a successful one. I like the concept of focusing on income because what if you have $1 million in assets but the real estate and stock markets take a serious dip? If you assets are no longer worth what they were you won’t be able to withdraw that 4 percent after all.

Reply

Bryce @ Save and Conquer April 25, 2014 at 12:33 pm

I can understand where an early retiree might want to have multiple sources of income. They will need that income to last hopefully for a very long time. I won’t be retiring until I am 66. At that point, I will be at my Social Security full retirement age. The only income streams I want to worry about then are Social Security and income from our investments. We should be able to live off only 2% of our investment portfolio at that time. Our income should be self sustaining.

Reply

retirebyforty April 26, 2014 at 3:33 pm

That’s great. Do you plan to leave the extra to certain charity? Or to your kids?

Reply

Mike Collins April 30, 2014 at 7:01 am

Social Security would be another one of those income streams you can live on.

Reply

John @ Sprout Wealth April 25, 2014 at 2:06 pm

I think this does make sense to a pretty good extent. Of course, having a nice lump sum is going to be nice but you also never know what’s going to happen thus the importance of having those different revenue streams. I don’t see us ever truly stopping working altogether, but likely doing something with our business as it grows. The key is to managing it right so you can still step away but make money from it.

Reply

Mike Collins April 30, 2014 at 7:04 am

If you enjoy your business and are healthy enough to continue indefinitely that would be great. It would add a stream of revenue and also keep your mind sharp.

Reply

JayCeezy April 25, 2014 at 7:55 pm

4% rule is “no longer operable” as they say in politics. It hasn’t been, for 20 years. Google ‘Morningstar 2.8% withdrawal rule’ and you will be rewarded. The 4% rule was introduced in 1994 by William Bengen, and has been blown out of the water by real-world returns.

Some of the retireby40.org readers are a bit younger, but the S&P500 dropped 50% in 2003, and again from 2007-09. Wow. The real return, including dividends (and not including inflation) for the S&P500 (which constitutes 70% of the US stock market) from 2000 – 2014 is 1.9% annually. Read that again. Think about what withdrawing 4% would do to your savings, in an environment that dropped 50%+ twice in 10 years and returned 1.9% annualized for 14 years.

Reply

retirebyforty April 26, 2014 at 3:38 pm

Ugh… I probably need to research and write about this topic. I don’t like the 4% rule either. Maybe for those down years, it’s better to take a part time job and leave your retirement fund along. You can do that in your 60s and early 70s. When you get to 75, the 4% rule should hold out.

Reply

JayCeezy April 27, 2014 at 8:53 am

Ugh is right! You may recall I was ready to retire in 2006, my wife was out of the workforce and enjoying the retirement lifestyle, and I was all set to burn my bridges and tell all deserving parties to “EFF OFF!”:-) Long story short, I wound up working another 5 years, my wife went back to work, and it was one of the most humbling experiences in my life. The thing is, I’m not seeing anything different in the 2014 economic environment from 2007. The only thing people can point to that would indicate a decent economy is the stock market, and that is artificially inflated by Fed ZIRP policy. Personally, I’m using a 2% rule in addition to other cashflow sources, but I have a 40-50 year timeline. No way will I go back to work part-time, especially at 60 or 70. But every year that passes squeezes the “Risk/Pig” a little further through the “Timeline/Python.” Good luck to us all!

Reply

No Nonsense Landlord April 25, 2014 at 8:16 pm

I am banking quite a bit on Real estate. I have a pretty decent portfolio too, to add as a backup, some pension, and hopefully social security.

With all of it, I may just be able to retire at 56.

Reply

Dividend Mantra April 25, 2014 at 8:35 pm

Joe,

I look at early retirement the same way. I focus on the dividend income only, and not the underlying prices on my equity holdings. My portfolio could double tomorrow, but if the passive income stays static then my financial independence is really no closer. The dividend income pays the bills, not my net worth. And since my portfolio is a tree, with every holding a branch that produces bountiful dividend fruit every month, I want to pluck that fruit and live off of it, rather than hacking off a branch at a time and killing the tree one cut at a time.

Have a great weekend!

Best wishes.

Reply

Dan @ Our Big Fat Wallet April 26, 2014 at 4:31 pm

I think it’s important to have multiple income streams upon retirement. My wife and I plan on earning income through our rental property (which will be paid off by the time we retire), government pension, RRSP and TFSA. I’ve invested in dividend stocks with the hopes that they will continue to provide a steady stream of dividend income when we retire

Reply

Martha Gonzales April 27, 2014 at 12:04 am

The article is great. In fact, 4% rule can definitely put me ahead of most but a severe medical cost can eat up all my money, especially during emergencies. When we make plans we don’t include emergencies and the sum required to come outr of the distress. I’ve seen one of my friends who spent almost all his money in paying medical bills of his wife’s terminal illness. I perfectly understand why 4% rule may not always work out. So, creating other income streams are a must and real estate investment can give a lot of money. However, it must be kept in mind that the real estates should be brought at the right cost so that after our retirement even if we sell it it gives us a positive return as well as income. In fact, rental income can be great, if we can invest in real estate and after buying it utilize it for rental income. It can earn us good sum of money during distress. Royalties are good source of steady income but creating it is difficult, at least for me. So, I’m keeping that aside. However, I do think that ever after retirement we should get indulge in small counseling or other less strenuous jobs that can also get us income but at least possible stress. That’s my take completely.

Reply

darren April 27, 2014 at 8:25 am

Joe,

I agree! Ultimately, assets need to be converted to income during retirement. Why not have multiple sources of income so that you can wait as long as possible, 70 1/2, before you’re forced to make withdrawals from retirement accounts? I despise the 4% rule, too, because everyone’s situation is different. Plus, when you plan on retiring will determine whether or not the 4% rule will even apply. Since my goal is to not work at a job I don’t enjoy or feel passionate about ever again, I’m focusing on creative income and residual income streams for my retirement from military service. Thanks for the great post!

Darren

Reply

The Patrick Grace Group April 27, 2014 at 9:10 am

In today’s world you can’t save your way to financial freedom or retirement. You have to have income streams that offset your expenses. A great way to do that is through stocks that pay dividends and rental property.

I like rental property because you can cash out refi when it’s paid off. Then your renter pays down the new mortgage. Don’t forget the tax benefits as well.

Reply

davidmichael April 27, 2014 at 11:50 am

This blog article encouraged me to reread Todd’s book once again after an absence of several years. I strongly recommend his book “How Much Money Do I Need to Retire?”

Now after 20 years of retirement, I feel many writers leave out the importance of seasonal work. I suspect that many people look at these blogs and feel like an early retirement is out of the question in order to build-up enough “Passive Income”. Personally, we had several financial downturns that depleted part of our expected income, but we just work in interesting jobs occasionally when we wanted to increase our cash flow. It’s no big deal and keeps us mentally and physically challenged. This summer, at age 77, I will be working as a camp host in beautiful Central Oregon (near Sisters) on one of the most beautiful Trout streams in the country (The Metolius). I’ll be paid about $6000 for that experience. So…I’m not saying that the Passive Income equation is not really important, but if one wants to retire early and can’t come up with the total needed funds, just know that there are tons of seasonal jobs out there for people with RVs who want to work outdoors in some of the most beautiful country on earth.

Reply

Jay April 29, 2014 at 10:56 am

Actually, I would refine this article’s title by a bit. Instead of just thinking “Income”, I would say to think “After-tax income”. It’s an important distinction and prompts people to reconsider the whole 401k thing as a primary vehicle. Unless you plan to live on the bottom-most rungs of the tax ladder, an income from 401k leaves you completely exposed to the maximum tax the government can muster.

Alternative investments like dividends, real estate, annuities, ROTHs, and EIULs give a better (and sometimes complete) tax shelter on the income they generate.

Reply

Joseph Brown August 8, 2014 at 1:17 pm

Excellent advice! A simple shift in focus from working for someone for 40+ years and dumping money into a 401k toward a focus on creating cash flow producing assets can really hasten up the retirement objective. Anyone can achieve an early retirement by simply taking an unconventional approach and focusing on investing in their own businesses, their own intellectual property, their own rental properties, etc…

Reply

Leave a Comment