Matching Retirement Income to Expenses
Have you read about the “4-box strategy” for matching your retirement income to your retirement expenses? You should because it makes sense for the careful planner worried about retirement income survival.
The first step is to identify and separate your retirement income streams into two categories: (1) reliable sources of lifetime income and (2) income from assets. This gives you the first two “boxes” in the 4-box strategy.
Category (1) income sources would include Social Security and pension benefits. Category (2) income sources would include using your retirement investments to generate income, e.g., interest, dividends, and periodic sales of stocks, bonds, and mutual funds.
The second step is to identify and separate your retirement spending into two categories: (1) essential expenses and (2) discretionary expenses. This provides boxes 3 and 4 of the 4-box strategy.
Category (1) expenses would include at least food, shelter, transportation, and health care. Category (2) expenses would include everything else, e.g., travel, entertainment, hobbies, etc.
The third step is to align the income from box 1 (lifetime income sources) with the spending from box 3 (essential expenses.)
The fourth step is to align your expectations for discretionary spending (box 4) with your reasonable expectations for box 2 income from your assets.
So what happens if box 1 (lifetime income) is not large enough to cover box 3 (essential expenses)? One possible solution is to reduce your shelter costs by downsizing and/or relocating to a lower cost area. Another possible solution is to use some of your retirement assets to purchase an immediate annuity to cover the gap between guaranteed income and essential expenses.
If you are fortunate, box 1 is larger than box 3. In that case, you can comfortably move some of your discretionary expenses (e.g., your favorite hobby or travel) from box 4 into box 3.
There are two significant benefits to using the 4-box strategy to implement a financial plan for retirement.
First, it causes you to assess how you will meet your basic spending needs in retirement. When and if you are able to do that, you will be less anxious about running out of money or having to depend on family to support you.
Second, it causes you to also look hard at your discretionary expenses and whether they can be sustained when you retire. After you match the size of box 3 with box 1, there may be a significant disparity between the sizes of boxes 2 and 4. In that case, you will have to either shrink box 4 (spend less on non-essentials) or enlarge box 2 (e.g., work longer and save more.)
Of course, inflation must be factored into this analysis.
Read more here about the 4-box retirement income strategy.
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