Week 25 Day 6: Building a Retirement Paycheck

Example retirement paycheck: Social Security (delayed to 70): $3,165/month. Portfolio withdrawal (4% of $800,000): $2,667/month. Small pension: $500/month. Total: $6,332/month ($75,984/year). If your expenses are $5,000/month, you are covered with a $1,332/month surplus for unexpected expenses or fun money.

Building blocks of retirement income, ranked by reliability: (1) Social Security: guaranteed, inflation-adjusted, lifetime income. The bedrock. (2) Pension (if applicable): guaranteed income, but usually not inflation-adjusted. Declining availability (only 15% of private-sector workers have pensions). (3) Bond ladder or TIPS ladder: maturing bonds provide predictable cash flow. Create a 10-year ladder with bonds maturing each year. (4) Dividend income: SCHD, VYM, or VNQ provide growing dividend streams but not guaranteed. (5) Portfolio withdrawals: sell shares as needed using the 4% rule or bucket strategy. (6) Annuity income: insurance company guarantees income for life. Expensive but eliminates longevity risk for the annuity portion. (7) Part-time work: even $1,000/month reduces portfolio withdrawal pressure significantly. The full income plan: Social Security covers 40-50% of expenses (for average earners). The portfolio covers 40-50%. The remainder comes from other sources (pension, part-time work, rental income). If the total exceeds expenses by 10-20%, you have a comfortable margin for healthcare surprises and inflation bumps.

The retirement income 'flooring' approach (Evensky, Horan, and Robinson, 2011) divides income needs into essential expenses (covered by guaranteed income: Social Security + pension + SPIA annuity + TIPS ladder) and discretionary expenses (covered by portfolio withdrawals). This approach maximizes the probability of meeting basic needs regardless of market performance while maintaining upside for lifestyle spending. The optimal split between annuitized income and portfolio is determined by Yaari (1965): in the absence of a bequest motive, full annuitization is optimal because it eliminates longevity risk at actuarial fair pricing. In practice, annuities carry insurance company margins (approximately 10-15%), illiquidity, and inflation risk (unless specifically inflation-indexed). Milevsky (2006) showed that the optimal annuity allocation depends on subjective mortality assessment: healthier individuals benefit more from annuitization (they are likely to collect for longer). The 'Product Allocation' framework (Blanchett and Kaplan, 2013) optimizes across the full set of retirement income products (stocks, bonds, SPIAs, variable annuities, Social Security timing) and typically finds that: (1) delaying Social Security to 70 is nearly universally optimal, (2) annuitizing 20-40% of the portfolio at retirement improves risk-adjusted income, and (3) the remaining portfolio should be invested in a diversified mix of stocks and bonds with systematic withdrawals. This integrated approach produces approximately 15-30% more spending in the worst-case scenario compared to a pure portfolio withdrawal strategy.