Other assets at retirement are the third leg of the stool. They might include savings in a savings account or money-market mutual fund, stocks, bonds, real estate or other property, cash values of life insurance contracts, income payable or cash values of annuities, amounts owed to you by others, and the market value of personal property you wish to sell.
It is best to enter retirement with an adequate cash reserve for emergencies and other unexpected expenditures. Most important financially, however, is a satisfactory annual retirement income. You may have to sacrifice some savings or other assets to attain the desired income level.
There is wide range of options for using savings. For example, you might put some or all life insurance contracts on a paid-up basis, thus lowering anticipated expenses rather than drawing from savings to pay the premiums. A reverse mortgage on your home will increase your mortgage and decrease your equity but add periodic payments from the mortgage company to your planned income. You can also liquidate other investments and reinvest the proceeds in a mutual fund which permits periodic withdrawals. The following example illustrates several options:
James Johnson retires at age 65. He owns his home, which has a market value of $75,000, and has savings accounts worth $15,000, $100,000 of life insurance with a cash value of $40,000, and stocks worth $10,000. His annual income prior to retirement was $25,000. His company retirement plan will pay him $5,500 a year during his lifetime, and then $2,750 to his wife, Vera, for her lifetime, if she survives him. Social Security will pay him $8,000 per year plus an additional $4,000 per year for Vera who is also 65. Their total retirement income for the first year, therefore, is anticipated to be $17,500.
Of his $25,000 gross salary before retirement, $20,000 remained after taxes. According to current tax law, no taxes will be due on any of his income after retirement, including savings account interest and stock dividends.
Therefore, his total retirement income of $17,500 equals about 88 percent of his $20,000 net income after taxes prior to retirement. He wishes to raise his post-retirement income closer to his pre-retirement net earnings without digging too deeply into savings and other assets.
His first decision is to stop paying life insurance premiums of $1000 annually and to use dividends on the policies to purchase paid-up life insurance. This reduces the principal amount of the insurance immediately from $100,000 to $70,000, to which will be added each year such amounts of paid-up insurance as dividends will purchase. By taking this step, he reduces his income needs from $20,000 to $19,000. His $17,500 retirement income is now 92 percent of his post-retirement goal.
Next, he sells stock for $10,000 which he invests in a money-market mutual fund, electing a 10 percent ($1000) annual withdrawal, payable monthly. If the money-market fund earns 10 percent each year, as many did in 1979, the value of the investment will remain at $10,000. If it earns more than 10 percent, the investment will grow. If it earns less, the investment will decrease. With this $1000 per-year withdrawal from the fund, retirement income increases to $18,500. However, about $100 in Federal and State income taxes will be due, so the net income is $18,400, or about 97 percent of the $19,000 goal. Withdrawing interest on savings yields $825, bringing the total spendable income to $19,225, or slightly over 100 percent of the goal.
These steps leave the equity in his home, the cash values of life insurance policies (which increase each year), the money-market fund, and the savings account. In the years ahead, withdrawals from one or more of these assets can provide more income to cover increasing expenditures due to inflation or other causes. Because of a reduction in work-related expenses and a fully paid mortgage, expenditures may be lower than anticipated, possibly freeing surplus funds for investment in savings or a money-market fund.