How retirement savers construct an income floor

In the world of retirement income planning, the mere mention of “income flooring” evokes never ending arguments from advisers, brokers, and agents on the best method to achieve this all-important lifestyle goal.

As with most things financial, simpler is usually better. Let’s look at an income flooring approach that you could explain to a nine-year-old.

Flooring for dummies

The simplistic view of income flooring is to figure out how much income you need to live comfortably for the rest of your life if you didn’t make another dime, and when you need that lifetime income to start.

Income flooring can be calculated for income needs right now or at a specific date(s) in the future. In other words, how much money will it take right now to have the income you desire today or down the road? Sounds pretty simple, but the devil is always in the details of how you choose to create that income floor.

Stacking income wood

Just like you cold weather people (I’m in Florida) stack wood for the winter, income stacking should be looked at the same way. You need a solid income base to build on and to hopefully add to those guaranteed amounts. These income sources can include your Social Security, pensions (if so fortunate), income-producing real estate, dividends from stocks, bonds, and contractual annuity payments.

Qualified longevity annuity contracts, or QLACs, are the newest stacking choice as of July 1 of last year and allows you to defer a guaranteed income stream within your Traditional IRA to as far out as age 85. If you don’t know about QLACs, then it’s time to get educated if you are planning for your income floor.

Annuity gap fillers

Whether you need income right now to fill a gap or sometime in the future, annuity guarantees allow you to start at the finish line to create your needed income floor. Annuities definitely have a role in the creation of many people’s income floors because they can be set up to contractually pay for a specific period of time, for life, or a combination of both.

Flooring for inflation

The wrench in the engine for income flooring is that gorilla in everyone’s room called inflation. That’s when the adviser argument really starts with the systematic withdrawal groupies attacking the contractual guaranteed cult. There’s no perfect answer, and it really depends on your risk tolerance.

Systematic withdrawal strategies typically involves a diversified portfolio, and withdrawing a percentage or dollar amount on an annual basis. The hope is that those withdrawals could track inflation. In a perfect world, and especially in these straight up markets, it does.

The contractually guaranteed crowd wants their income floor to never fall below a specific level, and is typically adverse to market volatility. Treasurys (TIPS) and transfer-of-risk annuity strategies, like immediate annuities, longevity annuities, and income riders, are the usual contractual solutions.

As fellow MarketWatch contributor Wade Pfau points out, there are really two different ways for people to approach income flooring; goals based and investment based. Both can work, and my thought on this matter is that a combination of both is probably best and should be customized to fit your specific situation.

Originally published 1.6.2015 by