How Social Security and Pensions Might Impact How You Arrange Your Nest-Egg.

Few people think about this, but you might want to.

Jim Lorenzen, CFP®, AIF®

Everyone intuitively understands the need to have a balanced approach to meet retirement needs; however, it’s also important to address risk in light of the long term inflation risk.  

Let’s take a hypothetical example using simple numbers.  And, suppose after all the data gathering, goal setting, and risk assessments have been completed in the financial planning process, June and Ward Cleaver (yes, I am that old) have decided they feel comfortable with a portfolio that’s comprised of 60% bonds and cash and 40% in stocks.  

June and Ward are retiring today after over thirty years of working and saving—they’ve done a lot of thing right—and have accumulated a nest-egg of $1 million.   So, in our simple example, that would indicate their money should be arranged with $600,000 allocated to bonds and cash, and $400,000 to stocks.  Simple.

But, suppose the two of them also have Social Security income—maybe even pension income, as well.  This additional ongoing cash flow shouldn’t be ignored in constructing their allocation.    Again, to keep numbers simple (I’m highly qualified for simple numbers).  Let’s say Ward and June have an additional $30,000 in annual ongoing income to augment their savings.   

What does that $30,000 annual income represent?  How much would someone need to have invested to provide the same income?

Assuming a 4% annual withdrawal rate on assets  – we’ll say that fits June and Ward’s situation  –  that $30,000 represents income on an additional $750,000 in assets… except these assets are illiquid:   June and Ward can only take the income, they can’t ‘cash in’ the principal.   It is like, in effect, an annuity, something some people use to simply ‘purchase’ a lifetime income.   I’m not a big proponent, but they do have their place in some situations—but that’s another story.

Nevertheless, if we consider that $30,000 annual income as actually representing an additional asset, June and Ward really effectively have $1,750,000 in assets, $750,000 of which we’ll consider illiquid and providing an income of $30,000 at 4%, but it never runs out of money.   If 60% of their total retirement ‘assets’ is to be allocated to bonds, their bond portfolio might now be $1,050,000 (60% of $1,750,000), $750,000 of which is already allocated and providing $30,000 in income. 

That leaves $300,000 ($1,050,000 – $750,000) to be allocated to bonds from their nest-egg.  This decreases their nest-egg bond and cash allocation from the original $600,000 to $300,000, and therefore raises their stock allocation from $400,000 to $700,000.   If long-term inflation is an issue – and it is – then were June and Ward really risking being under-allocated to stocks?

The ‘guaranteed’ $30,000 cash flow, representing an illiquid asset, provides them with the ability, i.e., gives them the freedom, to still address short-term needs and objectives with $300,000, while allowing more money, $700,000) to address long-term inflation risk.

Historically, stocks have performed, simply because they represent the economic engine of the United States.   And, it has never made sense to bet against the U.S.A.   Pistons drive the engine and the engine provides forward movement.


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Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742.  IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.

Opinions expressed are those of the author.  The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.