When you retire from your job, your income from work stops coming in and you are forced to replicate your paycheck from other sources.
First you would look at any guaranteed sources of income you have. The typical ones are:
If those sources do not generate enough income you must either spend less or make up the difference from your pool of assets that you have accumulated over your working years.. Usually these types of assets include:
Savings and Investments
When utilizing your assets to bridge the gap in your spending you have two strategies you can utilize.
Capital Preservation – This is when your assets are large enough that they generate enough income that you never have to touch the principal of your assets.
Capital Depletion – Each year you use the income that your assets generate. But the income generated is not enough so you must also use some of the principal every year to as well. What’s significant about this strategy is that the depletion starts to snowball quickly. Every year since you are using some of the principal, the amount of income your assets generates lessens.
Here is an example that illustrates each strategy
There is no right or wrong strategy as long as your income needs are met by either one. The preservation strategy is probably preferable since it provides more flexibility and can help if you miscalculate and your expenses are more than you projected in retirement. (see: How to Calculate Your Health Care Expenses in Retirement) But if you use the preservation strategy, it may mean that you could have had a higher standard of living and spent more each year.
With either retirement income strategy you use its critical that you know year by year how you are going to pay your expenses and how long your assets will last. One way to ensure this happens is to follow the strategies in my book The Retirement Fitness Challenge: Shape Up Your Finances and Ensure Your Money lasts. You can download a free copy of the book here.