Bridging the retirement income gap

What the retirement income gap actually is

Your retirement income gap is one number: what you need every month, minus what is guaranteed to arrive every month. That is the whole definition, and almost nobody has calculated it.

What people have instead is a balance. Four hundred thousand. Nine hundred thousand. It is a big, satisfying figure and it answers the wrong question. A balance tells you what you have. It tells you nothing about what you can safely spend, for how long, or what happens to it in a bad year.

Two households with identical $800,000 balances can be in completely different situations. One has a $900 monthly gap and a pension. The other has a $4,200 gap and no pension. The first can weather a bad market. The second is buying groceries out of a brokerage account and cannot afford a bad three years. Same balance, different retirements.

How to work out yours

Three steps, and you can do it at your kitchen table in about fifteen minutes.

• Add up what your life costs each month. Split it into essentials — housing, utilities, food, transport, health insurance, other insurance, debt — and the discretionary spending that is the reason you retired: travel, dining, gifts, grandchildren, giving.
• Add up what is genuinely guaranteed. Social Security for both spouses, any pension, any income annuity you already own. Rental income, dividends and a 4% withdrawal do not count here. They are income, but they are not guaranteed, and this step is about the floor under your feet.
• Subtract. What is left is the amount your savings have to manufacture every month, on time, for the rest of your life, in a good market and a bad one.

Then do one more comparison, because it is the most useful thing on the page: compare your guaranteed income to your essential bills alone. If guaranteed income already covers the essentials, you are in an unusually strong position — a market crash costs you a vacation, not your groceries. If it doesn’t, some portion of your necessities is currently funded by an account that can fall 30% in a year.

The worksheet below walks through it line by line, and there is a quick version of the same arithmetic on the home page if you just want a rough figure in thirty seconds.

The floor, and why it changes everything

There is a way to handle the part of your income you cannot afford to get wrong. An income annuity converts a portion of your savings into a payment that arrives every month for as long as you live, regardless of what markets do. Used properly it is not a replacement for your portfolio. It is a floor underneath it.

Cover the non-negotiables with guaranteed income. Then the rest of your money is free to stay invested for growth, for travel, for the grandchildren — because it is no longer the thing keeping your lights on. That single structural change is what lets people stop checking the market before they check the weather.

The three ways to fill a gap

There are really only three, and most good plans use two of them.

1. Withdraw from your portfolio

The default. Flexible, liquid, and you keep control of every dollar. The catch is that the amount is not guaranteed and the timing is not under your control. A poor market in your first few years of withdrawals does lasting damage, because you are selling shares at a discount to pay the electric bill. It also means the size of your retirement is decided partly by luck — which is the subject of the next page.

2. Delay Social Security

The cheapest guaranteed income available to most people and the most overlooked. Between your full retirement age and age 70, delayed retirement credits increase your benefit by roughly 8% for each year you wait, and that higher amount is inflation-adjusted and lasts for life. For a married couple, delaying the higher earner’s benefit also raises the survivor benefit — which matters enormously, because one of you will eventually be living on one check instead of two. If your gap is modest, this lever alone may close a good part of it.

3. Buy guaranteed lifetime income

An income annuity covers what the first two can’t. Sized correctly, it fills the distance between your guaranteed income and your essentials line, and nothing more.

What an income annuity actually is

The word covers several different products and the differences matter.

• An immediate annuity (SPIA). You hand over a lump sum and payments start within a year. The simplest version: no moving parts, no fees to hunt for, the highest payout per dollar. The trade is that the money is committed.
• A deferred income annuity (DIA). You commit money now and payments start on a date you choose — often at 75 or 80. Because the insurer holds the money longer, a smaller amount buys the same income. Useful for covering the later years specifically.
• A fixed indexed annuity with an income rider. Your account value stays accessible and grows subject to a cap, while a separate benefit base grows at a stated rate and determines your future income. More flexible, and more complicated: the rider carries an explicit annual fee, and the roll-up rate applies to the benefit base, not to money you can walk away with. That is the single most misunderstood feature in this industry, and I will show you both columns side by side before you decide anything.

How much should go in

Enough to cover the essentials line, and no more. That is the honest answer, and it is usually a good deal less than people expect — often a quarter to a third of savings rather than all of it.

Sizing it by your bills rather than by your balance does two things. It keeps the majority of your money liquid and invested, and it means the guarantee is doing the one job guarantees are good at: making sure the necessities are never in question. If anybody proposes moving everything you own into a single contract, get a second opinion.

What you should know before you buy one

• Money you commit is generally no longer liquid — that’s the trade for the guarantee.
• Payments are backed by the claims-paying ability of the issuing insurance company, not by a government agency.
• You almost never use all your savings. We size the floor to your essential bills, not your whole balance.
• Different payout options change the amount: single life pays more, joint-and-survivor protects a spouse.
• Inflation matters. We look at whether a rising-payment option is worth its lower starting figure.