Everyone seems to have their own retirement strategy. While some people seem to be misinformed, personalized retirement plans are generally a good thing. Everyone’s life is different so it only makes sense that their retirement plan follows suit.
Yet at the same time, there are typically two distinct philosophies for retirement planning. These two philosophies aren’t anything new. While almost all employers have replaced pension plans with 401k or 403b investment accounts, even when pensions were popular, there was still a difference in how everyone approached retirement. The two predominant choices are and always have been: lump sum or yearly income.
While it is too simplistic to suggest that one approach is always “better” than the other, there are clear advantages and disadvantages to each retirement strategy. Each has its own risks. If you are trying to work out your retirement plan, you may be interested in the comparison of the two approaches.
Lump Sum Retirement Planning
Building up a lump sum or nest egg off of which you can live is still quite popular today. Many employer retirement funds are intended for this purpose. The basic idea is to contribute a percentage of your salary toward traditional personal pension schemes each and every year until you retire. Over several decades, the annual contributions along with compound interest can add up to a sizable figure. Depending on how much you contributed and how long you worked for, it is expected to have enough to live your retirement years on this money alone (maybe in addition to social security).
The clear advantage of this approach is that you have the money to spend if necessary. This means if you have a major expense, you don’t have to worry about your yearly income not being able to cover it. Most people also consider this form of retirement plan more secure as you can allocate your funds appropriately to provide more security. The major disadvantage to this retirement approach is how long it takes to acquire a large enough nest egg to live off of. This is why very few people actually retire early. They simply can’t afford to rely on the wealth they have accumulated because it takes so long to build up.
Yearly Income Retirement Planning
A different way to look at retirement planning is to build up sources of income that replace one’s day job. In other words, develop income streams that can cover your annual expenses. The sources can vary by investor, but they often include passive income streams like real estate investing, dividend stocks/ETFs, and income from a business because they are able to focus on this without dedicating a lot of time or energy throughout their career.
There are many advantages to this retirement planning approach. The first, and perhaps most obvious, is that this retirement planning strategy allows someone retire much earlier than those following the other approach. Instead of waiting to have wealth 25x their yearly expenses, all that is needed is to build up income streams that reach their expenses. For someone living frugally, this can be accomplished pretty quickly. Another benefit to this approach is that it keeps your retirement plan simple. Instead of having to worry about where to put your money, how much to withdrawal, whether you will use your wealth too quickly, the only thing you have to focus on is the cash flow. Does your income exceed your expenses? That’s it.
While it may be “simpler,” it does come with its own disadvantages. If you relying on income from a business for your retirement income, you better make sure that it won’t disappear anytime soon. The future of the business better look strong because if you lose necessary income, you may be forced to go back to work. There’s nothing more humiliating than coming out of retirement because you can’t afford next month’s rent.
My Approach to Retirement?
While I certainly like the security of the nest egg approach, I am also attracted to the ability to retire early with the yearly income approach. However, I don’t think I would feel comfortable relying on passive income to retire at too early of an age (unless it were multiple times my expenses). This is why I plan to take a hybrid approach. I will continue to contribute a lot of my family’s income to traditional personal pension schemes, while also building passive income streams with dividend investments and real estate.
How are you approaching retirement planning?
This article was written by Corey, a staff writer from 20’s Finances. He writes to motivate young adults to take control of their money.