Retirement Planning Strategies – Nest Egg Versus Residual Income

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In my first America Saves Week post, I shared some alarming statistics about retirement. Most concerning regarding Retirement Planning Strategiesretirement is that 45% of working of age households have no retirement account assets. In the perfect world, we would all be educated on retirement from a young age, and we would also never foolishly deplete our retirement savings thinking that “there is always time” to rebuild it. Sadly, that is what I did when I was younger on more than one occasion.

When you think of retirement, there are actually two strategies to consider. Most people are taught to think of retirement in terms of a next egg, where you build a large amount of money and live off of the interest. This is a common tactic, but it isn’t always practical for those who are late to building their retirement funds. The second strategy is the residual income method. This is where you determine how much money you will need to live on monthly, and generate a residual income to cover that amount. The two most common tactics to build this residual income are real estate investing (rental properties with monthly rent payments) and a business where you can be a passive owner. I have found that this is a great strategy for those who are older because it is easier to grow an income to $3,000 per month than it is to grow a nest egg of $600,000, which is how much you would need to have saved (assuming you could earn a 6% annual return.)

Here are some questions to ask yourself when determining how much retirement income you need:

  1. Will your house be paid off by the time you retire? If so, this would mean that what is typically ones largest expense no longer has to be accounted for. I would make that a financial goal.
  2. How much money will you need to live on and keep the same quality of life? I recommend making a goal of being debt free – including your home mortgage – by the time you retire. Think of all of your other living expenses (and include travel since you will have the time) and determine how much monthly income you will need.
  3. Do you have any retirement plans that will pay you monthly? I am not referring to social security. I advise people to plan as if social security will not exist because for most people, it is hard to live on a social security income and have a good quality of life. If you have a job that offers a pension, you are truly blessed and a few steps ahead of those who don’t.
  4. Where will you live? If you currently live in an area with a high cost of living, you might consider moving to a “retirement” friendly locale; one with a lower cost of living.
  5. Are you contributing to your retirement account at a fast enough pace? If you are not able to put away enough money monthly, you might consider how to increase your income so that you can. This could come through increasing your value at your current job, getting an additional job – or a new job, or starting a business.

Whether you choose the nest egg theory or the residual income theory, the key is having a plan and working the plan. If you are a nest egg builder, you will want to start much sooner rather than later to leverage compound interest. Likewise, if you are choosing the residual income method, starting earlier may mean retiring earlier as your monthly income grows.

Some people choose a combination of the two, which gives you a sense of security as both strategies have potential downsides. A market crash can impact a nest egg, and a down turn in rental income or business can negatively impact your residual income.

Why I Wrote This Post
I am participating in America Saves Week campaign, which is an initiative of the Consumer Federation of America, with a goal of encouraging and inspiring American’s to save. Even better, we are offering our Fiscally Sound audience the opportunity to win $100 simply by taking the America Saves Pledge. In addition, you can enter to earn up to $750 by telling your savings story and sharing it via social media. What better way to start your savings plan than by winning money? Click here to take the pledge and learn about the contest.

If this has inspired you to take a step towards a saving plan, I’d love to hear about it. Feel free to email me or simply comment below.

Stay Tuned for the next America Saves Week post where I will discuss saving the extra money that you acquire.

 

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