Saving for retirement is not merely about getting a stash of cash. You need to think saving for retirement in two ways: developing a reliable income stream and adequate accumulated retirement savings.

The two concepts are related but distinct. Failing to separate the two will necessarily blur the lines and make it difficult to maintain one or the other properly. An extreme example can best illustrate the importance of having a retirement fund and income stream during retirement.

Suppose Mr. Jones has a retirement fund of $400,000.00 with no income stream. Alternatively, Mrs. Smith has a retirement income of $4,000.00 with no retirement savings. To maintain a comfortable lifestyle, both Mr. Jones and Mrs. Smith need $3,000.00 per month.

Mr. Jones invests his $400,000.00 lump sum in a high-yield savings account, where it compounds at 6% per annum. However, Mr. Jones has no income stream, so he has to rely solely on money working for him. However, his monthly interest payment is only $1,947.00 and he needs $3,000.00. He cannot invest the fund at a much better rate, since he needs immediate access to it either. Therefore, he withdraws some of the capital in the first month.

What happens next is that Mr. Jones' starting balance for the second month is even lower- $398, 052.97. Every month, Mr. Jones must withdraw from his capital to finance his income deficit. Eventually, that deficit financing will deplete his retirement savings. By his 19th year of retirement, Mr. Jones will have no retirement savings and no income. That this estimate does not factor inflation on living expenses suggests that Mr. Jones will actually experience a reduction in standard of living way before his balance reaches $0.00. Without an income stream Mr. Jones risks outliving his retirement savings.

Mrs. Smith has more retirement income than she needs, although she has no savings to start with. She religiously saves $1,000.00 a month in a high-yield savings account (6%). However, an unfortunate situation arises after just 18 months of retirement. Mrs. Smith needs $80,000.00 immediately but only has close to $19,000.00 in savings!

Mrs. Jones has few options and would likely have to borrow just over $61,000.00 and repay it with interest. It is an additional burden on her income and affects her ability to save as well. She has to live rather frugally for a while. Worse yet, she is aware that she is not financially able to cope with unexpected or contingent expenses that could arise. Mrs. Jones is not equipped to deal with life's uncertainty or even the certainty of a rising cost of living.

Without adequate retirement savings, you may not be equipped to handle unforeseen expenses or the rising cost of living. Inadequate retirement income can deplete your retirement savings faster that you should as well. If Mr. Jones had half of his income needs, his retirement savings could extend way beyond his 19th year of retirement or be used to meet rising living costs.

With individuals generally living longer, planning for at least 30 years of retirement is necessary. If you balance retirement savings with your retirement income, you have a better chance of overcoming longevity risk. Adequate retirement income and savings prepares you for the certainty of inflation and the uncertainty that life inherently bears.

Learn more about this author, Darrell Victor.
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