What an Income Floor Is and Why It Matters in Retirement
An income floor covers your essential expenses no matter what markets do. Here's how to define it, check your own gap, and why it matters.
What an Income Floor Is
An income floor is the part of your retirement income that shows up every month no matter what the markets do. For most people it starts with Social Security. For some it includes a pension. And for many, it's filled out with guaranteed income from an annuity.
The idea behind it is simple. Split your retirement spending into two buckets.
- Essentials: housing, food, utilities, insurance, healthcare, taxes. The things you have to pay whether the market is up or down.
- Everything else: travel, gifts, hobbies, the extras that make retirement enjoyable but can flex if needed.
The goal of an income floor is to cover the first bucket with income that's guaranteed or very dependable. Then your investments can be used for the second bucket and for long-term growth, without the pressure of having to sell in a bad year just to pay the electric bill.
Why It Matters
The biggest risk early in retirement usually isn't a single bad year. It's having to withdraw money during a bad stretch, which can permanently shrink a portfolio. A solid floor reduces how much you depend on market timing, because the bills that absolutely have to get paid aren't the ones relying on whatever your investments happen to be worth that month.
A solid floor reduces how much you depend on market timing.
How to Check Your Own Floor
You can get a quick read on where you stand with three steps.
- Add up your monthly essential expenses.
- Add up the income you can count on: Social Security, any pension, and any existing guaranteed annuity income.
- Look at the gap between the two.
That gap is what your savings currently have to cover every month, in every market. If the gap is small, you may already have a strong floor. If it's large, your portfolio is doing more of the heavy lifting on the expenses you can't skip.
Narrowing the Gap
If the gap is larger than you'd like, there are a few directions people look at, such as the timing of Social Security, or using part of their savings to create guaranteed income. Each option involves trade-offs, including access to your money and what happens to it at death, so it's worth reviewing with a licensed professional rather than deciding based on one number alone.