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How to Build Your Retirement Money Plan

Philip Moeller

Turning your retirement savings into a flow of predictable income payments is, of course, essential to a successful retirement. It's also often one of the hardest and most overlooked tasks leading up to actually retiring.

Some experts may give different names to the steps of this task, but they boil down to three: your preparation, your buckets and your investments.

Your Preparation

Review 10 or even 20 retirement books and the same preparation steps appear over and over again. Here are the ones common to most approaches:

1. Add up the value of your savings and investment accounts.

2. Calculate how much additional money you can afford to set aside each year.

3. Play with different possible rates of future investment gains and see what your nest egg will look like when you'd like to retire.

[Read: 7 Ways to Turn $250,000 Into Retirement Income.]

4. How long do you think you'll live? Most experts recommend erring on the side of longevity, but your family health history may argue otherwise. For starters, figure you'll be able to pull 4 percent out of your portfolio every year and not risk outliving that income. However, this 4 percent "rule" is increasingly being challenged as too inflexible in today's volatile market environment. Use it as a guide.

5. Factor in Social Security and any pensions you are set to receive.

6. Total your annual retirement income (don't forget to consider taxes).

7. Build a realistic retirement expense budget; consider setting aside a cushion for emergencies.

8. Compare your income and expenses. Perhaps you'll need to tack on some more working years before they balance out. Most likely, you'll need to cut expenses as well.

Your Buckets

Retirement income needs to be broken down into components that achieve different objectives. Some people call these pieces of retirement income buckets; others may call them tiers or layers.

Most experts say you should have a cash spending account that begins with enough money to pay all your expenses for at least several months, and even longer if you can afford it. This will reduce the pressure to sell securities when market conditions are bad. It's also the account into which your retirement income payments will flow, often automatically due to electronic deposit arrangements.

Next, you should think about aligning your guaranteed income with your essential expenses--the things you have to pay. Guaranteed income includes Social Security and pensions. If this income does not cover your basic expenses, many advisers suggest using some of your nest egg to buy the missing piece of guaranteed income.

The most common way is by buying an annuity, but you could also consider buying U.S. securities and using their interest payments to cover the basic expense gap. At the same time, many other advisers prefer to close this basic spending gap with investment earnings from your nest egg. Odds are, you'll earn more money than with an annuity. And while your investment earnings are not guaranteed, you will not have to largely give up control of your funds, which is the case with an annuity.

[Read: Why Mutual Funds Are Getting Cheaper to Own.]

I understand but disagree with this view because it exposes you in declining markets to either selling investments at a loss or reducing your standard of living by cutting basic living expenses. Do everything you can to cover fixed expenses with guaranteed income.

Discretionary spending would then be provided from your investment funds. The thinking is that you could curb such spending if market downturns reduced your investment income. You could even split your discretionary spending into smaller buckets, reserving your highest-risk, highest-return holdings for luxury and whimsical spending plans that wouldn't crush you if your investments fizzled out.

Lastly, you may have a legacy bucket and want to leave money to your heirs.

Your Investments

Once you've defined your income buckets, there is still a lot of heavy lifting to actually produce those regular income payments. Where are all your investments parked? Which ones are taxable and which ones aren't? How do you maximize tax benefits when withdrawing funds? What about those federal rules requiring minimum distributions from IRAs at a certain age? How do they work?

There is lots of good news here for self-directed investors who can't afford or don't want their own financial adviser. It's hardly a secret that millions of baby boomers are entering their retirement years. Trillions of dollars of employee retirement accounts will need to be converted in the coming years into sources of long-term income payments. Investment firms, particularly the big mutual fund companies that manage 401(k)s for millions of employees, want access to this stream of conversions and lucrative long-term investment fees.

[See 7 Mutual Funds That Make Huge Bets]

They have invested heavily to build online retirement planning, investing and retirement spending tools. Many tools are sophisticated enough to reflect tax strategies, different investor risk preferences, and nuances of individual retirement needs. At the same time, investment companies are creating new breeds of retiree investment funds that offer systematic withdrawal plans and other "set it and forget it" funds that generate monthly payouts from investment accounts.

Find the sites that work best for you to help execute the three basic components of your retirement plan. And don't forget to also prepare the needed legal documents that will protect you and your family members if you have an unexpected health emergency: power of attorney, healthcare proxy and living will, and, of course, a final will. Talk about your needs with a legal adviser and key family members. These are essential matters that are best discussed when you're healthy, not after you become ill.

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