Engineers don’t guess. When you build a skyscraper, you can’t have it fall, so you run the math and you test the structure before anyone moves in. A retirement income plan deserves the same treatment. Retirement is the largest financial decision most people make, and unlike a career setback at 35, you don’t have decades of earning ahead to recover from a mistake at 65.
That’s the difference between a retirement savings plan and a retirement income plan. Saving is about accumulating a number. Income planning is about mapping exactly where your money will come from, how your spending will change over time, and how you close the gap between the two — then verifying the answer holds up under conditions worse than the ones you’re assuming.
Here’s how that gets built.
Step 1: Project what you’ll actually spend
Start with spending, not with your portfolio balance. What you need is a year-by-year projection, not a monthly budget, because retirement spending doesn’t hold still. That projection should reflect housing costs, healthcare (especially if you retire before Medicare begins at 65), travel and hobbies, property taxes and insurance, ordinary lifestyle spending, and inflation.
Spending also has a shape. Many retirees spend more in their early, active go-go years and less once travel tapers off in the slow-go years. Some costs move the other direction — healthcare tends to rise as you age. A plan that assumes one flat inflation-adjusted number every year for thirty years is unlikely to match how you’ll actually live.
Step 2: Map the income you already have
Next, identify the income that doesn’t depend on your investment portfolio: Social Security, pensions, annuity payments, deferred compensation, and any part-time work.
Timing is the part people underestimate. You might stop working at 63 but delay Social Security to 70 to increase the benefit. Delaying is a reasonable choice for many people, but it isn’t free — it creates a multi-year stretch where your savings carry the entire load. You need to know how you’ll fund those years before you commit to the strategy.
Step 3: Size the gap
Now subtract. The difference between projected spending and non-portfolio income is your income gap, and it’s the number your investments have to produce.
A simplified version: say your total annual spending, essentials plus lifestyle, comes to $96,000. You expect $50,000 a year from Social Security and a pension. That leaves a $46,000 gap to fill from savings — from IRAs, 401(k)s, brokerage accounts, or some combination.
Underestimating this gap is common, particularly in the years before Social Security or a pension begins. The cost of getting it wrong runs both directions: spend too freely and you draw down assets faster than the plan assumes, or spend too cautiously and you live smaller than you needed to out of uncertainty.
Step 4: Structure the portfolio around when you need the money
Once you know what you need to withdraw and when, the portfolio can be built to deliver it. A retirement portfolio structured for income matches assets to time horizons rather than chasing return alone:
- Money needed in the next one to three years belongs in cash or low-risk investments
- Mid-term money, roughly three to ten years out, fits bonds or balanced holdings
- Money not needed for ten-plus years can stay invested in stocks for growth
This is what produces a retirement paycheck — predictable cash for near-term spending while the rest of the portfolio keeps working. The tradeoff is explicit and worth stating plainly: the price of safety is lower expected return on the near-term money. You’re accepting less growth on a portion of the portfolio in exchange for not being forced to sell stocks during a downturn to cover groceries.
Step 5: Decide which accounts to tap, and in what order
Most retirees hold three account types — taxable brokerage accounts, tax-deferred accounts like 401(k)s and traditional IRAs, and tax-free Roth accounts. Which one you draw from changes your tax bill.
A common starting sequence works like this: withdraw from taxable accounts first, since you’re taxed only on the gains rather than the full withdrawal; use tax-deferred accounts next, since those withdrawals are taxed as ordinary income; and preserve Roth assets for later.
That sequence is a default, not a rule, and there are legitimate reasons to break it:
- Large one-time purchases. Funding a car or a remodel from a Roth account avoids spiking your taxable income for the year.
- No legacy goal. If leaving assets to heirs isn’t a priority, spending Roth money earlier can make sense.
- Required minimum distributions. Once RMDs begin, drawing on Roth funds can keep you from being pushed into a higher bracket.
A few other factors shape the sequence. If you’re between 55 and 59½, leaving funds in your 401(k) and withdrawing directly may let you avoid the 10% early withdrawal penalty. If you retire before 65, keeping adjusted gross income low may qualify you for a healthcare tax credit. And in early retirement years with modest income, long-term capital gains may be taxed more favorably than ordinary income.
One caution worth naming: pulling a large sum from a pre-tax account to pay off debt or fund a major purchase can trigger a tax spike and Medicare premium surcharges in the same year.
Step 6: Stress-test the plan before you rely on it
A plan that works on paper under one set of assumptions hasn’t been tested. At Sensible Money we use three projection models — we call them retirement readiness tests — and each one exposes something the others don’t.
Fundedness
Fundedness is a term from the Retirement Management Advisor coursework, and it rests on the math concept of present value. The question it answers: how much would you need today, earning what rate of return, to cover a specific set of future withdrawals?
A simple illustration. Suppose you retire at 65 and need $30,000 a year, and you plan to delay Social Security to 70 — so savings must produce $30,000 a year for five years. Using a net present value calculation, roughly $118,515 invested at 3% a year would fully fund those withdrawals. At 1% a year, you’d need closer to $138,536. Because the money is needed soon, it should be invested conservatively, which is exactly why the assumed returns in this example are low.
Real analysis is more involved than that. It incorporates your 401(k), IRAs, taxes, inflation, healthcare, stock options, deferred comp, and later-life downsizing, and it assumes longer-horizon money earns more than 1–3%. The output is a fundedness ratio comparing the present value of your projected withdrawals to the assets available to fund them — the same discounted cash flow logic used to value a stock.
The historical audit
A historical audit runs your specific withdrawal plan through actual past markets. Would your plan have survived retiring in the early 1970s, right before a market crash and years of high inflation?
The mechanics: imagine sixty versions of you, each retiring in a different year starting in 1927, each living thirty years. That gives sixty complete thirty-year periods to test. We run this analysis with our investment partner Asset Dedication using your numbers, not a generic academic scenario. For a plan to clear this test, we want to see success across every period tested back to 1947. (A 100% historical success rate does not guarantee a similar future result. Past performance is no guarantee of future results.) Outcomes from the Great Depression era that fall short are informative rather than disqualifying — if conditions that severe recur, there are spending adjustments available to protect a baseline lifestyle.
Monte Carlo analysis
Monte Carlo simulation runs your plan against thousands of randomly generated return sequences — 2,500 in the version we use — including patterns worse than anything markets have actually delivered. It produces a range of outcomes: a median path, an 80th percentile path, a 20th percentile path, and a fixed-return reference line for comparison.
We consider Monte Carlo the least useful of the three. It’s a reasonable starting point, but because it generates conditions harsher than the historical record, it often frightens people into preserving wealth they were meant to spend.
Step 7: Turn the plan into a paycheck, then revisit it
The last step is operational. Most retirees prefer monthly transfers from the portfolio to checking, because it mimics the paycheck rhythm they spent forty years living on. Others use quarterly transfers. Routing every income source — Social Security, pension, and portfolio withdrawals — into a single checking account makes the whole thing easier to track.
Then review it annually: confirm income sources, rerun the projections, and rebalance to reflect current tax law and actual spending. There is no single sequence or structure that fits every situation; the right one depends on your portfolio mix, your tax bracket, your goals, and how much variability you can live with.
What you get from the work isn’t certainty. It’s a written plan and a way to check whether you’re still on track — so a bad market quarter is something you evaluate against the projection rather than something you react to.
