The flooring approach is a retirement strategy that uses guaranteed income sources, like Social Security, pensions, or annuities, to cover essential expenses. This creates a stable “floor” of income for basic needs. When using this strategy, it’s important to identify your essential expenses and choose the right income sources. A financial advisor can help you find the right balance and select the best products.
What Is the Flooring Approach?
The flooring approach to retirement income planning strategy that aims to provide retirees with guaranteed income to cover essential expenses. It creates a stable income “floor” using sources like Social Security, pensions and annuities. And it’s intended to cover basic living costs, such as housing, food and healthcare, regardless of market changes or economic downturns.
To implement this strategy, retirees first must calculate their essential expenses and then identify reliable income sources to meet these needs. Social Security benefits often form the cornerstone of this strategy, given their stability and inflation adjustments. Pensions, if available, provide another layer of security. For those without sufficient pension income, purchasing annuities can be an effective way to guarantee a steady stream of income.
Once the essential expenses are covered by the income floor, retirees can invest their remaining assets more aggressively. This approach could allow for potential growth and provides flexibility for unexpected costs or extra spending. It also helps reduce the risk of outliving savings while maintaining a stable financial base.
Though should note that this strategy can limit the amount of money available for investment growth, and thereby potentially reduce overall returns.
How to Use the Flooring Approach for Retirement Income Planning
Anyone can use the flooring approach to help them plan for retirement. Here are five general steps to help you get started.
Step 1: Identify Essential Expenses
Essential expenses are the non-negotiable costs that you incur regularly. These typically include housing, utilities, groceries, healthcare and insurance. By calculating the total amount needed to cover these expenses, you can determine the minimum income required to maintain your standard of living.
Step 2: Assess Guaranteed Income Sources
Guaranteed income sources typically include Social Security benefits, pensions, annuities and any other income streams that are reliable and predictable. The goal is to match these income sources with your essential expenses so that you can pay for basic needs regardless of market or economic changes.
Step 3: Bridge the Gap
If your guaranteed income sources fall short of covering your essential expenses, you will need to bridge the gap. This can be achieved by purchasing additional annuities or other financial products that provide a steady income stream.
Step 4: Invest the Surplus
Once your essential expenses are covered by guaranteed income, you can invest any surplus funds in growth-oriented assets. This might include stocks, bonds, mutual funds or real estate. The purpose of these investments is to build wealth over time and provide for discretionary spending, future goals or unexpected expenses.
Step 5: Regularly Review and Adjust
Life circumstances and financial markets change, so periodic reassessment can help you keep aligned with your needs and goals.
Flooring Approach for Retirement Planning: Pros and Cons
Before you commit to this retirement planning strategy, you should compare the benefits and drawbacks for your nest egg. Here are two common benefits to consider first:
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Offers financial stability: One of the primary benefits of the flooring approach is the financial stability it provides. By securing a guaranteed income to cover basic living expenses, retirees can enjoy peace of mind during economic downturns, as it reduces the risk of having to make significant lifestyle adjustments due to a drop in investment income.
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Simplifies retirement income management: With a guaranteed income stream in place, retirees can focus on managing their discretionary spending and investments without worrying about covering their basic expenses. This can make budgeting easier and reduce the stress associated with managing a complex portfolio.
Now, let’s take a look at these three general drawbacks:
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Limited growth potential for guaranteed income sources: One significant disadvantage is the limited growth potential of the guaranteed income sources. Annuities and pensions typically offer lower returns when compared with other investment options, which can result in a lower overall retirement income. This may be a concern for retirees who wish to maintain a higher standard of living or leave a financial legacy for their heirs.
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Risk of eroded purchasing power due to inflation: Another potential downside is the risk of inflation eating into the purchasing power of your guaranteed income. While some annuities offer inflation protection, not all do, and those that do often come with higher costs. Retirees relying solely on fixed income sources may find that their money does not go as far as it used to, particularly in the face of rising healthcare costs and other expenses.
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Less flexibility: The flooring approach can also be less flexible compared to other retirement planning strategies. Once an annuity is purchased or a pension plan is in place, it can be challenging to make changes if financial circumstances or goals shift. This rigidity can be a disadvantage for retirees who value the ability to adapt their financial plans as needed.
Bottom Line
The flooring approach for retirement income planning can provide a reliable strategy for financial stability. By covering essential expenses with guaranteed income sources, retirees could reduce the risks of market volatility and outliving their savings. This method also offers peace of mind and more freedom for discretionary spending.
Tips for Retirement Planning
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A financial advisor can work with you to create a personalized retirement plan that covers costs of living, healthcare and other expenses. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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If you want to know how much your retirement savings could grow over time, SmartAsset’s retirement calculator could help you get an estimate.
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