The Cash Flow Pyramid is a depiction of the different levels of confidence we can have with the different kinds of cash flow we might receive in retirement.

The most secure types of income are at the bottom of the pyramid. Those are guaranteed, or said another way, promise-based. These include things like Social Security, Pensions, Wages, Guaranteed Income Annuities, Charitable Annuities, Guaranteed Income Life Insurance, Reverse Mortgages and Rental Income. A good way to know if a source of cash flow falls into this category is to ask yourself if there is a guarantee or promise in place ensuring a specific amount of income so long as you perform your duties under the contract.

Our list is not exhaustive, but it represents the most common guaranteed income sources for most retirees.

At first glance, the key would seem to be to have as much of your income as possible come from the bottom level of the pyramid. However, this isn’t always feasible, or even wise, because you need to balance your need for stable, increasing, lifetime income, with your need for flexibility and liquidity as the years go by.

Typically, there is a cost associated with any guarantee. For example, the most stable sources of income usually aren’t also completely liquid – like a Pension or Social Security check. Those come with a high level of assurance you’ll get the income, but there is no liquid pool of money you can access whenever we want. There are exceptions to this rule that provide income guaranteed as well as liquidity, but those are the exceptions rather than the rule.

The second level of the pyramid is cash flow that’s perceived to be very stable, but not guaranteed. We have a pretty high level of confidence that it will be there when we need it. These would be investments or savings vehicles that are very conservative in nature, either because of the underlying investment or vehicle itself or because of the way they are managed.

Examples might be a short-term bond or certain defensively tactical investment strategies. As a wealth advisor, I remind my clients that the value and associated income stream of both will fluctuate, but they tend to be much more stable than, say, that of an individual stock or mutual fund – which leads us to level three.

The top level, variable, refers to assets that have significantly more potential for volatility, both in their underlying value and also in their associated cash flow. Oftentimes these are the investments you may have grown most accustomed to during the accumulation phase of your lifetime, because you could tolerate more volatility and had little to no need for income. Thanks to your annual salary. These would be things like stocks, bonds, mutual funds, ETFs, variable annuities, subaccounts in our 401(k)s or other retirement plans, and the like.

One final, important thing before we move on: these levels are not subjective. As a wealth advisor, I often hear one person can’t say their long-term bond or stock dividend feels like it’s in level 1, another that it feels like it’s in level 2, and another level three. Just because your experience with something has been a certain way in the past, doesn’t mean you can be certain it will always be that way. Your assurance is either intrinsic to the underlying asset or it isn’t. Like real estate, which always goes up, right? Until it doesn’t. There are far too many examples of this that I could share with you from my past twenty years of doing this, but suffice it to say, this is not a subjective exercise.

So the whole purpose of the Cash Flow Pyramid is to help you better understand how stable & predictable your income sources are, which brings us to the second concept I want to introduce to you… The Income Gap.

The Income Gap is simply the difference, in any given year, between the amount of money you are guaranteed to receive and the amount you actually need. In other words, the difference between what you’re getting from the bottom level of the pyramid and what your total need is.

So the income gap is how much income you’ll need each year from non-guaranteed sources – either from level two or three. This is why it’s so important to have a plan that details the sources of your income for each and every year of your plan. Not just an estimation based on your overall portfolio, which is what most people have. I can’t imagine retiring with something like that as my only security.