Investing Retirement Planning Why You Should Solve for Retirement Cash Flow, Not Income Income, cash flow, and withdrawals are not the same thing By Dana Anspach Dana Anspach Twitter Dana Anspach is a Certified Financial Planner and an expert on investing and retirement planning. She is the founder and CEO of Sensible Money, a fee-only financial planning and investment firm. learn about our editorial policies Updated on November 8, 2021 Reviewed by Thomas J. Brock Reviewed by Thomas J. Brock Thomas J. Brock is a CFA and CPA with more than 20 years of experience in various areas including investing, insurance portfolio management, finance and accounting, personal investment and financial planning advice, and development of educational materials about life insurance and annuities. learn about our financial review board Fact checked by Kyra Baker Fact checked by Kyra Baker Kyra Baker is a fact-checker with nearly 10 years of experience working and assisting on editorial projects within the culture, arts, and publishing spaces. For the past eight years, she has worked as a fact-checker at Art Papers Magazine, an Atlanta, Georgia-based art magazine. She leverages this experience for The Balance, fact checking content for accuracy across a variety of financial topics. learn about our editorial policies In This Article View All In This Article Cash Flow vs. Income Your Cash Flow Needs Does the Terminology Matter? Photo: FredFroese/E+/Getty Images When talking about retirement "income," many people assume that it refers to money from a job they have, Social Security benefits they receive, pension income, or interest and dividends from investments they own. This definition of income tends to match what would show up on a tax return as income. However, this definition of income doesn’t always work for retirement planning. What you need in retirement is cash flow. Each month you have expenses, and you need cash coming in to meet those expenses. Depending on how you plan for retirement, that cash flow might come from many different places, and not all of it will fit the technical definition of income. Learn how retirement cash flow is different than income. Key Takeaways Solving for cash flow means that you plan your retirement investments to be able to withdraw from the principal rather than the interest portion.Cash flow is more important in retirement than income because cash flow isn't always taxed.Try to find retirement plans that provide returns that let you withdraw from your principal and let the interest continue to compound. Cash Flow vs. Income Let's say you estimate you will need to buy a car about every 10 years in retirement. At retirement, you buy a CD or a bond that will mature in 10 years to fund your next car purchase. When it matures, you plan to spend both the principal and interest to purchase the car. You will have the cash flow you need to buy the car, but when the CD or bond matures, it will not be reported as income on your tax return. Instead, you will report the interest the CD earned as income on your tax return each year along the way—even though you let the interest accumulate. In retirement, you want to plan out your cash flow needs and choose investments that have an appropriate risk level to match those needs. Your Cash Flow Needs The amount of income you report on your tax return may be quite different than your annual cash flow needs. For example, in early retirement, you may report less income on your tax return, and in later retirement, you may report more income—yet your cash flow could remain the same. How could this be? Suppose you retire at 65, but you make a plan and start Social Security at age 70. To meet your cash flow needs from 65 to 70, you buy an immediate annuity with a five-year payout, and you buy it with non-retirement money. Note The monthly annuity payment you receive will provide cash flow, as each payment you receive is a combination of principal and interest. However, only the interest portion is considered taxable income on your tax return. In this situation, you have more cash flow than income. Now, fast forward seven years. At age 72, you are required to take annual distributions from your retirement accounts. These withdrawals are reported as taxable income on your tax return. Each year you get older, you must withdraw a larger portion of your remaining retirement account. You may not need to spend it all. In this case, you have more income than your cash flow needs require. Does the Terminology Matter? Unless you have a lot of money relative to the amount of cash flow you will need in retirement, it is unlikely you will be able to live off your income. Instead, it is likely you will need to use some of your principal by following a plan that allows you to use it at a measured pace so you have a comfortable retirement lifestyle—while at the same time, not running the risk of running out of money. This kind of planning solves for the amount of cash flow you will need. Now you know why retirement planners don't spend much time discussing with you the rate of return you can plan to see with your retirement accounts. Instead, they talk to you about how much you can draw from the account each month. Ideally, you will have investments that continue to earn a reasonably impressive return, but plan to draw on accounts more than you earn. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. IRS. "Retirement Topics — Required Minimum Distributions (RMDs)." Accessed April 27, 2021.