Different Ways to Plan For Retirement Income
I’m so glad to see the idea of retirement income planning becoming more popular. Especially since there are so many Baby Boomers retiring each day. The going estimate is around 10,000 per day that are turning 65.
With that many people reaching retirement age every day it is so important to plan for their income needs. And not only that, but to plan for those needs by using their hard earned savings in the most efficient, low-cost, and low-risk way possible to make sure they meet their retirement objectives.
The reality is that the income sources that you will get in retirement (almost by default) will likely not be enough to cover your living expenses. I’m speaking of Social Security here. And if you have a pension (very fortunate of you I must say) even it too will not be enough to cover most people’s expenses.
This will require you to spend down your savings to fill the gap if you are like most people.
And this can be stressful.
Think about it. We are trained our whole lives to accumulate assets. It feels good to save and build up our nest egg.
But ultimately we know that we are saving for a reason. Because there will come a time when we will no longer work. We will retire. And that is what people are saving for.
But your mindset has to change from the accumulation mindset, to the de-accumulation mindset. And always in the back of your mind you may worry about outliving your savings… of running out of money before retirement is over.
The de-accumulation stage can be difficult to adjust to initially. But it’s going to happen one way or another, unless your lifetime guaranteed income sources from Social Security and a pension are enough to cover your expenses.
For most people they won’t be.
The way to feel more comfortable with spending your assets that you have saved up (saved up for the purpose of retireing I might add) is to have a smart plan in place.
The plan must help you to not run out of assets. And the plan should be structured in such a way as to most efficiently use the assets you have. And by this I mean using the least amount of assets possible to generate the necessary income for you.
And of course let’s not forget that it needs to do so in the lowest-cost, lowest-risk way possible.
5 Ways to Generate Retirement Income
So here are 5 ways to generate retirement income. Which one you choose is up to you. In all likelihood you will use a combination of these 5 elements. You may even incorporate other elements that I have not mentioned here. Let’s go!
#1: Use Annuities
The first way is to use annuities. There are different approaches you can take to this.
On one end of the spectrum is using the contractual guarantees. This involves choosing the specific annuity (or annuities in most cases) that will give you the highest guaranteed payouts. Regardless of what happens in the world or the stock market, these payouts are guaranteed.
This is the surest way to know you will have a specific level of income.
Another way to approach annuity income is by using the guaranteed income payments as a base but having the option of getting higher income if the annuity performs better. If it’s a variable annuity and performs better in the market, the lifetime income payment may be greater than the baseline guarantee.
If it’s a fixed index annuity it may have a provision where it stacks the interest earnings growth on top of the income rider’s guaranteed increase. This can potentially boost your lifetime income payments.
Usually the annuities that have the highest guaranteed payout will not have this other “stacking” option.
So if you want the potential of a higher lifetime income payout, you usually have to be willing to take a lower guaranteed payout. And if the stars align and your annuity performs great you could get slightly more income.
And if the annuity does not perform as well, you could end up with slightly less lifetime income.
The choice is yours. I tend to gravitate to using annuities with the highest contractual guarantees. They are set in stone. But if you want to reach a little higher, you can potentially get a slightly higher income payout by going with an annuity that requires a certain level of performance. It’s up to you.
Once again we find that it’s back to the idea of taking a little risk for something potentially better (the higher payout) at the expense of having a little bit lower guarantee that is for certain.
Neither way is right or wrong.
#2: Use a Dividend Portfolio To Generate Retirement Income
Another method that can be used to generate retirement income is using a dividend portfolio. There are plenty of well established and strong companies that you can buy stock in that pay a regular dividend.
This strategy involves you building a portfolio of these types of stocks and using the dividend income from it as income in retirement.
Some of the pros to this strategy is that your investment is always liquid. You can sell the stocks whenever you want.
Also, you would only be spending the dividends that are paid off from the portfolio. This would preserve your original investments.
The downside is that since you are only using the dividends it will probably not generate as much income as the annuity strategy. You will have to have more money committed to this strategy to generate the same level of income as the annuity strategy.
Another downside is that dividends payments are not guaranteed. A company can choose to not pay a dividend. So this introduces a level of risk in your income stream in retirement.
#3: Use a Muni-Bond Portfolio
Another option is to use a bond portfolio comprised of municipal bonds. These would pay you interest that you could use in retirement.
You can use tax-free municipal bonds to help you get a higher yield. They will typically pay a slightly lower rate (on a risk/return basis) than taxable bonds, but depending on the tax bracket you are in this may be beneficial to you.
Also be sure that you are investing in solid bonds. There is always a risk of default of course. Remember not all municipalities are as safe as others. Would you really want to invest in something very risky here?
One of the pros of this strategy is that they are tax-free. Another pro is you would only be spending the interest generated and not your original investment (much like in the dividend portfolio above).
The downside is since you would only be spending the interest it would require more money to generate the same amount of income that the annuity strategy would give you.
Also, you must keep the credit risk in mind as well. There are some municipal bonds that you would probably want to avoid. I would not want to invest in the city of Detroit, for example.
#4: Maximize Social Security
Another way to help boost your retirement income is to maximize your Social Security income.
If you draw at age 62 you will take a reduction in your benefits. A reduction that will last the rest of your life.
If your full retirement age is 66 this reduction would be 25%. And if you delayed up to age 70 it would increase by 8% each year that you delay.
If you are still working up to age 66 it is fairly easy to “afford” to delay drawing benefits. Since you would still be working you would not need the extra income from Social Security.
But if you have quit working it can be harder to delay to age 66 (or beyond).
One strategy is to use your savings to live off while delaying your Social Security. Not many people like to do this (understandably) because it involves spending down their assets to get a boost later from Social Security.
This obviously reduces their savings. And if they kick the bucket before drawing Social Security they really suffer (or their heirs suffer I should say). They essentially would have spent down their money to get a higher Social Security benefit… that was never collected. Ugh!
But nevertheless, maximizing your Social Security benefits is one way to help boost your retirement income. It is especially useful if you continue working up to at least age 66.
#5: Commit to a Withdrawal Strategy From Your Portfolio
Another method to generate income in retirement is to commit to a withdrawal strategy from your investment portfolio.
You’ve probably heard of the 4% withdrawal rule. If not, in a nutshell it says that if you have a balanced portfolio (it needs to have equity exposure for growth potential) you can withdraw 4% from it the year that you retire. Then each subsequent year, increase whatever that dollar amount was by the inflation rate, and the portfolio will very likely last you throughout retirement.
The upside to this is that your money is invested in the market and has greater growth potential.
The downside to this is that your money is invested in the market and has the potential to go down.
Some people can do this strategy and stay committed even when their portfolio drops by a lot, like what happened in 2008. These people are able to continue withdrawing from the portfolio even though it has gone down. And they have faith that it will rebound.
Most other people cannot do this. And that’s fine. It is unnerving to see your income source fluctuate in value.
So there are no guarantees from this strategy. If your portfolio performs poorly you may not be able to generate enough income off it through withdrawals.
If it performs very well, you may be very fortunate and have more income.
Which method will you choose? Or (more realistically) which methods will you use as a combination approach?
There is no right or wrong answer. But one thing is going to be true:
You want to most efficiently use your assets to generate the necessary income in the lowest-risk, lowest-cost way possible.
If you can do that then you will know that you are putting your savings to the best use possible to accomplish your spending goals in retirement.
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