Are you concerned about retirement income? If so, take heart, you are not alone. According to a Transamerica Center for Retirement Studies survey, the number one fear (43%) is Outliving Savings and Investments. A large part of my practice involves helping soon-to-be retirees calm those fears by creating sustainable retirement income plans. I consider this as one of the "Big Three Retirement Decisions" retirees face along with when to collect Social Security and the Pension/Lump-sum retirement decision.
In our practice we discuss six options for structuring retirement income. (Waiting for your great aunt who is a millionaire to pass away does not count as an option!)
DIVIDENDS: Using this method we employ a portfolio of high quality, dividend paying stocks. Instead of reinvesting the dividends to purchase additional shares, the dividends are distributed and become your monthly income. Your income is based upon the dividend yield of the portfolio.
- Advantages: Principal retention, capital gains tax efficiency (non-qualified accounts)
- Disadvantages: variable monthly income, principal fluctuation
- Best For: Retirees who have other sources of stable income and do not wish to "sell investments" to fund retirement
FIXED INCOME: These solutions are often debt (bonds) or real estate (REIT) based. They typically pay a fixed rate of interest (fixed not guaranteed) for a certain amount of time.
- Advantages: easy to structure monhtly income, liquidity
- Disadvantages: interest rate sensitive
- Best For: Retiree's looking for stable monthly income but less concerned with inflation protection
ACCOUNT LIQUIDATIONS: Using this method we create a diversified portfolio of securities (stocks, bonds, mutual funds and exchange traded funds). When income is desired we determine which positions to sell and use those proceeds to create monthly income. We generally reinvest dividends when using this approach.
- Advantages: Systematic reallocation of portfolio back to model, monthly income is more consistent than dividend approach
- Disadvantages: Eating into principal to fund distributions
- Best For: Retirees who desire a non-variable monthly check with the ability to access principal when needed for additional expenses.
ANNUITIES: Using this method you are transferring longevity risk (chance you will live to an old age) to an insurance company. This is accomplished through Living Benefit Riders or Annuitization. Your life expectancy is pooled with thousands of other purchasers and an "average life expectancy" is determined. If you live less than average the insurance company benefits but if you live longer than average you are living on "their dollar".
- Advantages: Long-term income potential, reduction of longevity risk
- Disadvantages: Typically after purchase you are locked into the solution, limited ability to access principal for one-time income needs, can be more expensive than the other options.
- Best For: a portion of a retirement income needs, a retiree who stays up at night worried about their money.
BUCKETS: Image 4 - 8 buckets sitting on a table and you place a portion of your retirement assets in each bucket. Bucket one holds the money you will be spending in the next 2 years. Bucket 2 will consist of assets to be spent in retirement years 2 - 4. Bucket 3 will hold the money needed during years 5 - 10 and this cycle is repeated in additional buckets until you reach your life expectancy.
We use the present value of a future stream of income along with an estimated return for each bucket along with the clients risk tolerance to determine how much to allocate to each bucket. We then evaluate buckets individually and invest with an appropriate risk profile based upon how long until the money is needed. Generally the shorter term buckets are more conservative while long term buckets look to accomplish greater growth with a higher risk profile.
- Advantages: Can be specific about portfolio allocation, ability to "right size" risk to a particular time-horizon.
- Disadvantages: May be complicated to implement and track, may involve additional statements, it's difficult for some individuals to watch the current bucket be depleted.
- Best For: Larger account sizes, retirees who have a good handle on future income needs.
COMBINATION: If retirement planning were a one-size fits all approach you could pick up your income plan at the grocery store. Often we find situations where retirees may prefer the flexibility of combing more than one approach. Often families will purchase an SUV and a sedan because each vehicle serves a unique purpose. Having both allows the user to mix and match to best meet their needs for a particular occasion. Combining retirement income approaches has the same effect.
- Advantages: Retiree income flexibility
- Disadvantages: May be more complicated to implement
- Best For: Retiree who desires stable income but flexibility to access principal, retiree unsure of what their retirement income needs might be
Now that you have an idea of income options, what's the best way to select an approach? Here are some factors to consider:
- How confident are you in your retirement income need projections?
- How do you handle portfolio fluctuation and risk?
- How much of your nest egg do you desire to leave to your beneficiaries?
- How comfortable are you developing a plan on your own vs. the need to hire a professional?
How can you increase your chances of being financially secure in retirement? The first suggestion is to have a good handle on your monthly income needs. This can be accomplished with a budget or by reviewing past expenses. Second, think about what your comfort level will be with risk and volatility. It's one thing to watch your portfolio fluctuation while you still have the ability to add money to it but it's a far different feeling to know you are retired and can no longer make contributions. What you have is what you have! Finally, live below your means. It never hurts to have a little "cushion" in your plan.
Developing a retirement income plan is a BIG decision and it is never too early to start planning. Consider hiring a professional for a second set of eyes to review your plan. This is one of the "Big Three Retirement Decisions" so why not spend a little time and money to ensure you look at it from all angles.
Spencer Corzine, has been helping clients understand their investments and reach their investing goals for over 18 years. He is a Certified Financial Planner (CFP®), a member of the Paladin Registry and resides in Austin, Texas with his wife and 5 children.
Serving clients in upstate New York, the Austin Texas area and over 20 other states.
Email: [email protected]
Direct Toll-Free Telephone: 877-738-7018
Strategies may employ an investment in annuities. Early withdrawals from these long term investments may result in surrender penalties. Withdrawal prior to age 59½ may be subject to a 10% federal tax penalty. Guarantees rates are backed by the claims paying ability of the issuer. Dividend yield investing may not be suitable for all investors. You should never invest solely on the basis of dividends. Higher dividends are not indicative of the quality of an investment. Additionally, higher dividends will result in lower retained earnings. As dividend yields may not be sustainable, income investors must be sure to analyze an investment carefully and their ability to sustain market fluctuations. Investments paying dividends do not carry lower risk. Dividend payments are not guaranteed by the issuing entity. The issuer can discontinue the dividend at any time. Dividend payments reduce the price of the security by the amount of the paid dividend.