Last time, on The Amateur Financier, we were discussing the different sources of income when retirement rolls around. There were four that came up, pensions, Social Security, working part-time, and relying on your personal savings. Not to give away and spoilers, but there’s not too much you can do about the first two, and working part-time, while effective at getting you more retirement money, does tend to put a little crimp in the whole concept of ‘retirement’.
That leaves your personal savings as the most important part of your retirement planning. It’s the one thing you have completely under your control and you must give it the most attention. You need to find a method of drawing upon your retirement savings in a way that provides you with a good income for your retirement years while making sure that you don’t exhaust your savings too quickly. That, unfortunately, is easier said than done.
Luckily, there are more than a few methods out there, as noted by assorted retirement planners and other financial writers. With using your personal savings becoming a large, and ever increasing, part of retirement funding, there are plenty of people who wish to share their suggestions. To help you get an idea of the methods available, I’ve put together a list of
6 Ways to Create Income During Retirement
1. Drawing on Interest Only
How it Works: Pretty much as the title indicates, instead of spending the money you saved, you put it into interest-yielding investments and live off that interest. By buying investments like bonds, REIT(s), and interest paying stocks, you generate the cash to provide for your needs during retirement. Just wait for the interest checks to arrive in the mail (or be deposited in your checking account, more likely), and BOOM, retirement party time!
Pros: You aren’t drawing on your principle, so you don’t have to worry about running out of cash. Your saved money will remain available for your offspring (or whomever gets your estate upon your passing).
Cons: This method requires high paying investments. In the current financial situation, they are quite rare (yields for S&P 500 funds are just over 2%, while those for short term bonds are less than 0.9%). As a result, you might use riskier investments (think junk bonds for starters), with a higher risk of losing your principle. Otherwise, you may need up thirty to fifty times as much as your annual desired income to provide the needed interest.
2. Regular Withdrawals From Retirement Savings
How It Works: If interest isn’t enough (or you simply want another option), you can consider taking a small portion of your money from the account at regular intervals (monthly, quarterly, annually) to provide for your needs, while leaving the rest of the money available to grow for future withdraws. The most commonly cited example is the ‘4% withdraw rule‘, withdrawing 4% of your account total each year (creative name, I know) and leaving the rest to grow until you make your next withdraw.
Pros: You’ll derive more income than possible from interest payments alone, and have more flexibility in how you invest (being able to go for investments that provide capital gains but no interest). By drawing from the assets that show the most gain, you’ll be able to effectively re-balance your portfolio throughout the year. Provided you keep your withdraws limited enough, your portfolio will be maintained and perhaps even increase in value.
Cons: Finding an amount to withdraw that provides you with a reasonable amount of income but limited chance of sizable financial loss is tough. (Even the 4% withdraw rule is coming under fire.) Early market losses or withdrawing too much early in retirement can leave you with limited funds to provide for you in the future. You still need a sizable level of funds in order to retire (Twenty-five times what you hope to spend, as you can guess).
3. Investment Bucket Strategy
How It Works: A strategy for arranging your finances to minimize potential of overdrawing while still providing a sizable living income. The basics involve splitting your retirement money in three ‘buckets’. The first bucket has some money (something like 2-5 years worth of expenses) in ‘safe’, cash-like investments such as money-market funds to provide for expenses. The second bucket (usually 5-10 years of expenses) is invested in bonds, sometimes in bond ladders, and used to refill the first bucket. Finally, the third bucket (all the remaining money) is put into stocks and ‘risky’ expenses, and when it ‘overflows’, or increases above the starting amount (ideally adjusted for inflation), is used to refill the second bucket.
Pros: By keeping barriers between your spending money and the riskier investments, you can help ensure that you don’t loss the money you use to live. By keeping some risky investments, though, you can increase your available funds. Making such an arrangement provides a way to balance the benefits of both the safe and risky investments available.
Cons: Having three different buckets means three different portfolios to manage, complicating your investment planning. Finding reasonable investments for each bucket can prove tricky.
4. Systemic Withdraw Funds
How It Works: If you think that it’s too tough to manage and withdraw funds on your own, there are other ways to go. One possibility is to use funds that provide regular, guaranteed payouts for a particular period (usually a year or so). The regular payouts from managed payout funds (or similar investments) enable the generation of money for living expenses and otherwise provide for retirement needs.
Pros: These managed payout funds provide a regular, previously determined income and limit declines in funding totals (in theory). It enables you to simplify your fund holding, using only one fund (a ‘fund of fund’) to meet your income needs. As a result, it makes your retirement investing more passive, requiring less oversight to meet your needs.
Cons: Like any mutual fund, systemic withdraw funds are capable of losing money, meaning less money to put toward future fund arrangements. The fund is subject to any risks inherent in the funds that make it up. The level of payouts may change every year according to the remaining funds available, and getting a sizable monthly income requires a fairly large amount of money.
5. Immediate Annuities
How It Works:– If you’re looking for a regular payment, one that makes up a higher percent of your money than available through a systemic withdraw fund or similar arrangement, what can you do? Well, one option is to put money into an annuity. There are quite a few varieties of annuities out there, but if you’re ready for retirement and looking for payouts soon, an immediate annuity is the type you want to consider, as they will start, well, immediately. They come in two varieties: fixed (which pay out a fixed income every month), or variable (which allow the potential for growth carry the risk of declining payout).
Pros: Provides payments for the rest of your life. Tax advantages are available when you put money into annuities. There’s also no limit on the amount of money that can be put into an annuity, unlike, say, 401(k) or IRA accounts. (Given the different types of annuities, there are some advantages that only apply to some types, which we’re not getting into in this article.)
Cons: Annuity fees tend to be high (particularly for those sold by insurance brokers). There can also be hefty surrender fees if you attempt to take your money out of an annuity, particularly in the first few years of the annuity contract. Annuity contracts are complex, and tend to be difficult to figure out. (As with the pros, the sheer variety of annuities mean that not all disadvantages apply to all annuities.)
6. More Than One of The Above Options
How It Works: You don’t need to use just one of these methods; you can combine some (or all) of them to fulfill your retirement financial needs. You could, to toss out one (complex) option, use systemic withdraw funds or annuities to provide a basic level of income, supplement that with the interest from some high interest sources, and then use the investment bucket system to make regular withdrawals and provide yourself with extra money on top of all of that. (Or perhaps some other method that isn’t quite as complex, if you don’t feel the need to include all five of the aforementioned suggestions.)
Pros: With a proper arrangement, you can cut out, or at least minimize, many of the problems that are involved with each of the methods mentioned. It’s possible to generate a regular, minimum guaranteed income, for example, and have extra money withdraws to provide for larger spending uses.
Cons: It greatly increases the complexity of any retirement income generating method (each method you include adds that much more trouble in keeping track of where your money exists). Spreading your money so widely can limit the amount of income from each one.