Your expenses and expected longevity are key considerations in determining the right investment products.
Consider a dynamic withdrawal strategy from your investments in order to make your money last as long as you need.
When making the transition from employee to retiree, it can be overwhelming to think through the many investment options available to convert the assets you’ve saved into an income stream that covers your expenses. To complicate matters, most people retire with a variety of income sources, adding to the stress of creating and managing a retirement income strategy.
All income sources have their pros and cons and complement one another. As a result, you may find that a combination of income sources work best for your personal financial situation and risk profile.
Here are a few key points about some of the most common income-producing investments that new retirees typically encounter.
Source #1: Social Security
One income source that almost all retirees in the United States will have in common is their Social Security benefits, which are paid out to citizens who have met the program’s requirements. For many Americans, Social Security will provide the bulk of their income in retirement.
While the idea of Social Security may seem straightforward, figuring out when to collect your benefits can actually be a bit complicated. Your Social Security benefits will vary considerably depending on the age at which you take them, your marital status and your spouse’s eligibility for benefits, as well as your birth year.
Collect your Social Security benefit at age 62 and your monthly check will be 75% the size of what it will be by taking your benefit at 66. Delay until age 70, and your check will be 32% bigger than it would have been at 66. It’s worth taking the time to review your particular situation and Social Security rules to determine the best strategy for you.
Monthly Benefits by Age You Start Receiving Benefits
This example assumes a benefit of $1,000 at a full retirement age of 66
Source #2: Guaranteed payments
There are two basic types of guaranteed payments.
Annuity: When purchasing an annuity, you are giving a single payment to an annuity provider (usually an insurance company) in exchange for a certain amount of income every month for the rest of your life.
Pros: If you are fairly risk-averse, this may be appealing to you, as the annuity provider takes on the investment risk.
Cons: In exchange for guaranteed income, you give up the ability to tap your assets in the event that you needed cash for a large expenditure. Annuities also typically leave heirs with fewer assets at the time of your death.
Fixed income (CDs/Treasury Bonds): Traditionally, many retirees have relied on fixed income from Certificates of Deposit (CDs) and government bonds to cover spending.
Pros: Having almost no risk, these investments provide income via interest and coupon payments and appeal to conservative investors.
Cons: These investments don’t provide much capital growth, and they do not protect against the risk of inflation. Without a very large portfolio, this is a difficult strategy to rely upon in today’s low-interest-rate environment because it requires considerable assets in order to produce sufficient income.
Source #3: Retirement investment portfolios
Diversified portfolios can be held within taxable accounts and/or tax-advantaged retirement accounts, such as your IRA or 401k. They invest in stocks and bonds, often both domestic and international, and aim to provide you with income as well as capital growth. Although there is a higher risk of lost principal than with annuities and fixed income, the benefit of a diversified portfolio is that it helps you outpace inflation and can improve the chances that you won’t run out of money.
Fixed withdrawal strategy: When owners of diversified portfolios hit retirement and need to tap their investments to cover their spending needs, they have typically relied on the 4% rule to guide how much they withdraw each year.
Pros: This rule is simple, easy to follow, and can give you a rough idea of where to start in terms of a withdrawal rate.
Cons: This strategy can put you at risk of outlasting your funds because it doesn’t take into account the impact that market swings can have on your portfolio.
Dynamic withdrawal strategy: This can be used as an alternative to the 4% rule, and takes into account market conditions in an attempt to reduce the chance you will run out of money.
Pros: Using a dynamic withdrawal rate strategy ensures that in down markets your withdrawals are not too high, and in up markets you benefit from growth through higher income. One example of a dynamic withdrawal strategy is Betterment’s retirement income solution, which uses a customized withdrawal model that routinely calculates a safe amount to withdraw from your portfolio. The withdrawal rate is based on your current age, expected longevity, inflation assumptions, portfolio value and asset allocation.
Cons: Income may vary slightly from year to year.
The bottom line
No matter what combination of the above solutions (or other income sources, such as part-time work or rental income) you choose to meet your retirement income needs, it is important to be flexible in putting together your retirement plan because expenses, market returns, and income sources can all vary considerably over what could be decades of your life. Being adaptable to changes in spending from year to year will help you maximize your income and minimize your chance of running out of money.
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