9 Ways to Generate Retirement Income
Are you getting closer to retirement? Here is a list of retirement income strategies to mix and match to create the cash flow you'll need.
Certificates of Deposit and Other Safe Investments
A CD is a Certificate of Deposit issued by a bank. They are usually FDIC-insured, and the longer the term of your CD, the higher the interest rate you'll receive.
Pros: The principal is safe.
Cons: This strategy will generate little current income. Income varies with interest rates as CDs mature and are renewed, and income may not keep pace with inflation. Depending on interest rates, it may require a large amount of capital to generate the amount of retirement income you need. Interest from CDs is 100% taxable unless you own the CD inside of an IRA or Roth IRA.
When it comes to choosing between safer investment alternatives, take the time to learn how they could be used for part of your portfolio rather than for all of your portfolio. In this way, you could use other parts to invest in things that are more likely to deliver higher income amounts.
A bond, like a CD, has a maturity date. You can buy bonds now so that they mature at various future points when you are most likely to need the income. There are many types of bonds, so you can choose between safe, government-issued bonds, or higher-yielding, corporate-issued bonds.
Pros: Bonds are likely to provide more income than a CD or other safe investment option. You can match bond maturities with cash flow needs. If you're at a high tax rate, you can use municipal bonds, which are likely to deliver tax-free income to you.
Cons: Income may not keep pace with inflation. Depending on interest rates, it may require a large amount of capital to generate the amount of retirement income you need.
Building a bond portfolio can be difficult to do on your own, so it is important to understand how to use bond ladders before buying bonds.
Stock Dividend Income
Some stocks—called the "Dividend Aristocrats:—have a history of increasing dividends each year, and some stock dividend mutual funds allow you to invest in a group of these stocks all at once.
Pros: Historically, capital will grow, and companies gradually increase dividends, providing a means for your income to rise with inflation. In addition, many companies pay out qualified dividends, which are taxed at a lower rate than interest income.
Cons: Principal fluctuates in value with market moves. Companies may reduce or eliminate dividends during tough times.
It pays to understand how the dividend yield on a stock works before you go searching for yield.
High Yield Investments
Some investments pay out super-sized yields: It may be in the form of private lending programs, closed-end funds, or master-limited partnerships. Be cautious—often higher yields come with higher risks.
Pros: High amount of initial income generated.
Cons: Principal will fluctuate in value. High-yield investments may reduce or eliminate their distributions during tough times. Higher-yield investments are usually riskier than lower-yielding alternatives.
High yield investing can be very risky. But sometimes, the extra risk puts more income into your account.
Systematic Withdrawals From a Balanced Portfolio
A balanced portfolio owns both stocks and bonds—usually in the form of mutual funds. Systematic withdrawals provide an automated way of selling a proportional amount of what is in the account each year so you can withdraw from the account to meet your retirement income needs.
Pros: If done right, this approach is likely to generate a reasonable amount of inflation-adjusted lifetime income. The stock portion provides long-term growth; the bond portion adds stability.
Cons: Principal will fluctuate in value and you must be able to stick with your strategy during the down times. In addition, there may be years where you will need to reduce your withdrawals.
A balanced portfolio approach is relatively easy to follow and is flexible enough to withstand market volatility. Study the withdrawal rate rules you want to use to give this approach the greatest likelihood of success.
Insurance companies issue contracts called annuities. With an immediate annuity in exchange for a lump-sum deposit, you receive income for life.
Pros: Guaranteed lifetime income—even if you live past 100.
Cons: Income will not keep pace with inflation unless you buy an inflation-adjusted immediate annuity, which will have a much lower initial payout. If you want the highest payout, you'll have no access to the principal, nor will any remaining principal pass along to your heirs.
Immediate annuities can be a good way to secure lifelong cash flow if you need the highest payout possible from your current principal. Learn the ins and outs of immediate annuities before you buy.
The Income for Life Model
This approach uses something called time segmentation to match up your investments with the point in time they will be needed. It provides a logical process for how much to put in safe investments and how much to put in growth-oriented investments.
Pros: Easy to understand and has the potential to deliver great results.
Cons: In its purest form, this strategy entails taking on investment risk, but it could be modified so that you would use guaranteed income products.
The "Income for Life Model" is a preferred approach for delivering retirement income. This type of model is used to fill in the pieces with a bond ladder and growth index funds. The pieces could be filled in with other options like CDs, index funds, annuities, and more.
Variable Annuity With a Guaranteed Income Feature
A variable annuity is a contract issued by an insurance company—but inside the annuity they allow you to pick a portfolio of market-based investments. What the insurance company provides is a lifetime income benefit rider that ensures that, if the investments don't perform well, you'll still have retirement income.
Pros: Guaranteed lifetime income that may keep pace with inflation if the market rises. The principal remains available to pass along to heirs.
Cons: May have higher fees than other options—and the fees in some products can be so high that you are forced to rely on the guarantees, as the investments are unlikely to be able to earn enough to overcome the costs.
Holistic Retirement Asset Allocation Plan
When you look at all the options available, most of the time the best option is a plan that uses many of the choices discussed. The goal of a holistic retirement asset allocation plan is not to maximize return—it is to maximize lifetime income. That is a different goal than the traditional asset allocation investing mantra of maximizing return per unit of risk.
Pros: A combination of several retirement income ideas named in this list is often what is needed to create the ideal income flow for your needs.
Cons: Takes a lot of work to put it together right, but the hours of planning can be worth the effort for months and years to come!
If you're near retirement, the most important thing you should know is that retirement investing needs to be done differently. You need income for life—not a hot stock tip.
By now, you should be ready to use these techniques in a coordinated way. And always remember—planning is not a one-size-fits-all approach. Your unique circumstances and abilities need to be considered.