Anyone who has received that intermittent mailing from the Social Security Administration may wonder how they can live on what they’ll get in retirement. Those who have diligently saved for retirement anticipating this shortfall have several ways to turn retirement savings into income. Here’s a brief selection of income-producing strategies for retirees.
Learn the 4% Rule for Withdrawals
A plan for the strategic withdrawal of funds from retirement savings can help stretch your money over thirty years or more. When you have reached retirement age, the 4% rule says to withdraw no more than 4% of your savings in the first year. In subsequent years, you would withdraw 4% plus an additional amount to adjust for inflation. For example, if you have $500,000 in savings, you would withdraw $20,000 during the first year. The next year, assuming an inflation rate of 3%, you’d take out that $20,000 plus an additional $600 (3% of 20,000) to adjust for inflation. These funds would supplement your social security payments for the withdrawal year.
Low interest rates and a sagging stock market can affect returns in retirement accounts and may blunt the effectiveness of the 4% rule. If your retirement savings are invested in conservative instruments like bonds, and they are yielding 2.5% interest, your money may not last the 30 years that the 4% rule predicts. Retirees who are concerned about outliving their money or scraping by on a pittance in their later year should consider scaling back their withdrawals in the earlier years of their retirement.
It’s also important to keep an eye on the balance of investments in your portfolio. Historically, stocks perform well over time, and portfolios balanced with 60% stocks and 40% bonds have endured the predicted 30 years.
Adjusted or Dynamic Spending
The 4% rule is a method that can stretch savings over bad times—but it doesn’t really recognize that there can be good times as well. When a retirement portfolio swells in value during a booming market, it may make sense to withdraw a little more. Running an annual simulation through a retirement income calculator produces an estimate of how long savings will last based on the current account balance and your planned withdrawals. If the odds of running out of money have gone up, you can scale back your withdrawals, but if those odds have plummeted, you can consider withdrawing a little more, while the remainder of your account continues to grow. Dynamic spending is a method where you set a range—establishing a maximum rate that you will never exceed and a minimum rate that is the least you can live with—to provide flexibility as market conditions warrant.
Another adjustment you must plan for is the required minimum distribution (RMD) from retirement accounts you hold. These include IRAs (except Roth IRAs), 401(k) plans, 403(b) plans, 457(b) plans, profit-sharing plans, and any other defined contribution plans. The age you must begin taking the distribution is now 72, except for those who reached age 70 ½ before January 1, 2020. The IRS maintains worksheets for calculating the RMD you must withdraw based on your age, your marital status, the estimated distribution period, and the balance in your retirement account(s). Failure to take the RMD results in enormous penalties, so retirees should pay close attention to their approaching RMD date.
The Bucket Method
Another, perhaps simpler, way to plan for income in retirement is known as the bucket method. With this strategy, you identify a spending bucket designated to last a set period of years, and an investment bucket, devoted to continued growth. The spending or withdrawal bucket stays invested in low-risk, high-liquidity investments like high-quality bonds or money market funds. The growth bucket can accept more risk and volatility, investing a greater percentage in stocks. Retirees can count on the withdrawal bucket for income, easing worry about market downturns in the growth bucket. Retirees can identify additional buckets to segment their savings—for healthcare expenses or emergencies, travel, or charitable giving.
Although traditional defined benefit (pension) plans are becoming rare, those who have them may be able to take their withdrawals in the form of an annuity—a regular monthly income calculated based on the amount in the pension fund and the participant’s life expectancy. Those with the much more common defined contribution plans (401(k) plans, 403(b) plans, etc.) may be able to roll over the entire balance (lump-sum distribution) into an IRA and manage their money within that type of account.
Another option with a lump-sum distribution is purchasing an annuity. These contracts guarantee a minimum income over a specified amount of time. Investors purchase immediate annuities with a large lump sum, and payments begin right away. These tie up a lot of money for a long time, but they do provide nearly immediate monthly income.
One can purchase other annuities with several payments over time, and the insurance company providing the contract invests those payments so that the amount in the account grows during this “accumulation period” until it is time to begin distribution. Annuities can supplement other types of retirement investments and offer retirees who don’t feel confident managing their own investments a reliable income. There are many different types of annuities with different features, fees, and potential pitfalls. Annuity brokerage agencies can help retirees understand the pros and cons of different types of annuities and whether an annuity is a good choice as part of their overall financial plan.
Retirement doesn’t necessarily mean stopping work altogether. The Social Security Administration imposes limits on how much you can earn per year if you are taking social security prior to your full retirement age, so keep that in mind if you decide to launch a “third act” career or take a part-time job.
Another way to turn retirement savings into income is through investment property. Retirees with substantial savings can consider a second home as a source of income. Tenants pay rent, either through a long-term lease or short-term vacation rentals. Real estate investing is a business, requiring management, maintenance, and accounting, so it’s not the best fit for retirees who hope to spend their time primarily in leisure pursuits.
Of course, part of any financial plan for retirement is anticipating how retirement income will be taxed. Withdrawals from tax-advantaged accounts (where your contributions were tax-deferred) are taxable as ordinary income. Dividends, interest, and capital gains are also subject to taxes. Consult your tax advisor to help you calculate the impact taxes may have on your retirement income.
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