7 Ways To Create Income in Retirement
While it’s common to run across financial advice telling you to save money for retirement, the issue of how one creates income in retirement is less discussed. After all, the whole point of a retirement nest egg is that you’ll eventually have money to withdraw!
Withdrawing from your retirement savings is certainly one method of having income in retirement, but there are many more.
Here are seven ways that may create income in retirement:
1. Withdraw CDs
Certificates of deposit (CDs) are a time-tested method of income. Invest in them and then withdraw them at maturity. The upside is that CDs are very safe, with no fluctuation of principal.
But be aware that CDs do have a downside. Interest rates on CDs currently stand at historically low levels, less than 1%. Because inflation runs at 1 percent to 2 percent on average, you run the risk of inflation outpacing your CD’s returns.
2. Withdraw bond interest and/or bond principal
Another time-tested method of obtaining income in retirement is withdrawing bond interest and/or bond principal at maturity. Many investors stagger maturity dates so that they can receive income at intervals during retirement.
The principal of a bond can fluctuate with the direction of interest rates. If bonds are held to their maturity the full amount of principal invested will be paid back. Also, bonds with higher credit quality can be used for capital preservation. While bonds with lower credit quality (high yield or junk bonds), may offer a higher yield but have a higher risk of default.
Here, too, though, historically low interest rates are a downside, as bond yields may not keep pace with inflation.
3. Purchase dividend-paying stocks
Because of the low-interest rates in cash and bonds, retirees should be aware that it may be prudent to keep some of their retirement money in stocks. Many financial advisors recommend an asset allocation for retirees that combine bonds and cash, for low risk to principal, with stocks.
Many blue-chip stocks offer strong dividends, as well as a historical record of dividend increases. Retirees may be able to create income by purchasing these stocks as part of their portfolio and then using the dividends as income rather than reinvesting them.
4. Use the 4 Percent Rule in balanced retirement funds
Many people are concerned that using investments as retirement income will lead to one of their worst fears: running out of money toward the end of their lives.
There are, however, strategies to ensure that your income withdrawals don’t decimate your retirement funds! One of the most frequently used is called the 4 Percent Rule.
The 4 Percent Rule holds that, if investors withdraw 4 percent every year from a portfolio invested half in bonds and a half in stocks, their portfolio has the potential to last 30 years without running out of money.
In other words, if you have $500,000 invested in such a portfolio, you should be able to withdraw 4 percent every year, or $20,000, for 30 years. If you retire at 66, your withdrawals can last until the age of 96.
Average life expectancies have been increasing for the last century, and are now in the late 70s and 80s. However, if you think you may live longer than the average, talk to a financial advisor about adjusting your portfolio and withdrawals accordingly.
5. Purchase an annuity
Over the past 50 years, pensions – once standard in corporate America – have increasingly dropped by the wayside. Defined contribution plans such as 401(k)s are now much more common than defined benefit plans like pensions.
There is, however, a way of getting the steady payout that pensions offered. It’s purchasing an annuity. Annuities are purchased with a large lump sum. In exchange, you will receive income from the annuity, usually paid monthly, starting at a specific age.
6. Maximize your Social Security benefits
If you are eligible for Social Security benefits, you can also effectively create more income in your retirement by deciding when you take them. Your choice has a great impact on the amount of benefits you receive.
People become eligible to receive Social Security benefits at the age of 62. If you elect to take them then, however, they are substantially reduced from the amount you’d receive if you waited until your full retirement age (FRA). The reduction can be as much as 30 percent.
Your FRA depends on your birth year. (It’s 67 for everyone born in 1960 and after, for instance. You can look up your specific FRA here.) At your FRA, you can begin to receive the full amount of benefits you’re entitled to, with no reductions.
However, you can also increase the amount you’ll receive if you elect to wait until after your FRA. Your benefits will rise approximately 8 percent for every year between your FRA and the age of 70. In other words, if your retirement age is 66 and you wait three years, your benefits would be 24 percent higher. (No further increases kick in past the age of 70.)
Importantly, all reductions and increases based on age are permanent. That is, if your benefits are reduced by 30 percent because you take them early, they will always be 30 percent less than what they would have been had you waited until FRA. Similarly, if you receive a 24 percent increase for waiting, that amount remains in force for the rest of your life.
7. Working during retirement
More and more retirees are not fully pulling out of the workforce, choosing instead to work part- or full-time, or to open a business. Your earnings from a job during retirement are, of course, income!
If you plan to go this route, be aware of your tax situation. If you plan to steadily withdraw from your investment portfolios in addition to earning income, you may end up in a higher tax bracket than you expect.
Withdrawals from your retirement portfolios are taxed at your ordinary-income rate in the year in which they are withdrawn if they are from traditional individual retirement accounts (IRAs) and 401(k)s.
In addition, if you work and draw Social Security benefits at the same time, your Social Security benefits can be subject to tax. If you are single and earn between $25,000 and $34,000, for example, 50 percent of your Social Security benefits are subject to tax. If your earnings are more than $34,000, up to 85 percent is subject to tax.
Interested in strategizing income methods for retirement? The CERTIFIED FINANCIAL PLANNER™ Professionals and Certified Estate Planners™ at The Normandy Group offer serious financial planning for today’s complex world. By combining tax, financial, and estate planning strategies we can help you achieve your goals. Contact us today for a complimentary consultation.
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