Consider this: You spend about as much time earning your retirement savings as you do spending it — that’s approximately 30 to 35 years on each side of the equation.
While your income during working years typically comes from one, maybe two, sources at any given time, income in retirement will likely come from multiple sources, each with a different tax profile and reliability.
No matter what combination of retirement income solutions 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.
6 Retirement Income Strategies You Can Rely On
1. Social Security Retirement Income
Most retirees in the United States will be eligible for Social Security benefits, which are paid out to citizens who have met the program’s requirements. While the idea of Social Security might seem straightforward, figuring out when to collect your benefits can actually be a bit complicated, as they can 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.
If you’re looking to collect your benefits at age 62, your monthly check will be 70 percent the size of what it would be by taking your benefits at 67, the full retirement age for those born after 1960 according to the Social Security Administration.
It’s worth taking the time to review your particular situation and Social Security rules to determine the best strategy for you.
2. Annuities and Fixed Income
There are two basic types of payments, or income sources, that are guaranteed to provide income over a specified period of time. While many retirees desire security, it comes at a cost: no opportunity for upside gain or flexibility in spending.
There are deferred and immediate annuities. Generally, the way they work is that you are giving payments over time, or 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.
If you are fairly risk-averse, this might be appealing to you, as the annuity provider takes on the investment risk. However, in exchange for guaranteed income, you give up the ability to tap your assets in the event that you need cash for a large expenditure. Annuities also typically leave heirs with fewer assets at the time of your death. Also, many single-premium immediate annuities tend to come with high fees.
Traditionally, many retirees have relied on fixed income from certificates of deposit and government bonds to cover spending.
The benefit here is minimal risk — these investments provide income via interest and coupon payments and appeal to conservative investors. However, these investments don’t provide much capital growth, and they do not protect against the risk of inflation. 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.
3. Best Retirement Investment Options
Diversified investment portfolios can be held within taxable accounts and tax-advantaged retirement accounts, such as your IRA or 401(k). They could include mutual funds, ETFs, stocks, and bonds, often both domestic and international, and aim to provide you with retirement 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. Note that IRA investors must take a minimum amount each year, known as required minimum distributions, from their accounts once they reach age 70 and a half, according to current tax law.
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 percent rule to guide how much they withdraw each year.
This rule is simple, easy to follow and can give you a rough idea of where to start in terms of a withdrawal rate. However, 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.
The dynamic withdrawal strategy can be used as an alternative to the 4 percent rule, and takes into account market conditions in an attempt to reduce the chance you will run out of money.
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. A dynamic strategy will factor in your current age, expected longevity, inflation assumptions, portfolio value and asset allocation. With this strategy, however, income might vary from year to year.
4. Rental Income
Creating a stream of income from rental property could boost income anywhere from $300 to $3,000 or more per month before taxes, depending on the location, type and size of the property. The IRS taxes this as regular income, but you might be able to generate a deduction for property depreciation and other expenses.
Rental income is also an opportunity to think outside the box, a money-generating source might exist in your land, extra storage space or even in your primary home (you can rent out your rooms on sites like AirBnB.com). Again, the IRS considers this taxable income.
Those who take this route could increase their income and appreciation over time; and obtain the ability to write down property depreciation on taxes and diversify from investment income. However, it can require an expenditure of time and money (and potentially stress) to be a landlord; it’s not a liquid asset and income could be erratic if there’s a gap between tenants. Additional insurance coverage might also be required.
Many people work well into their 70s (or even 80s!) — some for income, some for the pleasure. You can work while receiving your other income, such as Social Security (or survivor) benefits, although you might not receive your full benefit if you’re under retirement age. However, by working and delaying a full Social Security benefit, you’ll also increase the amount you will receive in the future when you finally do stop working.
By working, you’ll maintain regular income and other workplace perks, socialization and diversification of income sources. However, there are fewer job opportunities for older employees, wages are lower and this will reduce time available for family or other interests.
6. Defined Benefit Plans
Defined benefit plans, or pensions, typically provide a fixed monthly income for life starting at a certain age based on how the much the individual earned, how much was contributed on his behalf and how many years he worked for the company. However, these plans are declining in popularity.
From 1998 to 2013, the percentage of employers offering traditional, defined-benefit plans to newly hired employees declined from roughly half to 7 percent, according to recent data from research firm Towers Watson. So while pension plans will be few and far between for retirees in the future, they will still be a source of income for some workers, especially those in the insurance and health care industries which have the highest use of defined benefit plans today.
Those who have these plans benefit from having a fixed retirement date and income security. Plus these plans demand little oversight, as the employer manages contributions. However, there is a potential for lower returns as the individual has little control over how and where money is invested.
Betterment is not a tax adviser, nor should any information in this article be considered tax advice. If you need tax advice, please consult a tax professional.
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Photo credit: Pedro Ribeiro Simones