Some people mistakenly think that their retirement planning ends once they have their savings plan in place with their contributions in and withdrawals out planned. You need a concrete strategy to turn those savings into a stream of income that will last throughout your retirement. In The Bradenton Times, Bruce Bittles talks about “Strategies for Turning Retirement Savings Into Retirement Income.” His annuity and investment information came from an article by Evan R. Guido, Vice President of Private Wealth Management with Robert W. Baird & Co.
The simplest way to use your retirement savings is with a systematic yearly withdrawal. One of the trickiest parts of this plan is figuring out how much to withdraw in the first year. You can choose a yearly percentage or a yearly amount and then adjust each year based on the markets, inflation, and how much you actually spent in the last year. Many studies have shown a 4% withdrawal to be a good starting point that should carry your money through retirement. There are some drawbacks to this plan, however. You could definitely outlive your money if you live longer than you guessed and market declines could also lead you to run out of money.
Required minimum distributions are a more advanced form of using a systematic yearly withdrawal. You use IRS life expectancy tables to determine the yearly amount you will take from your portfolio, with yearly percentage increases based on the dollar amount of your portfolio. Like the first plan, your portfolio focus is on the total return. You also have the flexibility to change your withdrawal amounts if needed. But negative markets and higher than planned for inflation can really reduce your withdrawals and your purchasing power with this plan.
Some investors prefer using a bond or annuity ladder approach. With a bond ladder, financial advisors invest your assets in a series of bonds that will mature over a specific time frame. One example is investing in 10 bonds that will each mature 10 years apart from the other. Your income is the fixed interest from the bonds. Any proceeds from the bond sales are reinvested into new bonds, but if interest rates happen to be lower at the point of sale, your interest income will decrease. Early in the plan your income is consistent and it is fairly easy to sell a bond if you need the income at any time. Look for a strong bond issuer to minimize the risk of their claims paying ability and remember that you will pay a commission to the broker for each bond you sell.
Using a bucket approach to your investing requires more work and time up front to set up all of the accounts, but is unique because it allows for a different type of investment to be used during phases of your retirement. You can time your different investments based upon other payments you will receive like Social Security, as well as what you plan to be doing during each phase of retirement. The sooner you plan to use each bucket, the more conservative the investment. As you approach the next phase of life and need to use the next bucket, the investment moves from more risky growth mode into a conservative mode. Risks included with this bucket approach are market fluctuations and inflation, as well as the fact that you may dip into the next bucket sooner than expected and have less for the future.
Using an annuity for retirement income eliminates the risk that most investments carry that you will outlive your savings. A single premium immediate annuity allows you to choose a guaranteed income stream to last for the rest of your life, or even a spouse’s life. Inflation is a risk with annuities as well, but for an added cost you can build inflation increases into your annuities. You want to use a strong insurance company for your annuities, just like your bonds, because your payments are based on their claims paying ability. When purchasing your annuity with non-qualified money, you only pay taxes on the money that you earn in your annuity, so these products are tax-efficient streams of income. You give up most control of your lump sum with an annuity, so only use the money you know you won’t need immediate access to during retirement to guarantee a lifetime stream of income.
Another type of annuity, a deferred variable annuity with a GLWB, offers guaranteed lifetime withdrawal benefits. This combines the guaranteed income found in the annuitization strategy with the systematic withdrawal plan’s ability to manage the underlying assets and long term growth. You have the ability to gain income in the event of a market increase, but your higher payments are locked in if there happens to be a decline in the markets. Since additional guarantees do come with added fees, you need to balance your needs with the costs you are willing to pay.
The best approach is likely a balanced approach, or a combination of many of those listed previously. The author breaks retirement expenses into three categories and lists potential investments to pay for each of those. The first, essential living expenses, is best suited for payments that are guaranteed just like the expenses for which they are paying. Social security and pensions should be used first and then supplemented with immediate annuities or variable annuities with GLWBs. Next, flexible retirement expenses like dining out and giving gifts are best paid for by investments that may fluctuate over time. These include the bond ladders and stocks which pay dividends. Discretionary retirement expenses are big purchases like a second home or large charity gift. These should be paid for with a long term investment that offers growth potential. A variety of investments is often the safest way to go.
Written by Rachel Summit
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