After years of working hard and saving, the next big challenge in retirement is figuring out how to turn your savings into a steady, reliable income that will last as long as you do. It’s not just about accumulating wealth; it’s about ensuring that wealth supports you throughout retirement, no matter how long it lasts.
In this post, we’ll explore three common strategies to turn your retirement nest egg into a lifetime income stream. Two of these options don’t involve annuities at all, while the third one does. Together, these strategies offer a solid foundation for those looking for income in a world where pensions are rare and Social Security alone may not be enough.
1. The 4% Rule
The 4% rule is one of the most widely known strategies for generating retirement income. It suggests that you withdraw 4% of your total portfolio each year. For example, if you have a $1 million portfolio, you would withdraw $40,000 in the first year, and then adjust for inflation in subsequent years.
Historically, this strategy has worked well in some market conditions, allowing retirees to generate income while still growing their investment over time. However, experts like Wade Pfau now caution that the 4% rule may no longer be as reliable as it once was. With rising life expectancies, low interest rates, and unpredictable market swings, there’s a real risk of running out of money if you rely solely on this method.
That said, the 4% rule can still be a viable option if you’re comfortable managing your investments and have a trusted financial advisor. The key here is discipline. If you’re willing to monitor the market and adjust your withdrawals as needed, this strategy might work well for you. However, be prepared for the fact that your income will fluctuate with market performance.
2. Bonds, CDs, and Dividend Investments
Another approach is to use traditional investments like bonds, CDs, dividend-paying stocks, and real estate investment trusts (REITs) to generate income. These assets can provide you with interest, coupon payments, or dividends, all of which can be used to fund your retirement needs.
The main advantage of this method is that you’re living off the income generated by your investments, rather than having to sell assets to generate cash. For many retirees, this can feel more secure and tangible. However, this strategy isn’t without its risks:
- Bonds can lose value when interest rates rise.
- Dividends are never guaranteed, and they may be reduced or eliminated.
- REITs and preferred stocks can fluctuate with the market.
The biggest benefit of this approach is flexibility. You can sell or rebalance investments whenever you want, and you retain full control of your assets. This can be a good solution for those who prefer to avoid annuities but still want a steady income stream. However, just like with the 4% rule, there’s no guarantee that the income will remain stable, as market conditions will always play a role.
3. Annuities: Guaranteed Lifetime Income
The third strategy is the only one that offers true guarantees—annuities. Unlike investments that are tied to market performance, annuities are contracts with insurance companies that promise to provide you with regular payments for the rest of your life.
Annuities essentially recreate the kind of dependable cash flow that many retirees once received from pensions or Social Security. With an annuity, you can have a predictable, guaranteed income stream, no matter how long you live.
Types of annuities that can be used to generate income include:
- Single Premium Immediate Annuities (SPIAs): These start paying out immediately after purchase.
- Deferred Income Annuities (DIAs): Payments start at a later date, helping plan for future income needs.
- Fixed Annuities and Multi-Year Guaranteed Annuities (MYGAs): These offer guaranteed interest, and you can withdraw interest annually without touching the principal.
The key advantage of annuities is certainty. With one, you know that your check will arrive every month, no matter how long you live. It’s a great way to transfer the risk of outliving your money to the insurance company. Annuities are also customizable—you can choose to structure the payments for your life only, or for joint lives, so your spouse continues receiving income after you’re gone. Plus, you can ensure that any unused funds are passed to your beneficiaries.
Creating a Balanced Strategy
Most retirees don’t rely on just one of these strategies. The most effective approach often combines elements from all three, ensuring a balance of flexibility, income, and security. For example:
- Use the 4% rule for flexibility and some market exposure.
- Keep a portion of your savings in bonds, CDs, or dividend-paying stocks for reliable income and liquidity.
- Allocate some funds into annuities to guarantee a lifelong income.
By diversifying your income sources, you can ensure that your basic expenses are covered with a guaranteed income, while still allowing for potential growth and flexibility in other areas of your retirement portfolio.
