One of my Baby Boomer clients asked for help with a retirement plan that would provide her with a specified level of “safe income” every month. She realized that she did not have enough put away to live off interest on U.S. Treasury bonds or savings accounts alone, something that could easily require a nest egg of $2 million to accomplish.
Very few of my clients have accumulated that much in savings. So, she was looking for other, higher-yielding sources of safe income.
I agreed to work with her, but first we had to agree on what “safe” means. Then we had to decide the meaning of “income.” Once we both accepted those two definitions, the plan was relatively easy.
What “safe” means: We must realize that nothing is 100% “safe.” Even Social Security may require reform, and some pension plans may need bailing out. And some sources of income that retirees count on from their savings depend on market performance, and therefore are riskier. But if you consider the real-world probabilities those risks present, the “guaranteed and lifetime” income sources listed below are both safe and should last a lifetime.
What “income” means: The most basic definition of “income” is an amount received by the individual without any other financial effect. Income, under this definition, is clearly different from drawdowns of savings, which may run out someday.
From safe to risky: Sources of income
Below is my list of retirement income generated from savings and investments, exclusive of salary, wages and bonuses. The income at the top of the list is the safest and least risky.
Guaranteed and lifetime income
These sources of income are not dependent on market performance or personal management or effort. All of them involve payments (either fixed or in some cases CPI-adjusted) that won’t change in the future simply because you receive them — meaning the payments aren’t coming from a source that will be depleted and eventually run out, like your own bank account.
- Social Security payments: Because payments last a lifetime and are adjusted for inflation, Social Security is a secure and valuable source of income. The only “risk” involved would be that certain reforms of the system may be required to maintain the current level of benefits for future retirees, and any change would likely have a transition period.
- Pension plan payments: Typically such plans last a lifetime, but only a few provide inflation protection. While it’s true that private pension plans have been known to fail, corporate pensions are backed by the Pension Benefit Guarantee Corp. Government pensions require continuous monitoring of political decisions that might affect these plans.
- Income annuity payments: Income annuities are contracts issued by life insurance companies that can provide guaranteed lifetime income starting at a date the retiree can select. Unlike Social Security and pension plans, an individual can customize the form of an income annuity, paying to the retiree, a spouse and a surviving beneficiary. Income annuities are supported by insurance company reserves and are protected by state-guaranteed funds.
Recurring income from savings/investments
You can consider the income from these sources “safe” because it won’t reduce your assets when you receive it. The sources themselves may be “risky,” however, because you can’t count on the market value of the investment if you need to liquidate.
- Dividends from a stock portfolio: The income from dividends will be affected by the dividend payout rates set by the corporations that issue the shares of stock. You can select portfolios or mutual funds that concentrate on high-dividend stocks. Of course, the risk would be that the companies could decide to cut their dividends or not issue any at all, which isn’t uncommon.
- Interest on a portfolio of bonds: When you invest in bonds other than U.S. Treasury bonds to get a higher level of interest, you assume a greater level of risk.
Withdrawals as retirement income
Both the income and the underlying savings source in this category can disappear before your retirement ends. Withdrawals from your investment portfolio decrease the amount of money available to you in the future. Also, unlike retirement income that is paid out to you, withdrawals typically need to be requested each year by you.
- Distributions from a 401(k), rollover IRA: Any amount you withdraw will impact future distributions, just as market performance will.
- Withdrawals from other investment accounts: Any amount you withdraw will affect future distributions, just as market performance will — no matter what the withdrawal formula.
- Withdrawals from fixed, indexed and variable annuities: Any amount you withdraw may affect future distributions. Make sure you understand what Living Benefit Guarantee these types of annuities might provide.
What’s your strategy?
Once my client understood our approach to creating a plan with safe income, she appreciated how we were going to achieve it. Under the income allocation model, we created a core allocation of safe income, supplemented by higher-risk withdrawals. With a safe core, she will be more willing and able to stay the course even with bumpy market returns.
She also recognized why income allocation includes withdrawals as part of its plan. (See below for a discussion of how to manage risk under withdrawal plans.)
When you employ an income allocation plan, you also can make all sources of income work for your retirement.
Managing risk of a withdrawal plan
With the risk of the market comes the potential reward of higher returns, provided you have the discipline to stay the course. Here’s how we manage withdrawals:
- Allocate the investment account between a portfolio of stock and bond investments, and a buffer portfolio of short-term investments, such as 85% to the balanced portfolio and 15% to the buffer account.
- Make a conservative assumption as to market returns in setting the initial level of withdrawals. We prefer to assume a rate of 4% or 6%, and let any outperformance either increase or extend withdrawals.
- Do not depend on withdrawals to provide payments for life and manage withdrawals for a fixed period of, say, 15 and 20 years. Under this approach, we structure the withdrawals so that, based on conservative assumptions, they are projected to last for the 15- or 20-year period elected.
- Reset withdrawals each year and use the buffer account to make up for any deficit in reset vs. planned withdrawals. By “reset,” we mean to take current market value of investments and then repeat the calculation process we used at the start.
- With safe income in place from other sources, stay disciplined with the original allocation.
If you would like to discuss your options for safe retirement income, contact me at Ask Jerry. I will work with you to analyze your options.
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Jerry Golden is the founder and CEO of Golden Retirement Advisors Inc. (opens in new tab) He specializes in helping consumers create retirement plans that provide income that cannot be outlived. Find out more at Go2income.com (opens in new tab), where consumers can explore all types of income annuity options, anonymously and at no cost.