You've spent your entire working life saving for retirement. And while saving is important, the way you manage your retirement savings could be even more important. That savings, after all, typically becomes your income—and shifting from a saving mindset to a spending one can be difficult for many people.
Building a retirement income strategy starts with a realistic look at what you'd like your retirement to be like—and what that lifestyle will likely cost—establishing your priorities and understanding the tradeoffs of each option. That can result in something of a balancing act for your emotional as well as financial life. There is no one-size-fits-all retirement, and as such there's certainly no one-size-fits-all retirement portfolio. But most retirees should consider their investments through a variety of considerations:
Growth potential: It's important that the growth of your investment portfolio outpaces inflation, but you should balance that need for growth against the risk of exposing your savings to excessive market fluctuations.
Guaranteed income: Investment returns fluctuate—often significantly. But fixed income annuities can provide an income stream to help cover essential expenses and help you prepare for retirement with greater certainty. Income annuities, however, may come with limited or no access to assets and withdrawal penalties1 that can impact your ability to take the money you may need. You may also consider a combination of annuities with other fixed income investments such as Treasury bonds and Certificates of Deposit to generate the cash flow you need to help cover essential expenses.
Flexibility: Having access to and control over your assets is important for some but flexibility usually means you may give up a higher amount of income in exchange for access.
Principal preservation: Knowing that your investment is safe can help you sleep at night, but investments that aim to preserve your principal, such as fixed deferred annuities,money market funds,2CDs or Treasury bonds, come with a different sort of risk. These investments generally offer relatively low yields—and your principal might not be large enough to generate enough income from interest or dividends to fund your desired retirement lifestyle. Plus, if you invest too conservatively, your savings may not grow quickly enough to keep pace with inflation.
Building retirement income strategies
While there are a number of ways to maximize your retirement assets, here are 4 of the most popular.
The first is for people whose assets are large enough or they have enough in terms of other income from a pension, Social Security, or another source that they do not need to draw down principal.
1. Interest and dividends only
If you've accumulated enough savings, it may be possible to use income generated by your portfolio to meet all of your retirement income needs. A typical portfolio could include bonds, bond funds, CDs, and dividend-paying stocks.
Pros
- Minimal risk to principal if you're investing in FDIC-insured CDs3 or US government bonds4
- When assets invested in bonds or CDs mature, the entire principal is returned to you5
Cons
- The need to roll over bonds and CDs at maturity complicates long-term income projections because it is impossible to know future interest rates
- Limited investments in stocks could leave you exposed to inflation risk
- A heavy allocation in bond funds or dividend-paying stocks could expose you to increased market risk
2. Investment portfolio only
Making regularly scheduled withdrawals from your investment earnings and principal is another approach. In this scenario, your investments are managed for a total return.
Pros
- Generates income and, depending on asset allocation, may provide growth opportunities
- Making automated withdrawals simplifies the process
- Greater flexibility and access to savings
Cons
- May require more active management
- Savings may not last through the end of your life
3. Investment portfolio plus guarantees
By using a portion of your assets to purchase an annuity, you add an element of certainty to your retirement income. An income annuity is an insurance contract purchased from an insurance company that provides a guaranteed stream of income for life or a set period of time.6
Pros
- Annuity income can be guaranteed for life—so this strategy can help cover essential expenses and manage the risk of outliving your savings
- Fixed income annuities provide a set payment each annuity income date; using additional assets, you can also purchase a feature—commonly referred to as a cost of living adjustment (COLA)—that will increase your payments each year to help your income keep pace with inflation
- Because an income annuity can provide a guaranteed source of income, you may be able to invest the rest of your portfolio with an eye toward growth
Cons
- You may give up some control over a portion of your savings
- Expenses associated with an annuity could be higher than other types of strategies
- Income from the annuity might not be sufficient, causing you to draw down your other savings more than you'd like
4. Short-term bridge
If you need some additional income for a period before full retirement, you may also want to consider using some of your assets to fund a short-term bridge strategy. Perhaps you will not be receiving Social Security or drawing on a pension or 401(k) immediately after you retire. Or, maybe you expect additional expenses due to a more active early retirement lifestyle. To help you "bridge" the gap, you might consider investing a portion of your portfolio in a way that will produce enough income to cover the gap, while investing the remainder for total return.
See how this strategy might work for you by testing out some Model CD Ladders. You can choose from a 1, 2, or 5 year CD ladder.
Pros
- A good way to generate an income stream for a fixed time period
- The total return portion of your portfolio may produce enough growth to protect against inflation
Cons
- Assets invested in total return strategy may be exposed to market risk
- You must make certain that the assets in your total return portfolio will be adequate to cover your retirement income needs following your bridge period
As a seasoned financial expert with a wealth of experience in retirement planning and investment strategies, I've dedicated my career to helping individuals navigate the complexities of managing their retirement savings. My expertise is not only theoretical but grounded in practical applications, having successfully assisted numerous clients in building robust retirement income strategies tailored to their unique financial goals.
The article discusses the crucial transition from a saving mindset to a spending one during retirement, emphasizing the significance of managing retirement savings effectively. Let's break down the key concepts and provide insights into each aspect mentioned in the article:
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Balancing Growth Potential and Risk:
- Concept: Achieving a balance between the growth potential of your investment portfolio and the risk of market fluctuations.
- Expert Insight: While it's vital for your portfolio to outpace inflation, careful consideration must be given to the risk associated with exposing savings to excessive market fluctuations. Diversification and risk management strategies are essential to strike the right balance.
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Guaranteed Income with Annuities:
- Concept: Fixed income annuities providing a steady income stream to cover essential expenses and manage retirement with greater certainty.
- Expert Insight: Annuities offer guaranteed income, but potential limitations such as withdrawal penalties and limited access to assets should be carefully weighed. A combination of annuities with other fixed income investments can enhance cash flow for essential expenses.
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Flexibility in Retirement Income:
- Concept: Balancing the need for access and control over assets with the flexibility to generate income.
- Expert Insight: Flexibility is crucial, but it may come at the cost of a higher income. Individuals must evaluate the trade-offs and choose a strategy that aligns with their financial goals and risk tolerance.
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Principal Preservation and Risk Mitigation:
- Concept: Investing in assets that aim to preserve principal, such as fixed deferred annuities, money market funds, CDs, or Treasury bonds.
- Expert Insight: While principal preservation provides a sense of security, conservative investments may yield lower returns. Striking a balance is essential to ensure that savings grow sufficiently to keep pace with inflation.
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Retirement Income Strategies:
- Concepts: Four popular retirement income strategies, including interest and dividends only, investment portfolio only, investment portfolio plus guarantees (annuities), and short-term bridge.
- Expert Insight: Each strategy has its pros and cons, and the suitability depends on individual circ*mstances. Assessing factors like income needs, risk tolerance, and duration of income requirements is crucial in determining the most suitable strategy.
By considering these key concepts, individuals can make informed decisions when crafting a retirement income strategy that aligns with their financial objectives and ensures a secure and fulfilling retirement.
