You worked hard and saved diligently for retirement. Now comes the fun part: enjoying the retirement you've been envisioning along the way. But before you do that, you need to have a strategy to generate income that can last your entire lifetime—income that can weather inflation, market ups and downs, unexpected expenses, and, yes, longevity.
In general, retirement income can come in many forms—such as dividends, interest, capital appreciation, investment principal, Social Security benefits, pensions, insurance, and even inheritances—to name a few.
To help frame this topic, here are the 4 key factors to consider before you start constructing your income strategy, the 3 building blocks you'll need to lay a sturdy foundation, plus 5 simple steps that may help you put and keep a plan in place.
4 key things to keep in mind
1. A long retirement
Today's healthy 65-year-olds may live well into their 80s or even 90s. This means there's a real possibility that you may need 30 or more years of retirement income. Without some thoughtful planning, you could easily outlive your savings and have to rely solely on Social Security for your income. And with the average Social Security benefit being approximately $1,450 a month, it may not cover all your needs.1
While inflation has been relatively low in recent years, it can have a powerful impact over the course of 20 or 30 years. That's especially true in retirement, when you can't count on raises like you might have had when you were working.
Even a relatively low inflation rate can have a significant effect on a retiree's purchasing power. For example, using a 2% inflation rate, $50,000 today would be worth only $30,477 in 25 years. Or, if you flip this example, in 25 years, you would need $82,030 to purchase something that costs $50,000 today.
3. Market volatility
Market declines can be unsettling when you’re relying on what you have saved to last the rest of your life. But you still need stocks for growth potential, which is as critical in your retirement as it is when you are saving for it.
Even if your time horizon is long enough to warrant an aggressive portfolio, you have to be comfortable with short-term ups and downs. If watching your balances fluctuate is too nerve-racking for you, think about reevaluating your investment mix to find one that feels right.
But be wary of being too conservative, especially if you have a long time horizon, because strategies that are more conservative may not provide the growth potential you need to achieve your goals. Set realistic expectations too. That way, it may be easier to stick with your long-term investing strategy. Remember, both more conservative and aggressive strategies may fluctuate over time, but to different degrees depending on market conditions.
4. Withdrawing the right amount from savings
You don't know what the future will hold for you, and the financial past is no guarantee of what will come next. Nevertheless, our historical research suggests that limiting withdrawals to 4% to 5% is a good place to start, provided that an investor is planning for roughly 30 years of retirement.
Based on investment performance for the 35-year period beginning in 1972, a hypothetical balanced portfolio of 50% stocks, 40% bonds, and 10% short-term investments would do quite well for a retiree who limited withdrawals to 4% annually. On the other hand, someone who retired at 65 and withdrew 8% adjusted for inflation would have been out of money shortly after age 75. Investors should review their portfolio at least annually to monitor and rebalance as needed.
The sequence of good and bad market performance years may also have a major effect on your portfolio's ability to sustain your income. For example, a portfolio that starts out strong in retirement and has losses later will likely be in much better shape than one that has down years early, even if strong performance in later years brings its average return back in line with historical averages.
For this reason, it's important to take into account the potential effects of fluctuating financial markets when you're deciding how much to withdraw early in retirement, as well as your ability to stay invested during these periods of volatility, and how to divide your retirement portfolio among asset types and diverse investments.
OK, so now you know what to keep in mind as you prepare a retirement income plan. Now let's turn to the elements of a sound plan.
3 key building blocks
Your retirement income plan should provide 3 things:
- Guarantees to help a retirement plan succeed
- Growth potential to meet long-term needs
- Flexibility to refine a plan over time
1. Guaranteed income for essential expenses to help a retirement plan succeed
When you create your plan, you'll want to make sure your day-to-day expenses—nonnegotiable costs, such as housing, food, utilities, and health care—are covered by lifetime guaranteed income sources. There are essentially 3 sources of guaranteed income.
Social Security: It can be tempting to claim your benefit as soon as you're eligible for Social Security—typically at age 62. But that can be a costly move. If you start taking Social Security at 62, rather than waiting until your full retirement age (FRA), you will receive reduced monthly benefits. (FRA ranges from 66 to 67, depending on the year in which you were born.) Find out your full retirement age, and work with your trusted financial advisor to explore your options.
Pensions: Although pensions used to be commonplace, they aren't so much anymore. Indeed, only 14% of workers have a defined benefit pension plan, according to the US Department of Labor.3 As a result, many people aren't able to rely on pension income in retirement. If you do have a pension, you'll want to weigh the pros and cons of how you withdraw the money—as a lump sum or stream of income.
Annuities: A fixed income annuity is a contract with an insurance company that, in return for an up-front investment, guarantees4 to pay you (or you and your spouse) a set amount of income either for the rest of your life (and the life of a surviving spouse in the case of a joint and survivor annuity) or a set period of time. There are different types of income annuities you may consider: an immediate income annuity, a deferred income annuity, or a fixed deferred annuity with a guaranteed lifetime withdrawal benefit (GLWB). Each allows you to buy an annuity now that would provide payments for the rest of your life to supplement retirement income and/or to manage longevity risk. Fixed payments continue and will not decrease regardless of what happens in the financial markets.
There are a few things to keep in mind, though. You may give up access to the savings you use to purchase an immediate or deferred income annuity, so you'll need to have other money available for unexpected expenses. If you purchased these annuities, you also forgo any growth potential for this money; however, you can pay extra for annual increases in payments to help offset inflation. In addition, you can select to provide protection for your beneficiaries if that is important to you. For example, a cash refund option provides a death benefit equal to the lump sum investment less any income payments received, ensuring you or your beneficiaries get back your original investment.
A fixed deferred annuity with a GLWB allows access to your investment. When you purchase this type of annuity, your future income amount is guaranteed to increase on each contract anniversary for a set period of time or until your first lifetime withdrawal, whichever comes first. You will know how much income you (or you and your spouse for joint contracts) will receive each year at any age you decide to take withdrawals. While each annuity offers an attractive blend of features, determining which annuity or a combination of annuities is appropriate for you is part of building a diversified income plan.
2. Growth potential to meet long-term needs
As you build your income plan, it's important to include some investments with growth potential that may help keep up with inflation through the years.
You'll want to consider how you can pay for those fun things you've always dreamed about doing when you finally have the time—discretionary expenses like vacations, hobbies, and other nice-to-haves. If the market were to perform poorly, you could always cut back on some of these expenses, and it's a smart strategy to avoid relying on one’s investment portfolio to pay for essential expenses.
Creating and managing an investment portfolio requires some effort along with the discipline to stay on plan even during volatile markets. You need to carefully research investment options and choose ones that match your goals. You also need to monitor your investments and portfolio, and rebalance when needed. And it's important to manage taxes on your investments too. If you don’t have the skill, will, or time to do that, a professionally managed account might be a better option.
3. Flexibility to refine a plan over time
It's important to combine income from multiple sources to create a diversified income stream in retirement. Complementary income sources can work together to help reduce the effects of some important key risks, such as inflation, longevity, and market volatility. Taking withdrawals from your investment portfolio doesn't guarantee income for life, but gives you the flexibility to change the amount you withdraw each month.
On the other hand, income annuities provide guaranteed income for life, but may not offer as much flexibility or income growth potential. As part of your overall financial plan, you may wish to preserve some principal for use in an emergency or to leave a legacy for heirs. You can accomplish this separately from, or in conjunction with, a diversified income plan.
Making a decision
Everyone's situation is unique, so there’s no one income strategy that will work for all investors. You'll need to determine the relative importance of growth potential, guarantees, or flexibility to help you pinpoint the strategy that is right for you in retirement.
More growth potential can mean settling for less guaranteed income. With more guarantees, you get less growth potential and less flexibility. Consider, too, your family's history regarding longevity and whether you plan to leave a legacy to your heirs.
5 steps to consider
So, how do you get started?
Next steps to consider
Call or visit to set up an appointment.
Determine if you're contributing enough to your savings.
Consider these 4 guidelines to help you reach your goals.