In my last post I described how in preparing for retirement we should be thinking about how much income can be generated for taking a look at two different payment terms Yield vs. Distribution rate. In a nutshell it is important to make a distinction between what is true income from interest and dividends and what can be considered a return of principal. Many investments pay an investor through distribution, but does this mean your principal remains intact? And, does it matter?
If you need an income stream that lasts for the rest of your life, it could or could not matter? If you are trying to leave behind a legacy it matters that a portion of your investment is coming back to you and you’re spending your principal. If you have no legacy concerns an annuity that guarantees you a lifetime of income, despite not being able to access any principal in a lump sum fashion maybe just fine. Wall street is all about trade-offs. You never get something for nothing.
Durability is what allows us to sleep at night and that can be just as important as important the cash flow itself. Durable income sources in retirement are those that are reliable and typically continue throughout your retirement years, offering a steady stream of income to cover your expenses. These can include:
Social Security
- Social Security benefits are one of the most common and reliable income sources in retirement. The amount depends on your earnings history and when you start claiming benefits.
- Durability: Government-backed, inflation-adjusted to some extent, and continues for life. This public benefit is something many Americans request on their own. However, an advisor can be extremely helpful as to the timing and claiming strategies used in order to maximize your benefits.
Pension Income
- A traditional defined-benefit pension pays retirees a fixed monthly amount, based on years of service and salary history.
- Durability: Typically guaranteed by employers or government entities, providing stable income for life. We are starting to see fewer of these, but the trade-off of stable lifetime income for the reduction of income to a spouse or elimination of any assets going to other heirs, is significant. Therefore, we always weigh options if the ability to take a lump sum cash payout in a rollover exists, is better than taking the lifetime income. Some annuities may give clients the best of both worlds, allowing lifetime income and access to principal.
Annuities
- Annuities are insurance products where you pay a lump sum (or series of payments) to an insurance company in exchange for a steady income stream, which can last for a fixed term or lifetime.
- Durability: Can provide lifetime income, depending on the type (e.g., fixed annuities, indexed annuities). Annuity contracts can vary in terms and scope with some offering a guaranteed income for a single or joint life between spouses as mentioned above in the pension discussion. Some may offer access to principal as well. Getting objective advice when considering an annuity is vitally important since contract terms vary so widely. Your objective must be considered and rarely if ever does any single insurance company have the best option for every retirement income investor. This is why we would never engage an agent that represents only one carrier to help us select the right annuity contract. An advisor who can offer the annuity products of several insurance carriers, is more than likely best to engage for help.
Investment Income
- Income generated from a well-diversified investment portfolio of stocks, bonds, and mutual funds.
- Durability: While not guaranteed, if managed prudently, dividends, bond interest, and capital gains can provide a long-lasting income stream. A common strategy is the “4% rule,” where retirees withdraw 4% of their portfolio annually. This would typically be recommended when a desire for legacy was more important than a guaranteed income stream for life. Often times 4% does not create enough cash for our clients to meet their needs. This is where a distribution rate based investment might come into play to increase the amount of spendable income in their pocket, even at the expense of decreasing the legacy left to family.
Rental Income
- Income from rental properties, including residential, commercial, or vacation rentals.
- Durability: Rental income can be a durable source if properties are well-maintained and located in desirable areas. However, there are risks associated with vacancies, property damage, and market fluctuations.
Part-Time Work or Freelancing
For some retirees, continuing to work part-time or freelancing in retirement can provide extra income. This is the least desirable option that we’ve encountered.
Dividend-Paying Stocks
- Investing in blue-chip companies with a history of paying dividends can provide a steady income stream.
- Durability: Dividend payments can grow over time, helping to keep pace with inflation, though they are not guaranteed. You need to have a strong stomach to own even the best companies in the world. Stock prices fluctuate up and down but some of the best companies continue to pay steady dividends, despite a depressed stock price. This is truly a retirement income strategy with legacy goals in mind.
Income from REITs (Real Estate Investment Trusts)
- REITs are companies that own, operate, or finance real estate, and they distribute income to shareholders.
- Durability: REITs must pay out at least 90% of their taxable income to shareholders, offering a potentially durable income stream. REITs are not unflappable. If you think about the commercial office market now and the remote work culture that has gripped the country, obviously 90% of today’s taxable income is not what it used to be. This is not something a retiree would look forward to.
Bonds (Treasuries, Municipal Bonds, Corporate Bonds)
- Bonds pay interest over a fixed period and return the principal upon maturity.
- Durability: Government-backed bonds, especially U.S. Treasuries, are highly reliable. Municipal bonds offer tax-free income, and corporate bonds may offer higher returns but come with more risk. You must understand that bond prices fluctuate as do stocks. Interest rates and bond prices are inversely related. For example, if interest rates rise, bond prices fall. This means in a rising rate environment you can expect to see bond prices or the value of your principal on your statement fall, just as you would if a stock market were to fall. The difference is that if you own the individual bond, at maturity the bond will recover to its original face value. This is why it is important, when possible, to buy individual bonds as opposed to bond funds. There is no reversion to face value; therefore, there is much more risk in a bond fund than owning the individual bonds.
TIPS (Treasury Inflation-Protected Securities)
- TIPS are bonds issued by the U.S. government, where the principal increases with inflation, offering inflation-protected income.
- Durability: Highly durable as they are backed by the government and offer protection against inflation.
Each of these sources has different levels of risk, inflation protection, and reliability, so a diversified approach can enhance durability and perhaps enhance the returns if you know your needs versus wants and understand the characteristics of the income to be received. Distribution rates tend to have higher amounts of cash being paid to the investor, but higher cash flows reduce and can even eliminate the possibility of leaving a legacy to your family. We are happy to help evaluate your options.
If you would like help navigating the path to secure retirement income, you can reach us by email at
lb****@ro*************.com
and upload any documents that you would like for us to review to our secure portal.