Here are 10 suggestions for ensuring you make the best possible decisions with your retirement savings.
Construct a Total Return Portfolio
The concept behind “total return” is that you place money into investments to target a 10- to 20-year average annual return. The annual return should meet or exceed the amount you want to withdraw systematically. The investments should be split between stocks, bonds, and cash. One common way to create retirement income is to construct a portfolio of stock and bond index funds, or work with a financial advisor who does this. The portfolio should be designed to achieve a long-term rate of return of around 7% to 10%. For the total return portfolio to work, you’ll need to reallocate capital during its life to match the rate of risk to return. There are many strategies for doing this. One of the most common is the equity glide path strategy, where you adjust your assets based on the criteria of the glide path you choose. Systematic withdrawals follow a predetermined withdrawal amount. Generally, you take out 4% to 7% of your funds per year and increase your withdrawals annually to account for inflation.
Use Retirement Income Funds
Retirement income funds are a unique type of mutual fund. You place capital in the fund, and it is managed for you. In this case, the managers allocate your money across a diversified portfolio of stocks and bonds for you. You place a minimum amount of capital into the account, and the fund managers will do the rest, letting it grow in value. Retirement income funds are great if you prefer to have someone else manage your money and you have a few decades to let it grow.
Purchase Immediate Annuities
Annuities are a form of insurance rather than an investment. Their purpose is to produce income for retirement. The concept is simple—you give the annuity provider a lump sum of money, and they promise to provide you with a set amount of income at specific periods. Immediate annuities tend to begin making payments to you within one month. Say you saved up $250,000 for your retirement. You might not be able to make your money last 25 years on your own. So you place it into an immediate annuity, and the company agrees to pay you $1,500 per month for the next 25 years. The insurance company knows they can invest the money you give them and make more—resulting in more money for you and a profit for them. They can pay you $1,500 per month if the annuity experiences a 6% annual growth rate. This way, they can make your annuity last 25 years as promised and the annuity company will take their cut, too.
Buy Bonds for the Yield
A bond is a loan to the government, a corporation, or a municipality. The borrower agrees to pay you interest for a set amount of time and return the amount you loaned them (the principal). The interest income (or yield) you receive from a bond or bond fund can be a steady source of retirement income if you plan their maturities right. Standard & Poor’s Global Ratings, Moody’s, and Fitch Ratings are companies that rate bonds. Bonds are given quality ratings, which give you an idea of the issuer’s ability to pay the yields and give back your principal. There are short-term, mid-term, and long-term bonds. Bonds have different rates; some have adjustable interest rates (called floating rate bonds), and others have fixed rates. High-yield bonds pay higher coupon (yield) rates but have lower quality ratings. Low-yield have higher quality ratings because they tend to have lower risks. Each can be used differently in a retirement plan. For retirement, individual bonds can be used to form a bond ladder. This strategy uses the maturity dates of bonds to match your financial needs at any given time. This investment structure is often referred to as asset-liability matching or time-segmentation. In this strategy, the intent is to hold the bonds until maturity. If you plan to retire in May of 2040, for example, and need your first payment, you will begin by purchasing a $1,000 bond that matures in May 2040. Next, you’d buy one that matures in June, then August, and so on. You continue doing this until you have every month covered that you’ll need income. This strategy works best when purchasing bonds that do not pay yields but whose face value is more than you paid.
Purchase Rental Real Estate
Rental property, which is sometimes called investment property, can provide a stable source of income for retirement. Investment property is a business, not a get-rich-quick affair. For those with real estate experience or who want to invest time to make it a business, rental real estate can make an excellent retirement investment. Of course, there will be maintenance costs and unexpected expenses to account for. Before you buy a rental property, you should calculate all the potential costs you may incur over the expected time frame you plan to own the property for. You also need to factor in vacancy rates—no property will be rented 100% of the time. Don’t go out and start investing in real estate without doing your homework. It’s a risky way to incur an income, and you need to be completely prepared before investing in real estate.
Buy a Variable Annuity With a Lifetime Income Rider
A variable annuity is not the same type of investment as an immediate annuity. In a variable annuity, your money goes into a portfolio of assets that you choose. You participate in the gains and losses of those investments, but you can add guarantees called riders for an additional fee. Think of a rider like an umbrella—you may not need it, but it is there to protect you in a worst-case scenario. Riders that provide income go by many names, including living benefit riders, guaranteed withdrawal benefits, lifetime minimum income riders, etc. Each has a different formula that determines the type of guarantee they provide. Variable annuities are complex, and many people who offer them don’t have a good grasp of what the product does or doesn’t do. Riders have fees and frequently have variable annuities that total about 3% to 4% a year. That means to make any money, the investments have to earn back the fees and more.
Keep Some Safe Investments
You always want to keep a portion of your retirement investments in safe backup plans. The primary goal of any safe investment is to protect what you have rather than create a high level of current income. All retirees should have an emergency fund. This account should not be included as an asset available to produce retirement income. It is there as a safety net or something to turn to for unforeseen expenses that may come up in retirement.
Invest in Income Producing Closed-End Funds
A closed-end fund is an investment company that offered shares in an initial public offering (IPO). After raising funds, they buy securities with them. The company then offers shares on the market for trade. Money doesn’t flow in and out of the fund. Instead, closed-end funds are designed to produce monthly or quarterly income. This income can come from interest, dividends, or in some cases, a return of principal. Each fund has a different objective: Some own stocks, others own bonds, and others use something called a dividend capture strategy. Be sure to do your research before buying. Some closed-end funds use leverage—meaning they borrow against the securities in the fund to buy more income-producing securities—and are thus able to pay a higher yield. Leverage means additional risk. Expect the principal value of all closed-end funds to be volatile.
Invest in Dividends and Dividend Income Funds
Instead of buying individual stocks that pay dividends, you can choose a dividend income fund. These funds have managers who own and manage dividend-paying stocks for you. Dividends can provide a steady source of retirement income that may rise each year if companies increase their dividend payouts. However, in bad economic times, dividends can also be reduced or stopped altogether. Many publicly traded companies produce what are called “qualified dividends," which means the dividends are taxed at a lower tax rate than ordinary income or interest income. For this reason, it may be most tax-efficient to hold funds or stocks which produce qualified dividends within non-retirement accounts (meaning not inside of an IRA, Roth IRA, 401(k), etc).
Place Capital into Real Estate Investment Trusts (REITs)
A real estate investment trust, or REIT, is like a mutual fund that owns real estate. A team of professionals manage the property, collect rent, pay expenses, collect management fees, and distribute the remaining income to you. REITs may specialize in one property type, such as apartment buildings, office buildings, or hotels/motels. There are non-publicly traded REITs, typically sold by a broker or registered representative who receives a commission. When used as part of a diversified portfolio, REITs can be an appropriate retirement investment. Due to the tax characteristics of the income REITs generate, it may be best to hold this type of investment inside a tax-deferred retirement account such as an IRA.
