If you are one of the fortunate few who have a defined benefit retirement plan, you have more predictability in your retirement income than most. You can calculate your combined pension benefits and any Social Security benefits that you have earned and have a clear idea of your annual income throughout retirement – assuming you aren't tempted to take your pension as a lump sum and head straight to Las Vegas.
With a defined contribution plan such as a 401(k) – or worse, no plan at all – the only certain income stream is Social Security. (We'll defer arguments about the long-term health of Social Security for another time.) It's up to you to balance out your sources of income and construct your nest egg in a way that provides a steady, more predictable income – typically around 4% of your overall nest egg per year.
Here are a few approaches to help you reach that goal.
1. Purchase a Fixed-Income Annuity – You give funds to an insurance company that in turn provides a guaranteed annual income for the rest of your life. Similar to how a defined benefit pension was created based on your employer's contributions over the course of your career, but in this case, you are paying a lump sum up front in return for immediate monthly payouts.
Annuities are often structured to provide lifelong payments, but they can be altered in many different ways. The annuity can be for a specified period of time. It may include death benefits, or it may include an investment portion designed to take advantage of growth opportunities.
In any case, remember that an annuity is a bet with the insurance company that you will outlive the break-even point on the monthly payments – and most alterations shift that break-even point toward a longer life (in other words, lower monthly benefits for the same lump-sum payment to the insurance company). Make sure you fully understand the terms of any annuity before signing, because it can be costly to reverse your decision.
2. Ladder Treasury Bonds – Invest a portion of your nest egg in long-term Treasury bonds and "ladder" them so that you have bonds that are set to mature each year. You may then cash them in at maturity to provide a known return, or sell them prior to maturity if you need to make adjustments to your plan.
Keep in mind that while Treasury issues are as safe as investments can get, they also provide low returns compared to many alternative investments. Should inflation rise, the purchasing power of your bonds drops at maturity unless you choose to purchase Treasury Inflation-Protected Securities (TIPS).
3. Invest in Dividend Stocks – While many investors choose stocks for growth, it's possible to find dividend stocks that provide well beyond the approximate 2% average for dividend yields. Since companies are not guaranteed to produce dividends, you can choose high-dividend mutual funds that invest in a basket of dividend-returning stocks to mitigate the risk. If you prefer, simply research stocks that have provided regular dividends in the past and that appear to be financially healthy, and invest in them separately.
Aside from the lack of guaranteed dividends, the tradeoff of this approach is lower growth. But virtually any option that provides a suitable guaranteed income stream comes at the expense of growth. Growth inherently requires greater risk, which is probably not your retirement objective.
These are only three of many strategies that can provide a steady retirement income. For more options or for help executing any retirement income strategy, seek the advice of a qualified financial advisor. A competent advisor can help you find the right balance between a steady income stream and the risks required to keep your retirement funds ahead of inflation.
Before you firm up plans for a steady retirement income, make sure that your estimated income is enough to cover your estimated expenses. It's not uncommon for retirees to underestimate their expenses and end up scaling back their retirement goals.
Pay special attention to your healthcare assumptions when reviewing expenses. A recent Prudential study estimated that a healthy 65-year old couple in 2017 will spend an average of $275,000 on healthcare costs over their lifetimes, not including long-term care.
If you enjoy the peace of mind from a steady retirement income that meets your needs, consider the strategies listed above and seek qualified financial help if necessary. If you find that approach too boring and mundane, Vegas awaits. Good luck with your choice.
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