Many new retirees or those near retirement age may be facing the transition of needing to convert their nest egg into actual retirement income, but are unsure exactly what their options are. A recent article from Forbes breaks down the three primary ways to make retirement savings work like cash, depending on individual needs.
Dividends and Interest
The first option is arguably the most conservative: Simply live off of the dividends and interests created from your retirement investments without ever dipping into the principal. Investing in treasury inflation protected securities (TIPS) goes a step further to ensure that income generated isn’t reduced because of inflation.
This strategy doesn’t produce much income percentage-wise, however; current 30-year TIPS have an interest rate of 0.125%, while the yield on the S&P 500 is roughly 1.3% and includes volatility risk and the chance of dividend cuts. A way to counter this is to seek higher dividend paying stocks, but that can also increase risk because the more stable dividend producers — dividend aristocrats and dividend kings — are a smaller group and therefore aren’t as diversified for investing.
Immediate Income Annuity
A second option is to use savings to buy an immediate income annuity that will pay out income to you and potentially your survivor as well for as long as one of you is alive. It’s akin to buying a traditional pension, but it comes with drawbacks.
For starters, some income annuities have their income set and don’t adjust for inflation, or if they do account they simply don’t pay much. Another drawback is that by paying out a chunk of principal, you aren’t able to capture any kind of investment growth from it, or pass it on as inheritance. A final consideration is that if something happens to the insurance company, there is a risk they wouldn’t be able to pay, though this is rarely the case, as most insurance companies are re-insured these days.
A final option is the one that most people utilize and are familiar with, which is the 4% rule; a portfolio that is split evenly amongst stocks and bonds can tolerate a 4% withdrawal of its initial value that increases annually for inflation. It offers better income opportunity than living off dividends and interest, is less risky than investing in a few higher-dividend securities, and sidesteps immediate annuity limitations.
Drawbacks to this investment choice are that the rate of expiration of funds is 30 years, so if you live beyond that, you could run out of money, and also it is based on the assumption that income needs are fixed. It doesn’t allow for flexibility and also is based on historical data, not future return potentials.
It’s important for advisors to be able to steer their clients in the right direction; Nationwide offers a variety of options for advisors to provide retirement solutions for their clients.
For more news, information, and strategy, visit the Retirement Income Channel.