One of my Baby Boomer clients asked for help with a retirement plan that would provide her with a specified level of “safe income” every month. She understood that she did not have enough savings to live off interest on U.S. Treasury bonds or savings accounts. Very few of my clients have accumulated that much in savings. So, she was looking for other, higher-yielding sources of safe income.
I agreed to work with her, but first we had to agree on what “safe” means. Then we had to decide the meaning of “income.” Once we both accepted those two definitions, the plan was relatively easy.
Nothing is 100% “safe.” Even Social Security may require reform and some pension plans may need a bailout. And some sources of income that retirees count on from their savings depend on market performance, and therefore are riskier. But if you consider probabilities, the “guaranteed and lifetime” income sources below are both safe and will last a lifetime.
The most basic definition of “income” is an amount received by the individual without any other financial effect. Income under this definition is clearly different from draw-downs of savings, which may run out someday.
From safe to risky sources of income
Below is my list of retirement income generated from savings and investments, exclusive of salary, wages and bonuses. The income at the top of the list is the safest and least risky.
Guaranteed and lifetime income
These sources of income are not dependent on market performance or personal management or effort once payments start. All of them involve payments (either fixed or in some cases CPI-adjusted) that won’t change in the future simply because you receive them.
Social Security payments — Because payments last a lifetime and are adjusted for inflation, Social Security is a secure and valuable source of income. Certain reforms of the system may be required to maintain the current level of benefits.
Pension plan payments – Typically such plans last a lifetime, but only a few provide inflation protection. Corporate pensions are backed by the Pension Benefit Guarantee Fund. Government pensions require continuous monitoring of political decisions that might affect these plans.
Income annuity payments – Unlike Social Security and pension plans, an individual can customize the form of an income annuity, paying to the retiree, a spouse and a surviving beneficiary. Income annuities are supported by insurance company reserves and are protected by state-guaranteed funds.
Recurring income from savings/investments
You can consider the income from these sources “safe” because it won’t reduce your assets when you receive it. The sources themselves may be “risky” because you can’t count on the market value of the investment if you need to liquidate.
Dividends on a portfolio of stocks – The income from dividends will be affected by the dividend payout rates set by the corporations that issue the shares of stock. You can select portfolios or mutual funds that concentrate on high-dividend stocks.
Interest on a portfolio of bonds – When you invest in bonds other than US Treasury bonds to get a higher level of interest, you assume a greater level of risk.
Withdrawals as retirement income
Both the income and the underlying savings source in this category can disappear before your retirement ends. Withdrawals from your investment portfolio decrease the amount of money available to you in the future. Also, unlike retirement income that is paid out to you, withdrawals typically need to be requested each year by you.
Distributions from 401(k), rollover IRA – Any amounts you withdraw will impact future distributions, just as market performance will.
Withdrawals from other investment accounts – Any amounts you withdraw will affect future distributions, just as market performance will — no matter what the withdrawal formula.
Withdrawals from fixed, indexed and variable annuities – Any amounts you withdraw may affect future distributions. Make sure you understand what Living Benefit Guarantee these types of annuities might provide.
What’s your strategy?
Once my client understood our approach to creating a plan with safe income, she appreciated how we were going to achieve it.
Under income allocation, we created a core allocation of safe income, supplemented by higher risk withdrawals. With a safe core, she will be more willing and able to stay the course even with bumpy market returns.
She also recognized why income allocation include withdrawals as part of its allocation. (See below for a discussion of how to manage risk under withdrawal plans.)
When you employ an income allocation plan, you also can make all sources of income work for your retirement.
If you would like to discuss your options for safe retirement income, contact me at Ask Jerry. I will work with you to analyze your options.
Managing risk of a withdrawal plan
With the risk of the market comes the potential reward of higher returns, provided you have the discipline to stay the course. Here’s how we manage withdrawals:
- Allocate investment account between a portfolio of stock and bond investments, and a buffer portfolio of short-term investments.
- Make a conservative assumption as to market returns in setting the initial level of withdrawals.
- Do not depend on withdrawals beyond a fixed period.
- Let favorable market returns, if any, increase or extend withdrawals.
- Reset withdrawals each year and use the buffer account to make up for any deficit in reset vs. planned withdrawals.
- With safe income in place from other sources, stay disciplined with the original allocation.