4 Tips How to Generate Income in Retirement

The transition from working and saving to retirement and withdrawing can be stressful if you’re not ready for it. Consider this: If you are fortunate enough to live to age 65, your life expectancy is about age 85. If you’re married, there’s a 45% chance one of you lives to 90. So, how do you generate income over the next 20-30 years while ensuring you don’t outlive your assets? Here are four tips:

Prepare your portfolio

What got you here won’t get you there. In other words, the challenges of constructing a portfolio during the asset accumulation phase are much different than those faced during retirement. When we’re, say 45, we invest with a diversified but aggressive portfolio designed to grow our assets for when we’re not working. When we’re 2-3 years prior to retirement or at retirement, however, the portfolio must balance the almost-contradictory goals of growing to outpace inflation, protecting what you’ve accumulated and generating income to cover your expenses. To quote my then 7-year old son when UK Football faced a 3rd and 15, “That looks hard!”

Tip: A bear, or down, market just as you enter retirement couldn’t come at a worse time if you’re forced to sell investment assets for income after prices have plunged. So, take the amount you estimate to be 1 year of expenses and put it into a short-term income fund that will generate a small, but reliable, return with little risk.

Tip:  Adjust your portfolio – defined as all of your investment accounts together (401(k), 403(b), IRA, etc.) – to protect against inflation while reducing risk. Inflation has averaged about 3% over the long haul so keeping money in cash is the same thing as losing 3% of its value each year. Stock mutual funds may provide for a bit of a bumpy ride at times but their steady, upward trend is a good hedge against inflation. So, keep a portion of your portfolio in stock mutual funds but de-risk by moving some to long-term income investments. These income investments should be relatively stable but also generate regular income that can be reinvested. Your financial plan will dictate the mix that’s right for you.

Determine when to take Social Security

Look at my blog from a few weeks ago to determine the optimal time for you to begin taking Social Security benefits - https://www.moneywatchadvisors.com/blog/7-steps-when-take-social-security. Waiting until at least your full retirement age to draw will result in larger monthly payments and, hopefully, more Social Security income in the long run.

Tip: Budget an average withdrawal rate from your investment accounts of about 4% each year. In other words, if your total portfolio is $1 Million, 4% each year is $40,000 of income. The rate may be a bit higher prior to taking Social Security but shouldn’t average more than that throughout retirement. Estimate your annual expenses, subtract Social Security income: what’s leftover is the amount you will need to take from your investment accounts each year. 

Minimize taxes

To get the most from your hard-earned retirement savings you need to shield as much as possible from taxes. This can get tricky if you’re still working and/or if you’re taking Social Security so incorporating a tax strategy within your financial plan is vital.

Tip: Take income from your investment accounts in this order:

1. Your taxable accounts first. You still need to calculate potential capital gains but, if your income is low enough in retirement, those withdrawals may be tax free;
2. Tax-deferred accounts such as your 401(k), 403(b) or a traditional IRA. You contributed to these pre-tax so the IRS demands you pay tax on the withdrawals now;
3. Roth IRAs. You contributed to these with after-tax dollars so, as long as you’ve owned the account at least 5 years, you can withdraw any amount and you won’t pay any income tax on what you contributed or the growth in the account. We leave these to the end so they will continue to grow, unencumbered by taxes.

Don’t underestimate the stress involved in transitioning from your professional life where you saved and grew your portfolio to the time when you start depleting that portfolio. A thorough financial plan specific to you and your needs will help ease that transition.

Steve Byars