Best wishes for a happy, healthy, and prosperous new year from the Cooperative Extension System. No doubt the current economic environment has you concerned about your financial future. One of the most frequently cited concerns of retirees and those planning to retire soon is running out of money during later life. Another concern is developing a system to make regular withdrawals from savings and investments to pay for living expenses. The latter is often referred to as a “creating a retirement paycheck.”
What exactly is a retirement “paycheck”? Income received on a regular basis after someone stops working. A retirement “paycheck” makes it easy to pay monthly bills, which provides financial security and peace of mind. It also continues a money management system that most people are used to before retiring where they received income in regular payments.
Another benefit of a retirement “paycheck” is that it can be structured to provide a “safe” withdrawal rate to reduce the risk of outliving your assets. Researchers have found that an inflation-adjusted withdrawal rate of 4% of a retiree’s portfolio balance will generally last for 30 years when the portfolio consists of 50% stocks and 50% bonds. For example, with $500,000 of savings, you would withdraw $20,000 ($500,000 x .04) during your first year of retirement and $20,600 and $21,218 in years 2 and 3, assuming a 3% annual inflation rate.
So how does someone create a retirement “paycheck”? There are a number of strategies to arrange regular income deposits at regular time intervals. Some common retirement “paycheck” planning methods include:
• Automatic Withdrawal Plans- Available through mutual funds, this feature allows investors to designate a dollar amount and a date (e.g., $500 on the 15th of the month) to receive an income deposit from their account. Payments are made by the investment company until the account balance is depleted.
• Income Replacement (Managed Payout) Mutual Funds- These are a new type of actively managed mutual fund, with a choice of maturity dates (e.g., 2048) that investors select to match their projected life expectancy. Payouts are structured according to the target date. The funds pay a monthly income that is adjusted annually for inflation and monthly payments continue until assets are exhausted.
• Bond or Certificate of Deposit (CD) “Ladder”- A “ladder” is a portfolio of bonds or CDs with different maturities (e.g., 6, 12, 18, and 24 months). As each bond or CD matures, the proceeds are reinvested at the longest time interval to maintain the ladder.
• Regular Withdrawals From Cash Assets- Many financial advisors recommend setting aside enough cash to provide 3 to 5 year’s worth of income not provided by Social Security or other sources to “ride out” recessions and bear markets. The remainder of a retiree’s assets would be placed in stocks, bonds, or mutual funds. For example, if a couple plans a $40,000 annual income in retirement and expects $25,000 from Social Security and a pension, their income “gap” is $15,000 and 3 to 5 year’s worth of cash assets is $45,000 to $75,000. Income can be withdrawn monthly or quarterly, as needed. The cash balance should be replenished regularly, starting with income from bonds and dividends and capital gains from stock when market conditions are favorable.
• Post-Retirement Income- Income earned in later life can be an important part of one’s retirement “paycheck.” In addition to providing continued income, remaining employed provides an opportunity to keep depositing money into retirement savings accounts and to earn a higher Social Security benefit.
• Purchase of Annuities- An annuity is a contract with an insurance company where an investor deposits a sum of money and the insurance company makes regular payments for the investor’s life (or a joint life expectancy with a spouse) or for a fixed time period. Annuity payments are generally based on factors such as age and gender. Investors should shop around for annuities with low expenses that are sold by insurance companies with high ratings for financial stability.
