Not long ago, pensions were commonplace in the United States. Pensions provide guaranteed income throughout retirement and reduce much of the stress that comes with using investments to cover living expenses.
Some employees do still receive pensions. However, the vast majority of Americans will depend on Social Security and various tax-advantaged accounts to fund them in retirement. While Social Security is guaranteed, the value of accounts can drop quickly if the market takes a dip.
Luckily, individuals can take steps to create a steady income for themselves during retirement. Taking these steps can help you develop guaranteed income each month that will act almost like a pension and offer a better sense of financial security.
These steps include maximizing Social Security, purchasing an annuity, and investing in a balanced mutual fund. Here’s what you need to know:
The Basic Strategy for Creating a Retirement Portfolio
Creating a retirement strategy similar to a pension makes sense for a wide range of different retirees. This strategy provides a predictable retirement income. From there, you can still spend a percentage of what is left without worrying about how you will cover basic expenses. Looking at an example can help reinforce why this is a good idea.
Imagine a couple that retires at age 70. The couple has a combined income of $50,000 annually from Social Security and have together saved $1 million for retirement. This couple could take half of their investment portfolio, or $500,000, and buy an annuity with joint survivorship rights. Under current economic conditions, this annuity would be worth about $27,000 each year. This means the couple should have $77,000 in stable, annual income.
While this amount may not sound like a lot, the couple’s actual income would be significantly higher as another $500,000 remains in the investment portfolio. Individuals do not need to take required minimum distributions from tax-deferred accounts until they turn 72. However, the government publishes guidelines for taking distributions sooner than that.
According to this table, individuals in this situation could take out 3.44 percent of the principal amount, for a total of $17,200 each year. When couples take only the required minimum distribution, they introduce a degree of uncertainty to their annual income. However, they also substantially reduce the risk of running out of money during their lifetimes. In the above example, the theoretical couple is making more than $90,000 annually with minimal concern for running out of money.
How to Think about Changing Performance over Time
People considering creating their retirement strategy should rightly worry about what would happen to their investments over time. Social Security increases with inflation, which helps increase income, but an annuity does not. In other words, inflation-adjusted income would slowly decrease over time.
For most people, this fact should not be a matter of significant concern. People tend to spend less as they grow older since they are not buying new vehicles or traveling as much. Private pensions were not typically adjusted for inflation, and people were generally secure financially since they usually needed less income later in life. Furthermore, Social Security still provides the biggest chunk of income, and that amount does increase over time.
In an average market, individuals would have about 80 percent of spending power at age 100 that they did at 65 using this system. In a favorable market, their spending power could actually increase. In the most pessimistic models, their spending power decreases by only 35 percent.
In reality, 65 percent of initial income at age 100 is fine for most people since individuals do not tend to spend much money at this age. This approach may be too much of a gamble for some retirees, particularly those who are concerned about healthcare expenses. However, it is a great strategy for many people who want a sense of security in retirement.
The Key to Creating a Successful Retirement Portfolio
Perhaps the most important part of creating a successful environment portfolio is maximizing your Social Security benefit. This benefit increases by 8 percent for each year that individuals delay once they reach full retirement age. Despite this, many people still claim it as soon as they are able.
The retirement portfolio relies on the cost-of-living increases made to Social Security, so getting the highest payment possible through this system is extremely important. Especially now, when low yields are a reality, maximizing Social Security is very attractive. Individuals also need to be careful in their choice of annuity to make sure that income will cover basic expenses when added to Social Security.
The other big question is what to do with the remainder of the money you have saved for retirement. Many financial experts would recommend a simple approach with a mutual fund that consists of 60 percent stocks and 40 percent bonds. This type of fund helps capture market upside while protecting against market crashes, at least relative to more aggressive varieties of mutual funds.
This protection comes from the fact that bond prices tend to rise when stocks decrease in value. The sort of mutual fund outlined above helps protect against market volatility, which is a key goal during retirement. If you have too much exposure to volatility after retirement, you could find yourself in a situation where your income from investment accounts dips too low to maintain your standard of living.