November 24, 2022
  • November 24, 2022

How to Create a Retirement Income Stream

By on April 7, 2022 0

During your working years, your largest stream of income usually comes from a job. When you retire, however, your income will likely need to come from a variety of sources, such as retirement accounts, after-tax investments, social security, pensions, or even continued part-time work.

For those looking to create a stream of retirement income, there are a variety of strategies available depending on your specific income needs and life goals. Two simple retirement income strategies include total return approach and the bucket approach.

Total return approach to retirement income

The total return approach is probably the best known strategy. With this approach, assets are invested with an emphasis on diversification, using a portfolio of investments that offer varied potential for growth, stability and liquidity, depending on your time horizon, risk tolerance and your current and future income needs. There are three defined stages in this approach, which depend on how close you are to retirement:

  • Accumulation phase: During the years of higher income, the goal is to increase the total value of the portfolio through long-term investments that offer the potential for growth.
  • Pre-retirement phase: As you approach retirement, this should include a gradual shift to a more balanced growth and income portfolio, with an increased allocation to stable, liquid assets to preserve your income.
  • Retreat phase: Once retired, maximizing tax-efficient income while protecting against capital decline can result in a portfolio heavily weighted toward income-producing liquid assets.

Advantages and disadvantages : The advantage of taking the total return approach is that, generally, the portfolio should outperform a portfolio with a strong focus on generating income over a longer period. The biggest downside to this approach is that it takes discipline. It’s important to remember that the appropriate withdrawal rate should depend on your personal situation and the economic environment, although many advisors suggest starting with a 3% to 5% withdrawal rate, which can then be adjusted each year in line with inflation.

Holistic approach to retirement income

This approach behaves similarly to the total return approach throughout the accumulation phase, but when you enter pre-retirement, you divide your assets into smaller portfolios, each holding investments geared towards different time horizons. timed and targeted to meet different needs. Generally, there are three common types of buckets based on specific needs, but you are certainly not limited to these three types:

  • Safety bucket: This tranche is designed to cover a period of approximately three years and focuses on relatively stable investments, such as short and medium-term bonds, CDs, money market funds, bond ladders and cash. This portfolio is designed to cover your needs and avoid dipping into the next two buckets when the markets are down, since the average bear market historically lasts less than three years.
  • Income bracket: This tranche should focus on seven years of income needs and is designed to generate retirement income while preserving some capital over a full market cycle. This segment typically includes assets focused on income distribution while offering some growth potential. Examples might include high-quality dividend-paying stocks, real estate investment trusts, or high-yielding corporate bonds.
  • Growth Bucket: This tranche is used to replace the first two tranches after 10 years and beyond and contains investments that have the greatest growth potential, such as non-dividend paying stocks, commodities and alternative assets. Although presenting a higher risk profile, this portfolio has a longer time horizon, therefore more time to compensate for short-term losses.

Advantages and disadvantages : The benefit of taking the bucket approach is that it can help create a sense of calm during market storms. Instead of panicking over growth assets in a downturn, a retiree can feel confident knowing that their income needs for the next few years are already in a more conservative position. The difficulty with this approach is deciding when to move assets from one compartment to another, which again requires discipline.

Funding Sources for Creating a Retirement Income Stream

Beyond social security and pensions, a number of instruments can be used to create retirement income. Which ones you use will depend on your specific goals.

Interest and dividends: The advantage of this source is that investors can expect to receive a consistent monthly or quarterly payout using an instrument such as dividend-paying stocks, closed-end funds (CEFs), or exchange-traded funds (ETFs). ) with a long-term history. The downside of relying on interest and dividends is that most retirees cannot live on these payments alone, especially when yields are low and inflation is high. Also, when it comes to dividend payouts, companies can adjust, reduce, or even stop them altogether.

Bond scale: This strategy involves building a portfolio of several individual bonds that mature at varying staggered dates, often annually. As each bond matures, the scale is extended by purchasing another bond, or it can fund the need for income in the given year. The advantage is that a bond ladder can provide a consistent and predictable return on investment. In addition, it offers protection against certain call risks, since the bonds are unlikely to be called at the same time. The downside to this source of income is that you may be forced to reinvest at lower interest rates, the quality of bonds may vary in risk, and they may underperform inflation, especially if they are purchased at a premium to face value.

Certificate of Deposit (CD) scale: Similar to a bond ladder, this type of investing involves purchasing multiple certificates of deposit with staggered maturity dates. A new CD is purchased as each matures later than the next, extending the ladder, or even used as income at maturity. Although this source of income is safer than the bond scale because CDs are FDIC insured, interest is not paid at maturity. Also, be aware that some CDs reinvest automatically, which could prevent you from receiving the earnings, so it’s wise to specifically search for CDs without this feature.

Annuities: With immediate annuities guaranteed by an insurance company, you pay a lump sum in exchange for a guaranteed payment that begins immediately. With deferred annuities, you invest in a contract, but the payout may not start for several years. Although they are reasonably safe and offer tax-deferred growth and potentially tax-efficient income, they have several drawbacks. Fees can be high, there’s a tax penalty for withdrawals before age 59.5, and it can be difficult to get away with no surrender charge if you change your mind later. It’s important to look for well-rated insurance companies when looking for coverage, as it may depend on the claims-paying ability of the insurance company.

Payment managed: A managed distribution fund is also called a retirement income fund (RIF), income replacement fund or monthly income fund. This source is often mutual funds usually created with retirees in mind, which pay regular and predictable income. The caveat being that income is not guaranteed and payments often fluctuate, and the fund manager can use the principal to meet the payment schedule.

Real Estate Investment Trusts (REITs): A REIT is a company that owns or invests in income-producing real estate and allows individuals to invest in large-scale commercial real estate or home loans. Types of REITs include:

  • Listed on the stock exchange: Available on the main stock exchanges.
  • Public, unlisted: Open to all investors, but may lack liquidity and may not trade on major exchanges.
  • Private, non-commercial: Usually not open to the public due to high net worth and/or high income requirements. Again, may lack liquidity and may not trade on major exchanges

REITs are further broken down by type, including:

  • Equity REITs: Owns income-generating real estate such as offices, industries, retail, hotels, residences, timber, healthcare, storage centers, data centers, and infrastructure.
  • Mortgage REIT (mREIT): Provides financing for real estate.
  • Hybrid REIT: Combines income-generating real estate investments and loans secured by real estate.

The advantage of REITs is that they can provide a reasonable hedge against inflation since most of their taxable income must be distributed to shareholders.

Part-time income: Not everyone is quite ready for retirement, and work can give a sense of self-esteem. The extra income can help hedge against inflation by covering expenses during a bear market instead of selling investments at a loss to pay bills. The main caveat is the potential reduction of Social security benefits while earning an income due to the Social Security Administration’s income test.

Alternative investments: These investments do not correspond to traditional stocks, fixed income securities or cash options. For this purpose, they typically consist of private equity, venture capital, hedge funds, commodities, tangible assets, and real estate.

As you can see, there is no one-size-fits-all approach to retirement income planning. Each of these strategies requires a radically different approach. With this in mind, you should seek advice from your financial advisor to help you build a personalized portfolio that will meet your retirement needs.

President and Founder, Global Wealth Advisors

Kris Maksimovich, AIF®, CRPC®, CRC®, is President of World Heritage Advisors in Lewisville, Texas. Since its inception in 2008, GWA continues to grow with offices across the country. Securities and advisory services offered by Commonwealth Financial Network®, Member FINRA/SIPC, a registered investment adviser. The financial planning services offered through Global Wealth Advisors are separate and unrelated to Commonwealth.