Retirement Guidelines

Your Financial Advice Site

Planning for Retirement
Retirement Plans

Retirement Income

If we properly plan for retirement, we will spend years — decades — saving enough money to provide ourselves with an adequate nest egg. During these years, of course, we have income through our jobs — hopefully enough to cover our daily expenses as well as whatever perks we have chosen to allow ourselves. However, once we retire, these paychecks will stop, and we’ll have to plan for other income streams that are sufficient to meet our daily needs.

How much income will you need in retirement? Traditionally, financial planners have projected that you will need from 70 to 90 percent of your preretirement income to maintain your standard of living in retirement. You will no longer have commuting expenses, nor will you need to maintain a wardrobe of expensive clothing to wear to your job. Also, you will no longer be paying out each month toward your retirement plan. However, these days, new retirees are healthier than they’ve ever been, and can look forward to longer lives than their forebears. Many people find they actually spend more in retirement, at least in the first years. Retirees take long trips to exotic destinations; they pursue expensive hobbies they never had time for when they were working. This kind of active lifestyle will require careful planning.

A traditional source of retirement income that most American retirees enjoy is Social Security; all qualified workers (those who have worked at least 40 "quarters," or 10 years, during their working lives) can apply for social security payments at retirement. Benefits are calculated based on a formula that takes into account the number of years worked, salary level, year of retirement, and other factors; however, the maximum monthly payment for a 66-year-old who retires in 2011 is $2,366, which is hardly replacement income for a retiree who used to draw a six-figure salary.

Many workplaces still offer traditional "defined benefit" retirement plans — employees pay into the plan throughout their working lives, and, on retirement, they receive monthly benefit payments from their former employer, calculated through a formula that takes into account various factors such as length of time worked, age at retirement, salary earned, and other variables. Most public-sector employees, and many union workers and employees at large companies, can look forward to such a steady income stream from their defined benefit plan in their retirement. However, your pension checks will only be a percentage of what you were receiving when you were working, and it may not be enough, especially if you plan on an active retirement.

These days, most employers have changed the kind of retirement plan they offer their employees, from a traditional defined benefit plan to a defined contribution plan, the most popular of which is the 401(k). With these plans, employees can elect to make contributions to their own personal retirement funds, and employees are likewise responsible for investing the money in their retirement funds. The size of the eventual nest egg then depends on how the employee invests his or her funds, and on how the markets fare over the years. This not only lays all the investment risk with the employee, rather than the employer, but it also necessitates more decisionmaking at retirement. Usually, a 401(k) is handed over to an employee as a lump sum, which the employee can then roll over into an Individual Retirement Account (IRA), or some other investment vehicle. If the retiree needs to draw immediate income from this lump sum, he or she will need to find the best way to do that.

In deciding what to do with your nest egg, it is best to diversify as much as possible. If you are looking forward to an active retirement that will require your money to last, you should stay partially invested in the markets, including in stocks, so you have a continuing opportunity for growth. You may have more time to study the equity markets yourself in your retirement, enabling you to make conservative stock picks. Stocks that pay healthy dividends (usually long-standing companies) are usually good picks, as are diversified, low-fee mutual funds from fund companies such as Vanguard and T. Rowe Price. Don’t risk too much money on wild hunches — read the financial press, stay informed, and make wise choices.

You might take some of your nest egg and purchase an immediate annuity. There are many varieties of annuities, many of which entail high fees, but an immediate, fixed annuity is a relatively simple transaction: for a lump sum of money, you will receive a monthly check for life. This provides an income stream and some measure of security, but you will be committing a portion of your nest egg and will lose liquidity. And since immediate annuity payments are calculated based on current interest rates, it may pay to wait — at least as of February 2011, with interest rates at extremely low levels.

A more flexible way to generate income from your nest egg is to purchase bonds. If you purchase a ten-year bond, for instance, at 4.5 percent interest, you will receive payments at designated times during the year representing the interest due, and, when the bond matures in ten years, you will receive the full principal. Bonds are issued by the U.S. Treasury and other government agencies; by states and municipalities; by corporations; and by banks, pooling together mortgages. You should research a bond purchase thoroughly and seek advice from a professional as necessary, but a portfolio of bonds issued by different types of organizations might be a good way to diversify your investments and provide a regular income stream.

If your nest egg is not sufficient to provide a comfortable retirement income, you might look at your other assets, such as your house. A reverse mortgage is a loan, available to seniors over 62 years of age, in which the homeowner can "borrow" the home equity built up in his or her house as a lump sum payment, or in multiple payments — again, offering an income stream. The loan does not need to be repaid until the house is sold, the owner moves out permanently, or the owner dies. While a reverse mortgage can provide needed income to a retiree who is house-rich but cash-poor, because built-up equity is being spent for the duration of the loan, there may be little if any equity left to pass on to heirs.

There are countless options for how to generate income from your nest egg; research your decision thoroughly, and seek the advice of a professional financial planner if you are unsure.

 

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