By: Laura Walton AFC®
One of the major disconnects in personal finance and savings plans is the lack of understanding about how to ultimately turn your “pot” of money into an income stream for yourself at retirement. There is no shortage of why and how to save/invest information out there…but the financial world has done a poor job of explaining how to manage all that savings into an income in retirement years that supplements your Social Security and any other pensions you might have.
I actually believe that this lack of knowledge contributes to less than enthusiastic savings plans. Convincing people to save and invest is a lot more difficult when the ultimate benefit is not that clear. So, let’s try to build some confidence on the eventual income side of your savings plan.
There are three main concepts to understand in this regard. Let’s assume for these three concepts that you have just retired and have accumulated 750k in investments and savings. You also have 2k/month coming from Social Security.
- A diversified stock and bond portfolio like we teach at the TCI Foundation can reasonably be expected to “pay you” 3-5% of the investment value per year. So the 750k can pay you around 22k-37k per year….with the key assumption being that I want to try and maintain my capital. This technique is widely favored by most (non-insurance) professionals as it usually allows for growth of portfolio and therefore a “raise” in income over the years to help with inflation.
- The insurance/annuity solution is used by those who favor a more guaranteed but lower income. For example, some clients might take 500k of their nest egg and buy an income annuity for life that pay them around 15-20k/yr. This is guaranteed for their life. But there is no raise on this income, so there is some risk to inflation. That is where the remaining 250k comes in. The goal there is to leave it invested to allow for some extra income as above in #1.
- Finally, some will choose to take some or all of their 750k and buy rental real estate….residential or commercial. This usually generates a good income of around 8%…around 60k/yr. But, of course, there are trade-offs. There is the always unpredictable maintenance as well as the vacancy risk. It is a rare person who really makes this work well into their 70’s but it can be done and deserves a look.
These are three brief summaries of how most people convert their savings into an income. There is obviously more that goes into it (taxes, income needs and wants, etc.) but this should help you understand that it is reasonable to assume around 3-5% per year is ultimately what you can count on from your long-term retirement assets. So, keep/increase saving and get your income “pot” bigger!