Investopedia’s recent article entitled “Four Sources of Income for Your Retirement” says that it's a great vision. However, generating income without going to work can be an unclear notion throughout our working years. Of course, we think we know what we want but aren't 100% confident as to how it will come about. So how precisely will you make your nest egg a steady flow of cash during your retirement years? A great way to start is to develop a concrete strategy based on these income sources.
- Immediate Annuities. Buying an immediate annuity is a great way to convert a lump sum into an ongoing income stream that you can't outlive. Retirees frequently take the money they saved up during their work years and use it to buy an immediate annuity contract. This is due to the fact that the income stream starts right away, is predictable and is not impacted by dropping stock prices or declining interest rates.
- Strategic Systematic Withdrawals. Even if you have millions stashed in your bank account, taking it all out in one gulp and stuffing it under your mattress is not a strategic way to take advantage of or protect your income stream. No matter the size of your nest egg, withdrawing just what you need and allowing the remainder to continue to work for you is a wise strategy. Calculating your cash-flow needs and withdrawing just that amount of money on a regular basis is the framework of a systematic withdrawal strategy. Of course, taking out the same amount of money each week or month can also be thought of as systematic. However, if you don't match your withdrawals to your needs, it’s not strategic.
- Laddered Bonds. These are created through the purchase of multiple bonds that mature at staggered intervals. This gives you consistent returns, low risk of loss and protection from call risk because the staggered maturities get rid of the risk of all the bonds being called at the same time. Bonds generally make interest payments twice a year, so a six-bond portfolio would generate a steady monthly cash flow. As the interest rate paid by the bonds is fixed at the time of purchase, the periodic interest payments are predictable and constant.
When a bond matures, another is bought and the ladder extended. The maturity date of the new purchase happens further in the future than the maturity date of the other bonds in the portfolio. The variety of bonds available in the marketplace gives you a lot of flexibility in creating a bond ladder, since issues of varying credit quality can be used to construct the portfolio.
- Laddered Certificates of Deposit. Creating a certificate of deposit (CD) ladder uses the same technique as building a bond ladder. Multiple CDs with different maturity dates are purchased, with each CD maturing later than its predecessor. For instance, a CD might mature in six months, and another maturing in one year, and the next maturing in 18 months. As each CD matures, you buy a new one—and the ladder is extended. That is because the maturity date of the new purchase is further into the future than the maturity date of the previously purchased CDs.
Remember that having diverse sources of retirement income protects against under-performing investments. This may include a pension, Social Security benefits, an inheritance, real estate, or other income-generating investments. Multiple sources of income—including a portfolio structured to include an immediate annuity, a systematic withdrawal program, a bond ladder, a CD ladder, or a combination of these investments—is a sound way to help safeguard your income, if interest rates fall or one of your investments delivers less-than-expected returns.
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Reference: Investopedia (Jan. 19, 2020) “Four Sources of Income for Your Retirement”