Retirement Income Blog

Many retirees lack control over 50% or more of their retirement income.  For example, if a retiree has income of $50,000 annually, and $30,000 comes from social security and employer pension, the retiree controls less than half of his retirement income making those sources somewhat useless to discuss.  So let’s focus on the sources of retirement income you can control and how to boost them.

Interest Income
An important source of retirement income is Interest income.  Interest income comes from money you loan.  You may loan it to a bank (in the form of savings accounts or term deposits), you can loan it to a company in the form of owning a bond, you can loan it to a local government in the form of owning a municipal bond and you can loan it to a national government, US or otherwise.  In all cases, these sources of retirement income you control because you select the instruments to own.  Generally, the longer term instruments will pay you higher interest income.  For example, if you want to loan your money to the bank for 12 months, don’t be upset to earn only 4%.  If however you loan you money to IBM for ten years, you may earn 6%–a whopping 50% more in your retirement income.

Of course you may come up with all types of reasons  not to lend to IBM–its not as safe as the bank, ten years is too long, etc. but all of these excuses add up to a much smaller paycheck for you.

Dividend Income
Dividend income from stocks and mutual funds can be an important and significant source of retirement income. If you own mutual funds, there are funds oriented toward paying a consistent dividend income and those that do not.  Are you in the right funds?  Similarly, there are value stocks that pay dividends in the 5% neighborhood while many growth stocks pay no dividends at all.  By your selection of stocks and funds, you control this important source of retirement income.

Annuitization
Although many retirees don’t often think of their retirement income in the following way, they should.  Your assets are always a source of retirement income and how much of your assets you “annuitize,” i.e. convert to an income stream, is a personal decision that can be the difference between eating filet mignon or dog food.  The simplest way to create this source of retirement income is to buy a life annuity from an insurance company.  For example, a 70 year old male purchasing a life annuity for $10,000 can expect payments of $8,500 annually for life.  Of course, when he dies, the $100,000 is gone.  BY purchasing the life annuity, he has converted capital to a source of lifetime income. The immediate annuity calculators will give you an idea of how much retirement income you can obtain in this manner.

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Annuities are term deposits with insurance companies.  They are similar to certificates of deposits at the bank (note: bank deposits are FDIC insured while annuities are guaranteed by the issuing insurance company).  There are two types of annuities: fixed annuities and variable annuities. Fixed annuities have these features:

  Your principal is guaranteed, it will never decline
  The insurance company adds interest to your deposit each year
 The annuity is for a specific term that you select—generally, the longer the term, the higher the interest
  All interest is tax deferred (you do not report it on your tax return) until withdrawn
  You may withdraw 10% of your balance annually
 If you withdraw more than 10% during the term, you will pay withdrawal penalties (called surrender charges)

Most fixed annuities offer an initial one-year rate with the rate changing each year.  A few companies offer a locked-in rate for the entire period.  We recommend that investors always get a locked-in rate.  Fixed annuities are the safest, most conservative choice.  In this short description of how fixed annuities work, we have not covered the many permutations–each annuity company’s contract is different so read it thoroughly. The annuity calculator will give you an idea of the amount you can accumulate.

Next, let’s consider how variable annuities work. With variable annuities, rather than receiving interest from the annuity company, your money is invested into stock or bond accounts (these are investment accounts like mutual funds).  You may earn more or you could lose principal, depending on the accounts you select and if the stock and bond markets rise or fall.  Variable annuities are the riskiest choice.

Maybe the best choice is an index annuity as it is a “hybrid” of a fixed annuity and variable annuity. With an index annuity, your principal is guaranteed like the fixed annuity, but your interest each year is based on increases in the S&P 500 index (this is an index based on 500 large stocks, such as IBM, General Motors, Intel, etc).  So, your interest you earn is tied to performance in the stock market but you can never lose principal (unless you withdraw your principal prior to the end of the term and pay surrender charges).  You get the guarantee of a fixed annuity with the potential profit of a variable annuity.

Everything discussed about how annuities work up until this point describes the growth phase (called the accumulation phase) of the annuity.  When and how do you get your money out? Here’s how annuities work regarding the accumulation phase and you generally have three options:

  You can leave the annuity alone and continue to let it grow
 You can exchange the annuity to another company that may pay you a higher rate
  You can start to make withdrawals

 The withdrawal phase is called the distribution phase.  You have three options:

  You may withdraw all of your money at once
  You can withdraw some money each year based on your desires
  You can annuitize the policy

Annuitizing means that you accept fixed monthly payments from the annuity company.  The payments can span your lifetime or be limited to a specified period (e.g. 10 years).  At the end of the period you select, the annuity is completely paid out.  If you select a lifetime payout, the payments will continue for as long as you live.

As you might imagine, the monthly payments are usually more for a fixed 10-year payout than if you select a lifetime payout (the option which pays the most depends on your age).

Annuitizing may or may not be a good deal and depends on your circumstances.  

If you are single and need to maximize your monthly income, the lifetime payments may be a very good deal.  On the other hand, if you want to leave money to your heirs, annuitizing would not be good because there will be nothing left at the end of the annuitization period.  

What is an immediate annuity?

An immediate annuity has no accumulation phase.  You make a deposit with the insurance company and immediately begin receiving payments.  These annuities are generally suited for senior investors (age 70 plus) who desire to increase their monthly income.  You can see how much you get using the immediate annuity calculator.

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