How Do I Use My Savings To Create Income?
Tim asks,”How do I use my savings to create income in retirement?”
In this episode, we’ll talk about:
- Immediate Annuities
- Dividend Paying Stocks
- Systematic Withdrawals
Listen now: How Do I Use My Savings to Create Income?
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Do you want to hear the full show?
The full episode is over 25 minutes long. And we’ve found that not everyone wants to spend that much time listening to things. But if you want to listen to the entire episode, it is below.
- What should I do with my old retirement plan?
- Can I use a trust to protect Mom’s assets if she goes to a nursing home?
- Should I use my employer’s new Roth 401k option?
- How do I use my savings to create retirement income?
- Can I make the maximum contribution to both a Roth IRA and the Thrift savings plan?
Transcript: How Do I Use My Savings To Create Income?
1. Immediate Annuity
This is an insurance contract that creates an income stream for the rest of your life. You can add survivor benefits to this so it will be the rest of you and your spouse’s life. It’s guaranteed by the insurance company and their ability to pay.
Eliminates market value risk
This eliminates any market value risk. There are no worries about the stock market going up or down.
You usually will get a higher payout than using the 4% rule. Immediate annuities typically pay out a greater percentage.
Income you can’t outlive
It will pay as long as you or you and your spouse are alive.
Lose control of your principal
You lose all control of your principal. So if you need more income or a lump sum in the future, you likely won’t have access to the principal for those needs.
The payout is typically a fixed amount. There are a few contracts out there that will provide some inflation adjustments. But those contracts will reduce the initial income benefit to account for the annual increase.
When you and your spouse have passed, there is no money to leave to your heirs. If you buy the contract, and two months later something tragic happens, that money is gone. There are a few policies that have refund provisions. But, that provision could reduce your monthly income.
Low Interest Rates
Low interest rates mean smaller payments. When interest rates increase, this will be a more attractive option.
This may be a reasonable choice for part of your savings. I wouldn’t recommend anyone put all their savings in one of these contracts.
What we often find is most people don’t like giving up control of their principal. And we believe there are better ways.
2. Income Producing Investments
You can also use income-producing investments. This means bonds and dividend paying stocks.
Bonds pay an interest payment. Unfortunately, bonds are not a great choice right now. You might be able to find good interest payments on some bonds, but you have to pay a high premium for them. This means when the bond matures, you’ll get less than what you paid to buy the bond. Newer bonds won’t have good interest rate payments. This limits your income stream. Bonds also offer little or no appreciation potential.
Dividend Paying Stocks
Dividend paying stocks make sense. Over time, dividends tend to increase. There is also potential to see your principal grow
Constructing a portfolio that can generate a 3% yield or higher can be a challenge. You want to buy good dividend payers. This means companies that reliably pay their dividend and increase their dividends.
You can do it, but you introduce other variables. There’s risk for concentrating too much in a particular stock. Dividend cuts can create problems. This isn’t a risk-free strategy.
The last thing to consider is most people don’t want to be 100% invested in stocks. So that can limit your income as well.
The third way is to use systematic withdrawals. This is one of the better inventions by the mutual fund industry. Over time, you sell shares of your investments to create income. It’s a very simple process.
You don’t have to use mutual funds to do this either. It can be done with exchange traded funds or individual stocks. You sell shares to produce your income.
You can combine this with a dividend strategy too. If you own a company that doesn’t pay a dividend, you could sell shares to supplement the dividends you get.
Here is something to remember when you’re looking at producing income. Snow or rain, it’s all water. If the “snow” represents dividends and the rain is “capital appreciation”, it all benefits you. It doesn’t matter if your income is from dividends or from selling shares.
3. Managing Taxes
You also want to think about your taxes. If you have many sources of retirement funds, you have that ability. Distributions from Roth IRAs, for example, are tax free. Income from a personal or joint account may be more tax friendly. Distributions from IRAs and pre tax 401k plans are taxed as ordinary income. Most of the time, 100% of those distributions are going to be taxable. When you have separate sources of savings, you can manage your tax liability to some degree.
Unfortunately, for many people, their only asset for retirement income is their 401k. This limits your ability to manage your tax bill.
It can help to talk to an advisor about your situation. They can help you with a strategy that makes sense for you.
About the Author
Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors. He specializes in helping hard working, middle class families plan for retirement.