How Do I Use My Savings To Create Income?

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
  • Bonds
  • Dividend Paying Stocks
  • Systematic Withdrawals

Listen now: How Do I Use My Savings to Create Income?

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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.

Advantages

Eliminates market value risk

This eliminates any market value risk. There are no worries about the stock market going up or down.

Better payouts

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.

Disadvantages

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.

Fixed Income

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.

No Legacy

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

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.

Systematic Withdrawals

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.

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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.

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Financial Planning

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.

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Do You Need $8 Million to Retire?

Do You Need $8 Million To Retire?

Do you really need $8 million to retire? This is one of those articles that makes you scratch your head and say, “Where is this coming from?”

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Do You Need $8 Million to Retire

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Do You Need $8 Million to Retire?

Transcript: Do You Need $8 Million to Retire?

The article appeared last week on marketwatch.com. It was titled,  The New Savings Target for a Modest Retirement: $8 million? The article is based on a blog post written by someone who calls himself the Financial Samurai. The Samurai believes that the 4% Rule is dead. The actual safe withdrawal rate is 0.5%. Let’s dig into this.

Using the 4% Rule

The 4% Rule is something that a lot of financial advisors use. It starts the conversation about how much income you can generate from your retirement savings. You can use the rule to set a savings goal, or you can use it to determine how much income your savings will provide.

If you’re trying to set a savings goal, determine how much income you’ll need from your savings. If you need $40,000 from your nest egg, multiply $40,000 by 25. Your target is $1,000,000. (4% of $1,000,000 is $40,000 a year.)

Do You Need $8 Million to Retire?

Perhaps you’re getting close to retirement. You’re wondering how much income you can expect to get from your 401k. You’ve saved $500,000 in your 401k. Multiply that by 4% and you get $20,000 for the first year.

$8 million to retire

If you use 0.5% to compute your savings goal, it changes the math significantly. Instead of needing a million dollars to create $40,000 of income, you’ll need $8,000,000!

More on the 4% Rule

This video and blog post goes into greater detail about the 4% rule. 

Is This Realistic?

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Your $500,000 401k with a 0.5% withdrawal rate creates $2,500 of annual income. That’s a little over $200 per month.

Do You Need $8 Million to retire?

Is This Realistic?

Is this half percent safe withdrawal rate, the “new normal”? We disagree. We believe the 4% Rule is a valid tool to use to start the income conversation.

Academic minds developed the 4% Rule by studying past return data for stocks and bonds. The researchers were looking for a withdrawal rate with a very high level of success. We define success as not running out of money during your lifetime.

They tested it through all types of extreme market events. This includes bear markets like the “dot com” bust, the Great Recession, and the early 1970s. The 4% Rule held up in all those circumstances. It doesn’t mean it will hold up going forward. It’s not guaranteed.

Higher Withdrawal Rates Increase Risk

We know this. As you increase your withdrawal rate, you increase the chances of running out of money. You increase the odds of significant spending cuts because of adverse market conditions. The 4% Rule is not a silver bullet. We don’t know what future returns will be. But the 4% Rule remains a good starting point. The pandemic, an over-valued stock market, or low bond yields don’t change our opinion.

You don’t need $8 million to enjoy a modest retirement. People can retire and live a happy life on far less. They figure out ways to make it work.

The 4% Rule is a baseline. We work from there based on each individual’s circumstances to create a plan.

Do You Need $8 Million To Retire?
Do you Need $8 Million to Retire
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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.

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Maintaining Spending Levels in Retirement

Maintaining Spending Levels in Retirement

Maintaining spending levels in retirement can be a challenge.  A recent study showed that nearly half of retirees were forced to reduce their spending because they didn’t have adequate resources. What are some of the characteristics of those who were forced to cut their spending?  We’ll explore that so you can make better decisions about your retirement.

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Show Outline

  • Intro
  • Consumer Financial Protection Bureau Study
    • Looked at the ability of retirees to maintain their spending level 5 years into retirement.
    • Most retirees see their spending decrease naturally.
      • Spend less on things like transportation and clothing
      • Do fewer things as you get older
      • On average, spending in retirement decreases by 19%
  • The Data
  • What can you do?
  • Outro

Spending in Retirement Decreases...

In general, people tend to spend less in retirement.  Many people find they spend less on transportation, clothing, and entertainment.  Those who had adequate savings saw their spending level decrease by 19%.  But, those who couldn’t maintain their spending level saw their spending drop by 28%.

The Factors in Maintaining Your Spending Level

Marital Status

Married couples are better able to maintain their spending level.  Receiving two Social Security payments is a significant factor.

Age

Older retirees had more success than the younger generations.  More older retirees received company pension benefits than Baby Boomers. 

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Social Security

Starting Social Security at younger ages means you receive a smaller benefit.  Delaying your retirement improves your benefit, spousal benefits, and survivor benefits.  This means you rely less on your savings.

Home Ownership

Home ownership factored into retirees ability to maintain their spending level.  Renters struggled compared to those who own their homes. 

Mortgage debt also played a role.  Those without a mortgage had more success maintaining their spending level in retirement.

Debt

Non-mortgage debt includes things like credit cards, car loans and leases, or other types of loans.

Those who carried debt into retirement struggled more than those who were debt free.

What Can You Do to Plan for A Better Retirement?

1. Consider delaying your retirement

Delaying your retirement can improve your Social Security benefits.  It can give you an opportunity to save more and benefit from compounded returns.  And it can help you eliminate debt.

2. Create a plan to be debt free

The data shows people who have debt struggle more.  Many times, loan payments are your larger expenses.  Eliminating those before you retire can reduce the stress on your retirement budget.

3. Save more aggressively

This doesn’t mean use more aggressive investments (though that can help).  It means make saving a higher priority, and try to save more.  

maintaining spending levels in retirement
maintaining spending levels in retirement
maintaining spending levels in retirement

 

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3 Ideas to Plan For Lower Returns

3 Ideas to Help Plan for Lower Returns

What we earn on our nest egg is a key component to our future plans. Over the past month, we talked about the potential impact of both lower bond and stock returns. What can you do to prepare for this? Today we’ll share 3 ideas to help you plan for lower future investment returns.

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3 ideas to help plan for lower returns

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3 ideas to plan for lower returns

Check out the other episodes from this month...

All month long, we’ve talked about the possibility of lower future returns for both stocks and bonds.  

What happens if future returns are less than historical averages? Bond yields indicate the future results from those investments could be well below their averages. And many “experts” believe future stock returns could also be less. This combination creates some significant challenges as you head into retirement.

Here are 3 things you can do to plan for lower future returns.

1. Delay Your Retirement

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Delaying your retirement improves your Social Security and pension benefits (if you will receive a pension). This works three different ways.  It shrinks the discounts you face for early retirement.  It increases your primary benefit. Or, with Social Security, you can receive delayed retirement credits. 

Waiting to retire also helps solve a problem with health insurance in retirement.  You are eligible to receive Medicare at age 65.  This means you won’t have to buy an expensive individual health insurance policy. 

Delaying retirement also allows you to reduce debt, save more, and benefit from compounded returns.

2. Monitor Your Spending

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In my experience, the primary reason people run out of money in retirement is overspending. The more you withdraw from your nest egg, the higher the chance you deplete your savings. Take a good look at your retirement budget. Try to find expenses or costs you can eliminate.

3 ideas to help plan for lower returns

3. Own More Stocks

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Investing involves a trade off. Trying to earn more can mean the short-term shocks are more severe. But, it may be necessary to consider an allocation that provides more opportunities for long-term growth. This may be hard to do, considering we haven’t completely recovered from a pretty steep drop. But in the long-run, the risks could be worth it, even if it is for a short period of time.

Be Flexible

It is important to be flexible.  The plans you created may need to be adjusted as the world around us changes.  None of us know what future returns will be.  But we need to consider what happens if future returns are lower.  Making good decisions now can help improve your chances for longer term success.  And, if things turn out better than expected, everything will be fine.

3 ideas to help plan for lower returns
3 ideas to help plan for lower returns

 

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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.

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Is the 4 Percent Rule Dead?

Is the 4 Percent Rule Dead?

Over the past two weeks, we’ve discussed expected future returns for both stocks and bonds. Several experts feel the future results will be much lower than historical averages. So that makes us wonder, “Is the 4 percent rule dead?”

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Lower expected future returns for both stocks and bonds can affect your retirement. Many “experts” expect stocks to produce below-average returns over the next decade. They forecast somewhere in the neighborhood of 6.5% per year. They also expect lower returns from bonds—somewhere between 1 and 2 % per year.

Lower Future Returns and the 4 Percent Rule

If these lower returns happen, it can create a major challenge for retirees. If these predictions hold, a well-balanced portfolio would earn somewhere between 4% and 5% per year.

Is the 4 percent rule dead

For the past 20 years or so, we’ve been big believers in the 4% rule for generating retirement income. This rules says you can take 4% of your retirement savings as income. So if you have a $500,000 nest egg, that translates to $20,000 per year or $1,666 per month.

Why Do We Believe in The 4 Percent Rule?

We use this guideline because it reduces the risk of running out of money during your lifetime. This has been back-tested during some of the biggest bear markets, and it has a high rate of success.

When you use historical return data, you can see why. Historical data shows a 60% stock-40% bond portfolio should grow by about 7% per year. So if you only take 4%, you would expect your account to grow by 3% per year. That’s enough to help your income grow each year to maintain your purchasing power.

What if Returns are Lower?

But what happens if the experts are right? What if those returns are less than average? Does the 4% rule still work?

In theory, if you earn at least 4% per year, you can take that much income and still maintain your principal. But there are a couple of things that come to mind. First, your odds of success will decrease a little. And, your ability to grow your principal to grow your income is also limited.

The second thing: what if you need to take more than 4% from your savings?  A lower return environment going forward means you will increase the risk of running out of money during your lifetime.

Balancing Risk and Reward

Financial planners always talk about balancing risks and rewards. And the amount of income you take from your retirement savings is a perfect example. The 4% rule is simply a guideline to help you think about that risk. And even with lower returns expected in the future, it still has merit.

No matter what future returns are, one thing remains true. The higher your withdrawal rate, the more you risk running out of money. If you are unsure of how this impacts you, talk to a financial planner.

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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.

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How Lower Interest Rates Affect Your Retirement

How Lower Interest Rates Affect Your Retirement

Lower interest rates create some obvious problems for retirees. Things like savings accounts and CD’s just aren’t earning much. But there is a longer-term problem with these low yields. Today, I’ll discuss how lower interest rates affect your retirement.

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how Lower interest rates affect your retirement

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How Lower Interest Rates Affect your Retirement

For many, bonds are a significant part of your retirement nest egg. And, in my mind, there are three reasons to use them.

Reason 1: Less Volatility

Bonds reduce volatility. Think about what happened in March. The stock market fell over 30%. If you were 100% invested in equities, your account went down a lot! If you had 40% in bonds, the drop was much smaller.

Reason 2: A Place to Invest Your Future Income

Bonds give you a source of funds to generate your income. Selling stocks when they are down 35% to get your monthly check isn’t ideal. Putting your future income in bonds solves this problem.

Reason 3: A Way to Rebalance

Bonds give you a source of funds to buy stocks at better prices. Let’s say we get another big drop in the stock market in the next few months. I’m not saying we will, but if we do, you have a source of funds to buy stocks at those lower prices.

How Lower Interest Rates Affect Retirement
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Lower Risk, Less Return

Owning bonds will reduce your future long-term returns. They just don’t generate the results stocks do. For example, the Vanguard Total Stock Market Index fund has averaged just over 9% per year over the past 15 years.  The Vanguard Total Bond Market Index fund has averaged 4.3% over the same time frame.  Adding more bonds reduces the impact of a bear market.  But it also reduces your future returns.

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Low Yields Translate to Lower Future Returns

Last week, we talked about lower expected returns for stocks and how that impacts your retirement.   The current low yield environment also means we should expect lower future returns for bonds too.

In fact, Vanguard recently said we should expect bonds to generate returns of about 1-2% per year over the next decade. 

So if we expect stock market returns of 6.5% and bond returns of 2% here’s what happens.

This is a real challenge when you need your savings to create income and grow to keep pace with inflation.

Lower interest rates and yields could have a major impact on your retirement plans.  It’s worth having a conversation with a financial planner to see how it could affect you.

What do you think?  Add your comments below!

Lower Interest Rates Affect Retirement

 

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Financial Planning

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.

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How Does Your Age Affect Your Retirement?

Last week we asked the question, “Will your retirement savings last 23 years?”  Today we ask, how does your age affect your retirement?

Video: How Does Your Age Affect Your Retirement?

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How Does Your Age Affect Social Security?

We are eligible to begin Social Security retirement benefits at age 62. But if we retire before our normal retirement age, our benefits get discounted. The discount can be as much as 30%.
 
Delaying Social Security beyond normal retirement age means larger benfeits. Each year we delay, our benefits increase by 8%.
 
The income you need from savings depends on how much Social Security you receive. If you get less from Social Security, you need more investment income. When your investment income gets too high, you increase the risk of running out of money.
How Does Your Age affect Your Retirement

A Case Study: John and Patty

John and Patty are both 60 years old. They have accumulated $330,000 in their retirement accounts. Between contributions and earnings, their accounts should grow by $15,000 each year.

At normal retirement age, John will receive $2,000 per month in Social Security benefits. Patty will receive $1,500.

Remember, every year everything you buy costs more.  So John and Patty will need more income later in retirement.  

Let’s see how the age they choose to retire impacts the financial parts of their retirement.

how does your age affect your retirement

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Age 62 WD Rate
A 6.5% Withdrawal rate is high. It increases the risk of running out of money.
 
What happens if they wait?
Age 65

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Age 67 WD Rate

Better, But Still Not Ideal

Waiting an additional 3 years does two things.  It reduces the Social Security discount.  And, it gives them a chance to save more.

As a result, they need less income from their savings. And because they have more in savings, the withdrawal rate is better.  But it still isn’t ideal.

Age 67

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Age 67 WD Rate

That's Much Better

Now both John and Patty receive their full Social Security benefit.  And the additional years of compounding also help.  Now the withdrawal rate is 4%, which has a higher probability of success.

For good measure, let’s look at what happens if they wait until age 70.

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Age 70 WD Rate

How Does Your Age Affect Your Retirement?

Time can be your greatest asset. And this is especially true if you aren’t as prepared for retirement as you hoped to be.

Early retirement discounts in Social Security benefits work against you. It places more responsibility on your nest egg for your income needs. And we believe the biggest threat to your retirement savings is your withdrawal rate.  

If you are able, working a few extra years should improve your retirement picture.  Those early retirement discounts disappear.  And the extra time you have to save won’t hurt either.

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