Retirement Income

Longevity risk. This is the danger that you will live longer than you’re financially prepared for, forcing you to cut back spending or take other drastic financial steps, as your savings start to dwindle.

Inflation risk. Over the course of a 20- or 30-year retirement, even modest rates of inflation can severely crimp the lifestyle of retirees who rely on income streams that are fixed in dollar terms, such as the interest payments from bonds, or the income payments from traditional employer pensions and immediate fixed annuities.

Four percent withdrawal rate. Studies suggest that retirees can withdraw 4% of their portfolio’s value in the first year of retirement, and thereafter step up their annual withdrawals with inflation, and still make it through a 30-year retirement without running out of money. Let’s say you retire with a $600,000 portfolio. You would withdraw $24,000 in the first year of retirement. If inflation runs at 3% a year, you would withdraw $24,720 in year two, $25,462 in year three and so on. Any dividends and interest you receive count toward each year’s total withdrawal.

Sequence-of-return risk. Retirees face two potential drains on their nest egg’s value: their own need for spending money and losses caused by market declines. Sequence-of-return risk refers to the danger that retirees suffer large investment losses early in retirement. Those losses—coupled with a retiree’s annual withdrawals—can greatly damage a nest egg’s value, sharply increasing the chance that the retiree may outlive his or her savings. By contrast, if retirees enjoy market gains in the first five years or so of retirement, they will often be in good financial shape for the rest of their lives, even if they later get hit with a large market decline.

Short-term vs. long-term investments. It’s helpful to separate investments into two buckets: those where you’re reasonably assured of not losing money—and those where you could suffer a large short-term decline. Investors with time horizons of five years or less should favor savings accounts, certificates of deposit, money-market funds, high-quality short-term bonds and similar conservative investments. Those with more than five years to invest might take the risk of owning stocks, and also longer-term or lower credit-quality bonds, with the goal of earning higher long-run returns.

Income vs. total return. Interest and dividend payments are one source of investment gain. But with bonds and especially stocks, your investment performance also hinges on what happens to the price of the investments you own. To calculate total return, you combine the investment income you receive with the gain or loss in an investment’s price.

Social Security. To qualify for Social Security retirement benefits, you need to work and pay Social Security payroll taxes for 40 quarters, equal to 10 years. You can claim Social Security as early as age 62 or as late as age 70. By delaying, you can receive a benefit that’s as much as 76% or 77% larger. Social Security benefits rise each year with inflation and are at least partially tax-free. In addition, your spouse and children may be eligible for benefits based on your earnings record.

Full Social Security retirement age. You can claim Social Security retirement benefits as early as age 62 or as late as age 70. Depending on when you apply, your monthly check will be calculated as a reduction or increase relative to the benefit you’re eligible to receive as of your full Social Security retirement age, which is age 66 or 67, depending on the year you were born. Once you reach your full Social Security retirement age, you have the right to suspend your benefit and thereafter earn delayed retirement credits.

Social Security spousal benefits. A husband or wife is eligible to receive a spousal benefit that’s equal to 50% of his or her spouse’s full Social Security retirement age benefit. To receive the full 50%, the husband or wife must be at full Social Security retirement age. If the spouse applies before full retirement age, the benefit is reduced. A husband or wife can’t receive spousal benefits until the other spouse applies for benefits based on his or her lifetime earnings record.

Delayed retirement credits. If you postpone claiming Social Security beyond your full retirement age, your benefit will be increased by 8 percentage points for each year you delay. For instance, postponing benefits from a full Social Security retirement age of 66 until age 70 would result in a 32% increase in your benefit. Keep in mind that spousal benefits are not eligible for delayed retirement credits, so there’s no increase in benefits if you postpone spousal benefits beyond your full retirement age.

File and suspend. This used to be a strategy popular with married couples. At full retirement age, one spouse—typically the main breadwinner—would file for benefits. This allowed his or her spouse to claim spousal benefits. The main breadwinner then immediately suspended benefits until as late as age 70. This resulted in a larger monthly benefit for the main breadwinner, and also potentially a larger survivor benefit for his or her spouse. Unless you suspended benefits by April 2016, this strategy will no longer work. The reason: Under the new rules, if one spouse suspends benefits, the other spouse’s spousal benefit is also stopped.

Immediate vs. tax-deferred annuities. Historically, immediate annuities have been used to generate retirement income, while tax-deferred annuities have been used to save for retirement. In recent years, thanks to “living benefits” riders, a tax-deferred annuity can now be used to generate retirement income. Insurers have also started offering deferred income annuities, sometimes called longevity insurance. These pay regular income starting at some future date.

Reverse mortgage. This is a way for those age 62 and older to tap into their home’s value without selling. The proceeds from a reverse mortgage can be received as monthly income, a lump sum or a line of credit. The reverse mortgage is repaid after the borrowers die or if they move elsewhere. At that juncture, the amount owed can never be greater than the home’s current value.

Next: Houses

Previous: Saving for Retirement

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