ALBUQUERQUE, N.M. — Most of us have spent our working lives collecting a paycheck. That paycheck disappears with retirement, of course, so your retirement plan should include a strategy for replicating it.
Begin with Social Security.
“Social Security is exactly what we want in the form of a monthly paycheck,” said Don Hurst of Hurst Capital Management. “That’s in place. That’s done. Then we have to think about how we get the rest of the cash we need.”
Assuming you earned enough in your lifetime, you will receive a regular payment from the Social Security Administration, though not nearly as much as you received from an employer.
Contact the Social Security Administration for an estimate of what it will pay you, depending on how old you are when you make your claim. You can apply for Social Security benefits online when you’re ready and have them deposited directly into your checking account.
Though fewer workers receive them today, you may have a conventional pension that will make regular, predictable payments. Your company’s human resources department will be able to provide an estimate of the pension payments you will receive. When you can make your claim will depend on the pension plan’s rules.
Pension plans sometimes offer options that you will have to consider. Some allow you to take a lump-sum payment upon retirement and invest the funds as you wish. Some will continue to make payments to your beneficiary after you die but usually with a trade-off: you are paid less while you’re alive than you’re paid if you decide you don’t want the survivor benefit.
You can start regular withdrawals from your conventional individual retirement account without incurring penalties at age 59½. At the age of 70½, the law requires that you start withdrawing from your IRA. Those withdrawals are taxable as ordinary income.
The amount you withdraw could change every year, since withdrawals depend on your age, your life expectancy and the amount of money you have in your account. Payments from the IRA account are made by the financial institution that holds your IRA.
You can calculate how much your payment will be using any number of online calculators and guides, including one on the IRS website, irs.gov.
You don’t ever have to withdraw funds from a Roth IRA, and since Roths appreciate in value tax free and aren’t taxed when they are withdrawn, some financial advisers suggest you leave your Roth funds alone for as long as possible.
Withdrawals from 401(k) plans are more complicated. As with the IRA, you must start withdrawing when you’re 70½, and the law allows withdrawals without penalty at age 59½. But the mechanics of withdrawal depend on the rules of the plan you have.
You can move the entire amount in the 401(k) plan to an IRA. Some employers require that you leave their plan when you leave the company. Others allow you to continue in the plan.
You’ll need to check with your employer or the plan administrator to determine how much can be withdrawn and how to go about withdrawing funds.
Once those sources are tapped, there are two ways most people can secure regular payments without having to manage their own investment portfolios: by purchasing an annuity or setting up a charitable remainder trust. Both approaches can generate regular income with some safety and reliability.
An annuity is a contract you enter into with an insurance company. You buy the annuity with either a single payment or a series of payments over time. The insurance company promises to pay you either a lump sum or a periodic payment.
There are several kinds of annuities. Some pay a fixed amount and guarantee a minimum rate of interest. Some are in the form of mutual-fund investments, so the payout depends on how much you invest and how well the fund performs.
“Annuities are good in certain circumstances and bad in others,” said William E. Hauenstein of Competitive Edge Wealth Management LLC.
The right annuity can provide a predictable income stream that goes straight to your checking account. Some annuities are indexed to inflation so income keeps increasing.
On the downside, annuities don’t offer many investment options, some restrict the amount of payments that can be made in your lifetime, and they are not particularly liquid, Hauenstein said.
They can be expensive, too, Hurst said.
“They come with a pretty handsome expense up front” in the form of a commission to the insurance broker who sells them, he said.
“Then, on top of that, the annuity is typically invested in a very, very safe way and you get a very low return. Then when your money comes out of the annuity, it’s taxed at ordinary income-tax rates, not (the lower) capital-gains rates.”
A charitable remainder trust agreement allows you to move assets into an irrevocable trust. The trust pays you a stream of income for a specified period of time, then transfers the assets to a charity. In addition to the income, the donor gets a charitable tax deduction.
Trusts are especially helpful if you have a highly appreciated asset to donate, Hauenstein said. If you sell the Apple shares you bought at $10 for $100, you pay a capital gains tax. If you donate the shares to a trust, the charity sells the asset and pays no tax on the capital gain, and you get to deduct the donation of Apple stock at $100 a share, Hauenstein said.
“It’s a wonderful vehicle for someone who is passionate about a charity,” Hurst said.
The downside is that once the assets are in the trust, you can never get them back, Hauenstein said, so you have to be very sure you will never regret your decision to donate.
Most retirees expect to tap their investment accounts to pay living expenses. The conventional rule of thumb is to withdraw 4 percent of your investment portfolio in your first year, then withdraw 4 percent plus some adjustment for inflation in every year thereafter. The idea is that if you stay invested in a well-diversified portfolio, your funds should last for 30 years or more.
Hauenstein said some retirees spend more like 5 to 10 percent of the portfolio.
Charles Schwab & Co., the brokerage firm, argues 4 percent might be too much, given how low interest rates and inflation are these days.
Whatever amount you decide is correct, brokerage firms make the mechanics of withdrawal easy, Hurst said. Just tell your broker that you want a monthly distribution from your investment accounts wired directly into your bank account on a specific date. You can have the broker withhold any tax that is due as well, he said.
The hard part is building a portfolio that you can tap.
Mutual funds pay capital gains and interest and dividend income. While you’re working, you might reinvest those funds into the mutual funds to keep your assets growing. When you’re retired, you can have some of those funds transferred to your bank account.
Hauenstein likes laddered bond portfolios. You buy bonds with different maturities – one-year, two-year, three-year and so on up to 10-year maturities. The interest is transferred to your checking account. As each bond matures, you replace it with another bond.
There are mutual funds that offer bond ladders as well.
Hauenstein and Hurst both like real-estate investment trusts, some of which make monthly distributions.
There are mutual funds and index funds that are designed to generate income, though the income is not guaranteed.
Hurst recommends preferred stocks. Preferred stocks usually have a decent dividend that the company that issues the preferred stock is required to pay before it distributes dividends to owners of common shares.