Whether you’ve just begun planning for retirement or you’re in retirement, you’re probably thinking about the multitude of ways you can save money. However, turning your cash into a sustainable, consistent source of income is just as important as saving it in the first place.
For most people in the United States, planning for retirement—and generating revenue during those years—means establishing a few guaranteed income sources. Guaranteed income is a great way to put your mind at ease as you plan for the future. It’s exactly what it sounds like: a consistent payout, regardless of market behavior.
Different Sources of Guaranteed Income: Pros and Cons
There are many types of guaranteed income and types of retirement incomes sources, and each has benefits and drawbacks. One of the most common forms is Social Security: guaranteed income backed by the United States government. However, a common misconception is that you are supposed to live off of your Social Security. Actually, Social Security was never intended to be a retiree’s sole source of income. Rather, it was meant to supplement other forms of retirement income, such as defined benefit pensions. So, you’ll likely need other sources of retirement income to live comfortably.
Private sources that contain some guarantees of the principal value include defined benefit pensions, reverse mortgages, bond portfolios, CDs, money markets, and annuities. Out of all these options, defined benefit pensions are an increasing rarity, and as such, many people have to develop plans for retirement income. If your employer offers a pension, it’s recommended by most professionals that you take advantage of it. But even with a pension plan, you may still need additional income sources.
Your Retirement Reality Tip
When planning a retirement budget and considering guaranteed income, remember that, while cash is guaranteed (up to FDIC limits), you income stream from that cash is not guaranteed for any specified period of time (i.e., 10 years or lifetime) because you could stretch out your withdrawals for a long duration or you could take a one-time lump sum distribution.
If you have substantial equity in your home, you can use it to generate income through a reverse mortgage. Reverse mortgages allow seniors to stay in their home while taking the equity out to pay for necessary expenses. Bear in mind, there are fees and an interest rate included in the amount owed, as well as limitations and restrictions including the amount owed being due upon selling or moving out of the home. It’s very important to read the fine print.
Treasury bonds are often considered some of the safest investments because they are backed by the full faith and taxing abilities of the United States government, but even these come with two inherent risks that impact their value: inflation and interest rate fluctuation.
CDs and money market funds are also considered safe because they are usually FDIC insured, meaning the government will reimburse you, up to a set limit, if something were to happen to the financial institution holding your money. However, CDs and money market funds potentially offer lower growth opportunities in today’s relatively low interest rate environment.
Annuities are a contractual agreement with an insurance company, and are a common source of guaranteed income. When you buy an annuity, you exchange an up-front lump sum of money for a guaranteed income payment for a time frame of your choice, whether immediately or at some point in the future. Annuities can even provide an income for the rest of your life.
There are two main categories of annuities: variable and fixed annuities. Variable annuities are investment products with the value of the annuity depending heavily on the performance of the underlying investment. Fixed annuities are insurance products and do not contain direct market risk associated with any investment. The value of a fixed annuity is guaranteed to never be reduced by any external factor such as the volatility of the market.
You may have also heard of a type of fixed annuities called fixed indexed annuities, which earn interest based on changes in an index. The insurance company uses a formula to determine how a change in the index affects the amount of interest to add to your annuity at the end of each index term. This formula means that the interest added to your annuity is based on only a part of a change in the index over a set period of time. If the index goes down over that period, zero interest will be added to your annuity; however, your annuity value won’t go down as long as you don’t withdraw the money. When you buy an indexed annuity, you aren’t investing directly in the market or index. This gives you some distance from the direct impacts of market change.
Annuities, variable and fixed, can offer an important and dependable source of income for life. (For more information about annuities, you can order the “Buyer’s Guide for Deferred Annuities” from the National Association of Insurance Commissioners.)
For many people, adding sources of guaranteed income into their retirement income can be a valuable part of their retirement income strategy. In this new retirement reality, people have to be diligent in planning for retirement income. Whether you have a defined benefit pension plan, are comfortable with Social Security as your main source of income, or believe you may need to implement a strategy for lifetime income from an annuity, planning ahead is the key. As you prepare for retirement, consider what balance you will be comfortable with between guaranteed and non-guaranteed income sources, and take steps to achieve that goal.