Sources of Income in Retirement
What are the sources of income in retirement?
Let’s develop a semi-comprehensive list and discuss when you might access each.
IRAs and 401k plans represent the largest bucket of savings for most retirees. Unfortunately, this money is a ticking tax bomb and must be addressed early in the planning process. Taking this money in the most tax-efficient form is often the most important part of tax minimization.
Atypical Retirement Accounts
Think about 457 plans here. There are two very different flavors of plans. First, this represents accounts that have forced distributions. Inherited IRAs now fall under this category as the SECURE Act forces a ten-year distribution.
This will not be a major source of income for high-net-worth folks, but planning is important nonetheless. If you are married, you must defer social security for the highest earner to get the maximal COLA adjusted life-long guaranteed longevity insurance check for the surviving spouse.
Think about tax-efficient asset location when planning your asset location.
These are usually fully taxable, which has significant implications.
Rent or Royalty
Or other sources of “passive income.”
Don’t plan on inheritance in your retirement strategy. Sure, death is the only real guarantee in life. But perhaps only insurance companies and mortuaries should depend on death as a business model.
Human capital is an important part of retirement. Many folks enjoy the social interaction you get with part-time work. Even a small amount of income early on can mitigate known retirement risks, let alone positively affect retirement satisfaction.
Reverse Mortgages are for the wealthy, too. Home equity is important to consider and can be an important buffer asset in a pinch.
Product to Consider for Income in Retirement
What products might you consider as part of your strategic retirement income plan?
Remember, products have many different uses. Some generate income now, some later. Others have tax-free distributions or loans. Some mitigate common risks in retirement.
You need to understand the gap you are trying to fill, the need for a product, before considering what product you need. You also need to understand fees and contracts.
Products transfer risk. This is what is important to know. Do you want to handle all the known retirement risks yourself or do some risk pooling?
With Income and Longevity Annuities, you get mortality credits. Those who (unfortunately) die early allow these annuities to pay out more than income you would get from bonds alone.
However, some products “hope” you die early (like annuities), and some “hope” you die late (like life insurance). So an insurance company can hedge its bets by owning various products!
Let’s take a closer look at some of these products as sources of income in retirement.
Annuities are not a bad word. They are useful products, sometimes. However, they are complicated, so take some time to understand your options before buying. See How Annuities Might Work in Your Retirement Withdrawal Strategy.
Single premium immediate annuities are the most useful annuities for income. They provide income after a lump sum payment. They are relatively inexpensive, and you can comparison shop online. Few inflation-adjusted products are available, so these are not for longevity insurance. SPIAs are for income. Although SPIAs may not be great in this low-interest rate environment, consider a SPIA ladder (where you set aside safe money to purchase a SPIA in the future) for future income needs and longevity planning.
Deferred income annuities are also useful but not well known. They can be funded over time or with a lump sum payment, and the income is deferred and turned on later. These are also straightforward with low commissions and provide the best longevity insurance currently on the market, aside from social security. Understand that mortality credits are why SPIAs and DIAs can pay more than bonds or CDs.
Qualified longevity annuity contracts are DIAs in your retirement accounts. I’m going to go out on a limb and say that every wealthy person with a large IRA should consider a QLAC for longevity insurance. That is if you plan on living a long life. You can turn these on as late as 85. Although you can only put $130,000 in a QLAC if your deferral period is long enough, this will be real protection against both inflation and longevity.
Most folks should avoid Variable Annuities. Please don’t shoot the messenger, but they are complicated and expensive. On the other hand, if you are sophisticated or have a lot of time to waste with an annuity salesperson, you can talk about the benefits of withdrawal or income riders. For DIY, there are investment-only variable annuities IOVA, which can be considered.
Fixed Indexed Annuities are also avoided unless you know what you are doing. These products can benefit from the upside of an index but suffer no losses if the market goes down. They are sold without fees, but you lose in the market’s upside with participation rates and caps. If you want to take market risk off the table and use part of your bond allocation (not your equity allocation!) in FIAs with withdrawal riders, have at it. These are for the sophisticated DIY who desires to have a salesman work with them.
Multi-year guaranteed annuities pay a guaranteed rate every year for 3-10 years. These can be used instead of CDs or Bonds when making a ladder. They can be purchased online and can easily be compared to interest rates on CDs or Bonds. If you set aside money for future use, the DIY investor might find some use in a MYGA or two as part of their income ladder or as a Buffer Asset.