How to Counter Retirement Income Challenges

Understand How to Turn Your Savings Into Retirement Income

Jose Luis Pelaez Inc./Creative RF/Getty Images. Retirement income alternatives exist if you know where to look.

If you are concerned about how to turn your retirement savings into income when you retire you are in good company. According to the Center for Retirement Research at Boston College, just over half of all households in America are at risk of not being able to replace their current lifestyle expenses during retirement. The good news is that retirement confidence has improved gradually since the Great Recession.

On the surface, planning for retirement or “financial independence” revolves around the challenge to be able to withdraw enough money to live on without taking out so much that your retirement savings expire before you do. The “4 percent rule” is a common rule used by many financial planners to help guide withdrawal strategies. This rule is based on studies that indicated you could have historically withdrawn about 4 percent of the initial value of a retirement portfolio made up of 50 percent stocks and 50 percent bonds and safely increased those withdrawals with inflation each year for 30 years.

The problem with this general guideline is that current “sustainable withdrawal rates” may be significantly lower due to a variety of factors including the low interest rate environment. Researchers such as have recently brought attention to the inherent risks of the “4 percent rule”. The current retirement income reality that many pre-retirees now face is closer to a 3 percent safe or sustainable withdrawal rate throughout their retirement.

, a fellow with the Society of Actuaries, has advocated for a similar change to the traditional “4 percent rule” that he referred to as the “feel-free” spending rule. This simple adaptation takes a retirees age and divides it by 20 to obtain a general guideline for how much of savings can be spent during a given year.

For example, a 70-year-old could plan on spending 3.5% of savings (70/20 = 3.5).

Whether you are in the accumulation phase of your retirement planning journey or in the late stages of your career, there are some strategies to help enhance the likelihood of success for your retirement income plan. Here are the pros and cons of these options:

Work Longer, Save More and Pay Off Debt

Pros: Working longer can help increase lifetime income from Social Security and pension benefits. It also allows your savings and investments to grow while reducing the number of years you will need to draw down these assets to meet your income needs. For example, if you have accumulated $300k in retirement assets the 4 percent withdrawal guideline would result in $12k income per year. However, using this same scenario the act of delaying retirement 5 years and maxing out 401(k) contributions at $24k per year would provide over $177k in additional retirement investments assuming a 3 percent real annualized return. This would generate over $19k in annual income using the 4 percent rule. Using the revised 3 percent withdrawal rate the extra savings would help deliver around $14k of income.

A few additional years in the workforce can also provide more time to help pay off a mortgage, student loans, or credit cards prior to retirement.

In addition to having more time to accumulate additional retirement assets, the ability to reduce future debt expenses can be a difference maker.

Cons: The biggest downside of this plan is the possibility that your job may no longer be there (or you may not be willing or able to continue working). While a growing number of employees plan to work beyond the age of 65, the median retirement age remains at 62. Working later is not an option you should count on. If you set initial plans for a retirement age on the lower end of the range of potential options a few extra years can help provide you with a margin of error. Since health and employers don’t always cooperate with our plans the best strategy is to save as much as you can in tax-advantaged accounts (401ks, IRAs, and Roth IRAs) and get into the game as early as possible.

Consider an Income Annuity

Pros: An annuity is a contract between an insurance company and you that is eventually designed to pay you out a steady stream of income for life. But not all annuities are created equal. While fixed and variable annuities get the most attention and are more likely to be sold, income annuities provide a guaranteed income stream from your assets. For example, a quick quote search at  reveals a 65-year old woman in Florida could receive lifetime income of $1,522 per month ($18,264 per year) using the same $300k of assets from the previous example. If your employer’s retirement plan offers an option to purchase an annuity you can compare the payment options and go with the highest payment possible.

Another alternative is to purchase a deferred income annuity, also referred to as a longevity annuity. Deferred income annuities do not start paying out income until a later date. The benefit is that it requires a smaller amount of your retirement savings to receive the same amount of income. Tax laws now allow you to use a portion of your IRA and/or 401(k) to purchase a deferred income annuity. A key advantage is that the deferred income annuity will not be counted when determining your required minimum distributions as long as the annuity starts paying by age 85. The main idea behind the delayed onset is that the annuity protects you from running out of income in case you use all of your retirement savings by that time.

Cons: The purchase of an immediate annuity removes the flexibility of this asset to continue to grow, remain accessible, or be passed along to heirs. This is the reason you should attempt to maintain enough money outside of the annuity to cover any emergency expenses or planned major purchases. Another potential downside is that the purchase of additional riders such as inflation protection will lower your initial payments. Since the income is guaranteed by an insurance company, your ability to collect payments for life depends on the financial stability of the insurance company. For that reason, you will want to review the financial rating of the insurer and diversify the purchase of annuities from different companies to minimize risk.

Take out a Reverse Mortgage

Pros: Many retirees find that a significant percentage of their total net worth is found in their homes. Home equity is a potential asset that could be used to improve your retirement income alternatives. A reverse mortgage differs from traditional mortgage products in that there are no monthly payments required. As a result, you can essentially turn a portion of your home into a lump sum payment or annuity. Following the aftermath of the housing crisis new reforms to reverse mortgage products have made reverse mortgages more appealing.

Cons: The biggest downside to using a reverse mortgage as a retirement income alternative is that you need to be a homeowner with sufficient equity in your home. Another con is that the reverse mortgage has to be repaid at the time of the owner’s death or if you move. This presents an obstacle if you plan to transfer your home to loved ones. While life insurance can help alleviate this concern another way to keep a home in the family is to have heirs qualify for a traditional mortgage. However, it may prove challenging for some family members to even qualify for a mortgage. This may not be a concern if you do not plan on keeping the home in the family. But the potential downsides are why many people often view reverse mortgages as a last resort. When it comes to improving retirement outcomes they can provide much needed flexibility and help you reduce the risk of taking money out of retirement accounts if you leave work during a market downturn.