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Nov. 28, 2020

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Personal Finance: Near retirement? An income strategy to help

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Just before retirement, there’s a huge job to tackle: figuring out how to create a stream of income that will make for an enjoyable retirement, without worries that your money will run out before you do.

That’s no easy task given the good chance that retirement will be a 25- to 30-year stretch, due to increasing longevity for those who reach retirement age.

Hiring a financial planner to help you run the numbers can be money well spent. Not interested in having someone manage your money? No problem. There are plenty of planners who work on an hourly or project basis. (If you aren’t able to tap into referrals, you might check out Garrett Planning Network; all members work on an hourly or project basis and, most important, vow to put client interests first.)

Prefer to go it alone? You might want to consider a fairly “simple” strategy that many planners would tell you makes sense. A trio of wonky retirement researchers affiliated with the Stanford Center on Longevity ran nearly 300 retirement income strategies through various simulations, and landed on a two-step approach that can deliver income and peace of mind for households that have done a solid job saving for retirement (assets up to $1 million) but don’t have so much saved up they are worry free:

Step 1: Cover all your essential monthly living costs from steady, reliable sources that will not be impacted by bear markets or recessions. Guaranteed income includes Social Security and a pension, if you are entitled to one. No matter what’s going on in the stock market or global economy, you get your payment every month.

To give yourself the most guaranteed income, wait until age 70 to start collecting your Social Security benefit. Your benefit will be 76 percent higher than if you start at age 62. Live until your early 80s — not a longevity outlier — and waiting will have netted you more money than an early start. Live past your early 80s, waiting keeps paying off.

That doesn’t necessarily mean you need to work full-bore until 70. Perhaps you work just enough in your 60s to “replace” the Social Security benefit you’re not yet taking. In 2020 the average monthly benefit is around $1,500.

Even if you want or need to stop working, drawing from your savings can still be smarter than starting Social Security.

If you don’t have a pension and Social Security won’t cover basic living costs, consider ways to reduce your expenses. Hint: Downsize the house.

Or consider using a portion of your savings to buy more guaranteed income in the form of an income annuity. To be clear, there are plenty of lousy (read: expensive) types of annuities to be avoided. But a single-premium immediate annuity is a plain vanilla annuity where you create your own pension. You fork over a chunk of money, and an insurer agrees to pay you a set amount each month for the rest of your life. (You can choose shorter payout periods, but for the purposes of this exercise, let’s focus on lifetime security.)

For example, a 70-year-old husband and a 67-year-old wife could lock in about $470 a month in lifetime income (for the spouse who lives longest) with a one-time premium payment of $100,000 at today’s interest rates. You can get an estimate of possible payouts for your personal situation at Immediateannuities.com.

Step 2: Consider investing at least 50 percent of your retirement accounts (401k, IRA) in a low-cost, broad-based stock index fund or exchange-traded fund and follow the math on required minimum distributions (RMDs) to set your annual withdrawal rate. (Your non-stock investments should be high-quality bonds.)

RMD percentages are based on calculations set by the IRS. The percentage increases with age and ranges from about 3.5 percent in your mid-60s to 4.5 percent in your mid-70s.

The idea here is that keeping 50 percent or so of your money in stocks gives you the chance of earning inflation-beating gains that are essential when you need your money to last 25 or 30 years. And because you have your essential living costs paid for with “guaranteed income,” you can (theoretically) stomach more stock-market volatility without losing sleep.

If you use the IRS’ RMD math to set your withdrawal percentage, your money should last you well into your 90s, even if market returns are about half their historic norm. Because you don’t need this income to pay your essential costs, you can treat it as a bonus of sorts to cover nonessential spending, and you have the flexibility to reduce payouts in years where the markets are down.

Using the 2020 RMD formula, someone age 65 would limit portfolio withdrawals to 3.13 percent. Someone age 68 would withdraw no more than 3.42 percent. At age 70 the withdrawal rate is 3.65 percent and at age 75 it is 4.37 percent. You get the idea.

While there are many potential retirement income strategies, the “Spend Safely” advice from the Stanford Center on Longevity provides a smart framework: Having your essential costs covered by guaranteed income should help you sleep more soundly throughout retirement.

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