How to Create a Reliable Retirement Paycheck: Three Strategies to Consider

If you’ve been working hard all your life, managing a paycheck is probably second nature to you. You know when it’s coming, how to budget, and how to save a bit for the future. But then comes retirement, and suddenly, the steady paycheck stops. Yikes! That’s where I come in—I help people transition from earning to creating their own paychecks in retirement.

Today, let’s break down three common strategies for making sure you have a reliable income stream during your golden years. I'll cover the pros and cons of each so you can decide what might work best for you.

1. Dividend and Bond Investing

First up is dividend investing and bonds. These are like cousins in the world of retirement income, so while they are certainly different we'll compare the two together today. Here's the gist: both rely on income generated from investments. With dividends, you’re earning money from stock profits; with bonds, you’re getting interest from loans you’ve given to companies or the governments or issuers of the bonds you have purchased.

Pros:

- Steady Income: Both dividends and bond interest can provide a regular stream of income, similar to what you’d get from a paycheck.

- **Principal Protection: Ideally, you’re not touching the principal amount; you’re living off the income it generates. While the principal amount of both stocks and bonds are subject to fluctuation, if you are only living off of the income generated from the investments this can help preserve your portfolio value in the long term.

Cons:

- Limited Growth: Higher income usually means lower potential for price appreciation in dividend paying stocks. For instance, companies that pay high dividends might not be investing as much in growth, which can limit how much the stock price goes up over time. Think of a utility company as an example, steady regular dividend payments but not much share price appreciation over time. Bonds are even less likely to grow in value because you’re essentially a lender, not an owner. So with an individual bond, if held to maturity you are likely looking at a return of your principal to reinvest elsewhere but not any actual appreciation in value.

- Inflation Risk: If your investments aren’t growing, inflation can erode your purchasing power over time. For example, if you’re living off a fixed rate bond or a high-yield CD, the real value of your money might decline as inflation rises. This can essentially decrease the true value of your portfolio at a historic rate of 2-3% per year, which over a 30 year retirement can have a meaningful impact on the value of your investments.

The Bottom Line: While this strategy offers stability, it’s crucial to balance it with other approaches to protect against inflation and ensure long-term growth.

2. The 4% Rule

Next, let’s talk about the 4% rule. This is a popular strategy where you withdraw 4% of your retirement savings each year. The idea is that, if you take a 4% distribution from the portfolio in year one of retirement, and adjust that distribution up each year to match inflation with a moderate risk investment portfolio, the portfolio will not run out of money around 96% of the time over a 30 year historic period.

Pros:

- Inflation Adjusted: You adjust your withdrawals each year to keep up with inflation, which helps maintain your purchasing power and therefore your standard of living.

- Proven Math: Historically, the 4% rule has been successful about 96% of the time, meaning you should end up with money even after 30 years, sometimes even more money than you started with.

Cons:

- Lacks Flexibility: It doesn’t adapt well to changing spending needs. Your spending might be higher early in retirement for travel and leisure, lower in the middle, and then spike again for healthcare later on. This is something called the retirement spending smile, and it aligns much more closely with how retirees tend to spend than a static amount each and every year.

- Potential Underspending: Sometimes, this rule might result in you leaving money on the table. If you’re still alive at the end of the 30 years, you might have more money left than you needed, which means you might have underutilized your assets.

The Bottom Line: The 4% rule is a good starting point to gauge if you’re on track. However, it’s not a one-size-fits-all solution and doesn’t replace the need for a comprehensive income plan.

3. Guaranteed Retirement Income

Finally, let’s talk about guaranteed retirement income. This is where you use a part of your portfolio to buy an annuity. An annuity is like creating your own private pension—it provides guaranteed monthly payments for you and your spouse for as long as you live. This is not without it's own risk, but it tends to align most closely with the idea of creating a true retirement paycheck.

Pros:

- Predictable Income: An annuity provides a reliable paycheck, typically a distribution that comes in each month for a fixed amount. Additionally annuities like this tend to provide lifetime income, meaning the check will continue for as long as you live. While each annuity is different you can certainly structure your payments to last for your life, or for that of you and your spouse.

- Longevity Protection: You won’t outlive your income, which is a huge plus for financial peace of mind. You don't need to worry about the paycheck stopping as long as your insurer remains solvent.

Cons:

- Potentially High Fees: Not all annuities are created equal. Some have high fees and terms that aren’t favorable. It is absolutely vital that you understand the terms of your particular contract, as well as being comfortable with the insurance company offering the annuity and their financial stability, as they are the ones making the guarantee.

- Less Flexibility: Once you buy an annuity, you can’t access that portion of your portfolio easily, sometimes at all beyond the monthly income. It's crucial to ensure that you don’t use up too much of your funds in this way, leaving yourself without liquidity for other needs or emergencies.

The Bottom Line: A guaranteed income stream can offer security and stability, especially if you use it to cover your essential expenses. It’s best used in conjunction with other strategies to maintain flexibility and manage unexpected costs.

Wrapping It Up

Each of these strategies has its strengths and weaknesses. Dividend and bond investing offer steady income but might lack growth. The 4% rule provides a general guideline but lacks flexibility. Guaranteed income via annuities offers security but can come with limitations.

The key is to balance these approaches based on your personal needs, preferences, and financial situation. A well-rounded plan might involve a mix of these strategies to create a retirement income that’s both reliable and flexible.

Got more questions or need help setting up your retirement plan? We'd be happy to help you create your retirement paycheck. Just click here to schedule a time to chat with us!

Until next time, happy planning!