Buying Annuities in Your 401(k)

Despite the economic challenges presented by the COVID-19 pandemic, the vast majority of workers continued to contribute to their retirement plans in 2021, according to the Investment Company Institute. All told, Americans have more than $11 trillion stashed in plans offered through their jobs.

But even though workers get a lot of advice and encouragement on their journey to retirement, they are often left on the tarmac when they reach their destination. Historically, employers have provided little guidance on what retirees should do with the big pile of money they’ve accumulated over the past 40 or 50 years. 

Now, a growing number of companies are providing workers with a way to turn a slice of their savings into a monthly paycheck in retirement. In addition to the usual choices of mutual funds and other investments, they’re offering workers the option of investing in an annuity that can be converted into guaranteed income after they retire. 

Retirees can already purchase annuities from a variety of insurance companies, of course, but few do, even though many retirement experts believe that annuitizing a portion of your savings reduces the risk that you’ll run out of money in retirement. In large part, that’s because the security that annuities provide comes with some caveats: In exchange for guaranteed payments, you must hand over a large lump sum to an insurance company, and you usually can’t get that money back. In addition, some types of annuities are loaded with fees and restrictions that are often hard to decipher without professional help.

In the past, companies resisted offering annuities in their retirement plans because they feared they would be sued if the insurer went out of business. The 2019 Setting Every Community Up for Retirement Enhancement (SECURE) Act sought to address those concerns by providing employers that offer in-plan annuities a safe harbor from such lawsuits. To avoid liability, employers must still vet annuity providers to ensure that they’ve complied with state laws and have maintained healthy financial reserves. 

Annuity Offerings on the Menu 

Several companies that have added annuities to their lineups are offering them in their target-date funds. Target-date funds, which are owned by more than half of participants in 401(k) plans, provide a set-it-and-forget-it portfolio that gradually shifts to more-conservative assets as you near retirement. 

For example, TIAA-CREF’s Secure Income Account, a deferred fixed annuity, replaces a portion of the fixed-income holdings in a target-date fund and accounts for 40% to 60% of the individual’s assets by the time the 401(k) owner retires, says Philip Maffei, managing director for corporate income products for TIAA-CREF. Upon retiring, the participant would have a choice of annuitizing all of the money in the account, annuitizing just a portion of it or taking a lump sum, Maffei says. 

Fidelity Investments, one of the nation’s largest 401(k) plan managers, is providing its 401(k) clients with a menu of immediate annuities from up to five different insurance companies. The annuities are available to workers age 59½ and older, who will have the option of converting any portion of their savings to an annuity when they retire. Funds that aren’t converted can remain invested in the Fidelity plan. 

Learning From Teachers’ Bad Experience With Annuities

Millions of educators already own annuities in 403(b) plans, the retirement accounts typically offered to public school teachers, and a lot of them would give their results a failing grade. Many school districts have turned the job of offering retirement plans over to sales agents who promote high-cost equity-indexed and variable annuities. Teachers who are unhappy with their investments often discover that moving their money to a lower-cost option will trigger hefty surrender fees.

Proponents of annuities in 401(k) plans say workers are offered plenty of protections from those types of problems. Even with the safe harbor provided by the SECURE Act, companies that offer 401(k) plans are required by law to act in the best interest of their employees, which means they must vet their plan’s investment options, including annuities. 

That kind of vetting could also give annuities offered through retirement plans an edge over annuities purchased on the retail market, providers say. “Having the plan sponsor play the vetting role gives a lot of peace of mind to participants that they’re getting a good-quality annuity product,” says Keri Dogan, senior vice president of retirement income at Fidelity.

A financial planner can help individuals select annuities available on the open market, but not everyone can afford to hire an adviser, says Jeff Cimini, head of strategy and financial management at Voya Financial, which provides retirement, insurance and investment services. Annuities “are complex, and generally speaking, they’re sold, not bought,” he says. 

Employees who buy annuities through their retirement plan may also benefit from institutional pricing, which means they’ll pay lower fees than they’d pay on the retail market, Dogan says. In addition, the SECURE Act mandates that annuities purchased in a 401(k) plan must be portable, which means employees who change jobs or retire can move their annuity to another plan or IRA without paying surrender charges or fees.

The Fine Print: Annuities Can Be Complicated

Although lower costs and portability could make annuities offered through retirement plans more appealing, annuities are still complex products. Fees and other expenses aren’t as transparent as they are for mutual funds and exchange-traded funds. In addition, annuities—including those offered in 401(k) plans—come in a variety of flavors. TIAA-CREF’s Secure Income Account, for example, is a deferred fixed annuity that offers a guaranteed interest rate, which currently ranges from 3.4% to 3.65%, depending on the size of the plan, with the option of converting the balance to guaranteed income after retirement. While Fidelity is currently limiting its offering to immediate annuities, it plans to add a qualified longevity annuity contract (QLAC), an annuity that starts payouts when a participant reaches a specific age, typically 80 or older. (These types of annuities require a smaller outlay of funds than immediate annuities because of the possibility that the owner will die before payments begin.) Some plans are adding variable annuities, which provide some exposure to the stock market before converting to income in retirement. 

If you decide to add an annuity to your portfolio, you’ll also need to decide when (or whether) to annuitize—that is, convert it into a guaranteed income stream, a decision that’s usually irrevocable. Complicating the decision is the current interest rate environment, which could depress the size of your monthly check, depending on when you annuitize an existing investment or purchase one that offers an immediate payout. In the case of immediate annuities, for example, payments are tied to rates for 10-year Treasuries, and while those rates are higher than they were a year ago, “they’re very likely to go higher in the future,” says Harold Evensky, a certified financial planner and chairman of Evensky & Katz/Foldes Financial.

While Evensky believes investing a portion of your savings in an immediate annuity can significantly reduce the risk that you’ll run out of money in retirement, he says most retirees are better off waiting until at least age 70 to buy an annuity because payouts increase as you age. And if interest rates continue to rise, you’ll also benefit from delaying payouts. 

That means leaving your funds in your 401(k) for years after you retire—something many large plans are starting to encourage. Having more assets in their plans gives employers more clout when they negotiate fees and other services with fund managers. 

A Snapshot of the Future? 

Under a provision in the SECURE Act, companies are required to include an illustration in their retirement plan’s quarterly or annual statements that estimates the amount of monthly income your balance would provide if you were to convert the funds to an annuity. While these illustrations could raise awareness about the value of annuitizing retirement income, retirement experts say they’re primarily useful for older workers who have accumulated a significant balance. Without supplemental tools, such as projections of how much additional contributions would add to the balance, younger workers or new plan participants could end up with a “discouraging picture” of the amount of guaranteed income their savings would buy, the Insured Retirement Institute, a trade association, wrote in a comment letter to the Department of Labor. 

Annuity providers are hopeful that the DOL will allow plans to include future contributions, company matches and investment returns in the income estimates. Participants in the Thrift Savings Plan, the federal government’s version of a 401(k) plan, already receive those kinds of projections in their plan statements, says Paul Richman, chief government and political affairs officer for the IRI. ■

Immediate Annuities

Annuity Income Projection

Retirement plan providers will soon be required to provide employees with an estimate of the amount of monthly income their current 401(k) balance would provide if they were to purchase an annuity that provides payouts immediately. The example below assumes the participant and the participant’s spouse (in the case of a joint life annuity) will be 67 on December 31, 2022.

Current account balance: $125,000

Single life annuity: $645 per month

Joint life annuity: $533 per month for participant’s life; $533 per month for spouse following participant’s death

learning the Lingo 

Types of Annuities

Here are some varieties of annuities that may be offered by your 401(k) plan: 

Single-premium immediate annuity. Also known simply as an immediate annuity, you typically give an insurance company a lump sum in exchange for monthly payments for the rest of your life or for a specified period.

Deferred fixed annuity. These annuities offer a guaranteed interest rate over a specific period and can be converted into an income stream in retirement.  

Qualified longevity annuity contract (QLAC). A type of deferred annuity that’s funded with assets from your IRA or 401(k). You can invest up to 25% of your account (or $145,000, whichever is less) in a QLAC, and the funds will be excluded from the calculation to determine required minimum distributions. When you reach a specified age, which can be as late as 85, the funds will be converted into payments guaranteed to last for the rest of your life. The taxable portion of the money you invested will be taxed when you start receiving income.  

Variable annuity. A type of deferred annuity that invests in mutual-fund-like subaccounts to create future income (usually in retirement).


Thinking about Rolling Your 401(k) into an IRA? 7 Deciding Factors to Consider

The Department of Labor has outlined new rules for advisers to follow when rolling over retirement plans. Whether it is a 401(k) to an IRA or an IRA from one custodian to another, there are several considerations that need to be evaluated before making a change. If you are initiating a rollover on your own, it may be beneficial for you to evaluate these items as well.

You should be able to get all the information you need on your plan from your statements, Annual Participant Fee Disclosure and Summary Plan Description. If you do not have access to these documents, you can usually request them from your human resource department.

All-In Fees and Expenses

Before deciding whether to do a rollover, you will want to compare the fees within your 401(k) plan vs. the fees for the IRA. Fees in the 401(k) could include any mutual fund loads, plan expenses and any underlying fees. Sometimes the fees may be higher in your 401(k), but there may be additional benefits to keeping your funds in the 401(k) wrapper.

It would be up to you to decide whether any benefits are worth the fees. For example, if you are opening an IRA and moving over to an investment adviser there will be additional management fees paid to your adviser, but you may also receive financial advice, retirement planning or wealth management services.

Available Services

Some retirement plans, such as 401(k)s, provide added creditor protection, the ability to take out a loan or take hardship withdrawals, which are not available with IRAs. In certain circumstances you may be able to keep some asset protection if 401(k) funds are rolled into a separate IRA and not commingled with other IRA funds. Some 401(k) providers provide investment education to participants that may be valuable if you are a younger investor.  You will also want to look at your vesting schedule and company match to determine whether they may be affected. In addition, some retirement plans offer Roth 401(k) contributions, which may not be available to you otherwise.

Available Investments and/or Products

Several 401(k)s offer participants limited investment options. On one hand, that could be viewed as a positive, because when there are too many choices it can confuse participants and make it harder to manage the plan. However, some plans’ limited options may be  more expensive, such as actively managed funds, and they might not offer any low-cost index options.

If you roll over funds into an IRA you then have access to a much wider universe of investments. That said, this should not be your only decision criteria. Some company retirement plans offer a “BrokerageLink” option, which allows you to move funds from the “core” 401(k) account to a brokerage account –  another way to access more investment options. Some plans have restrictions on what can be invested in a BrokerageLink so you would want to consult the plan document before deciding.

Guaranteed Income/or Interest Rates

Are you invested in anything earning a guaranteed interest rate that you will lose by moving from a 401(k) to an IRA or other plan? For example, TIAA CREF’s 401(k) offering has TIAA Traditional, which could be earning 3%-4% –  a great return in this environment. You may not want to roll out funds into an IRA and lose access to this option.

Tax Considerations

If you are required distribution age but still working past retirement (providing you are not an over 5% owner in the company), you can defer taking money out of your 401(k). Unfortunately, if you have an IRA on the side, that IRA is subject to required distributions at age 72, even if you continue to work. If you leave the funds in the 401(k) you can still contribute and don’t have to take money out.

One caveat related to the Roth part of a 401(k): If you are age 72 and a greater than 5% owner or retired you have to take a distribution from the Roth side. A way to get around this is to roll the Roth 401(k) balance into a Roth IRA prior to age 72.

Also, if you happen to be in a zero-income year and all you have is retirement funds and need cash, it may make sense to take a taxable distribution rather than do a rollover.

Distribution Considerations

If your 401(k) retirement account is invested in an insurance product or annuity you will want to evaluate whether there are any surrender charges. Usually annuities cannot be moved to IRAs in kind. Some annuity products may have certain benefits that will be lost if liquidated, so you will want to make sure you understand how your product works before making a decision.

Some plans may offer annuity options rather than a lump sum, which would be lost if you roll your 401(k) over to an IRA. You will want to look at the financial implications of the lump sum vs. the annuity options to see which option is better for your situation, especially if you have a spouse who can receive survivor benefits.

You will also want to check if there are any in-service distributions options or guaranteed payment options.

Beneficiary Considerations

If you are married, your 401(k) must list your spouse as beneficiary unless your spouse signs a waiver. You can list anyone on an IRA as a beneficiary, so you may want to review your estate planning and beneficiaries if you make any changes.

Senior Financial Adviser, Evensky & Katz/Foldes Financial Wealth Management

Roxanne Alexander is a senior financial adviser with Evensky & Katz/Foldes Financial handling client analysis on investments, insurance, annuities, college planning and developing investment policies. Prior to this, she was a senior vice president at Evensky & Katz working with both individual and institutional clients. She has a bachelor’s in accounting and business management from the University of the West Indies, she received an MBA at the University of Miami in finance and investments.


3 Investment Ideas for Retirees Right Now

Ah, retirement. Picture long, blissful walks on the beach. Or you’re watching the sunset from the balcony of your cruise ship and thinking: This is it – the way life should be. Then you casually check your smartphone to see how your investment accounts are doing and, gasp! You might not be as rich as you thought were.

Retirees are facing major headwinds right now when it comes to investing: Troubles in Ukraine, higher inflation and stock market jitters to name a few. If you are in or near retirement and wondering what you can do with your portfolio, here are three ideas I share with some of my clients:

1. Consumer defensive stocks

I want clients to be as diversified as possible. However, I may tilt their portfolio to consumer defensive stocks for retired or more conservative clients. Defensive stocks generally include utility companies like natural gas and electricity providers, healthcare providers and companies whose products we use day-to-day, like toothpaste companies or food and grocery stores.

According to the Center for Corporate Finance, a leading finance educator to financial professionals, defensive stocks tend to be less volatile than other types of stocks. Less volatility can mean less upside potential, but it can also mean less downside risk, which I find is what many retirees want – less downside (and hopefully better sleep at night).

2. Bonds for retirees – but not just any bonds

I like municipal bonds for retirees. Municipal bonds are issued by states, cities or local municipalities. There are many types of municipal bonds. General Obligation municipal bonds are backed by the taxing authority of the issuer – meaning the state or municipality uses taxes to pay the interest to bondholders. Revenue bonds are municipal bonds backed by a specific project. A toll road uses tolls as the revenue to pay bondholders.

Interest from municipal bonds is usually exempt from federal taxes (though there may be alternative minimum tax (AMT) considerations for certain types of investors). If you live in the state where the bond is issued, the interest may be exempt from state taxes as well.

I like tax-free interest for retirees for several reasons. Retirees may have other sources of taxable income, such as pensions, annuities or rental income, whose income may push them into a higher-than-expected income tax bracket. Retirees may also take money out of 401(k)s and traditional IRAs in retirement for required minimum distributions, which are taxable as ordinary income. Having some tax-free interest may prevent the retiree’s income from creeping up into the next higher tax bracket in retirement.

Findings from the 2019 Municipal Finance Conference suggest there is less risk of default with general obligation bonds than revenue bonds. This is because revenue bonds typically depend on the vitality of a project, which is more uncertain than the state or municipality’s ability to raise taxes to pay for a general obligation bond. For this reason, I may tilt a portfolio more toward general obligation municipal bonds than revenue bonds for retirees.

Municipal bonds are not without risk. There is no guarantee of principal and market value will fluctuate so that an investment, if sold before maturity, may be worth more or less than its original cost. Like any bond, municipal bond prices may be negatively impacted by rising interest rates. Also, municipal bonds may be more sensitive to downturns in the economy – investors may fear a struggling state’s economy may be unable to repay the bond.

For these reasons, I like to be as diversified as possible. I may use short-term muni bonds for more principal stability and less interest rate risk. I might also blend in intermediate-term municipal bonds for additional yield. If the portfolio is larger than $250K I prefer to buy individual municipal bonds for greater customization and tax-loss harvesting opportunities.

3. Beyond stocks and bonds

I like to sprinkle in small amounts of other investments. I call these my “satellites.” Depending on the client’s financial situation and tolerance for risk, I may add in real estate or small amounts of commodities, including coal, gold, corn and natural gas. I generally use mutual funds or exchange-traded funds for the diversification and the relatively low cost. I usually only buy small amounts, maybe 2%-5% of a portfolio, to help diversify the portfolio and provide an inflation hedge.

Inflation is a significant real enemy for retirees. Rising prices erode the purchasing power of a portfolio. One nice thing about owning real estate is the owner often can raise rents, which is a hedge against rising prices. I may buy Real Estate Investment Trusts (REITs) which pool together various properties. I may also use Private REITs, which are not traded on the public market, so they are less liquid, for more sophisticated investors. Private REITs are not suitable for everyone, as they tend to carry higher fees, don’t have published daily prices, but they often provide higher yield than publicly traded REITs.

For more on fighting inflation see my blog post Could Inflation Affect Your Retirement Plans?

Parting thoughts

Investing in retirement is different than investing while working. In retirement, an investor’s time horizon shrinks – they need the money sooner to live off and there’s no paycheck coming in to replenish the account. There is also less time for a retiree’s portfolio to recover from a stock market correction. Because of this, I find retirees fear losses more than they enjoy their gains.

Understanding these differences is important for successful investing in retirement. Using these three approaches – shifting slightly more to consumer defensive stocks, using municipal bonds to help prevent further taxable income, and adding small amounts of inflation-fighting investments like real estate and possibly commodities – in my opinion can all help smooth out the ride for retirees.

The author provides investment and financial planning advice. For more information, or to discuss your investment needs, please click here to schedule a complimentary call.

Disclaimer: Summit Financial is not responsible for hyperlinks and any external referenced information found in this article. Diversification does not ensure a profit or protect against a loss. Investors cannot directly purchase an  index. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors.  

CFP®, Summit Financial, LLC

Michael Aloi is a CERTIFIED FINANCIAL PLANNER™ Practitioner and Accredited Wealth Management Advisor℠ with Summit Financial, LLC.  With 21 years of experience, Michael specializes in working with executives, professionals and retirees. Since he joined Summit Financial, LLC, Michael has built a process that emphasizes the integration of various facets of financial planning. Supported by a team of in-house estate and income tax specialists, Michael offers his clients coordinated solutions to scattered problems.

Investment advisory and financial planning services are offered through Summit Financial LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Links to third-party websites are provided for your convenience and informational purposes only. Summit is not responsible for the information contained on third-party websites. The Summit financial planning design team admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit’s clients. Neither they nor Summit provide tax or legal advice to clients.  Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local taxes.


When You Claim Social Security Can Have Huge Implications for Your Spouse

It’s unfortunate, but many people don’t have a basic understanding of how claiming Social Security benefits early can haunt them — and their loved ones. For example, 45% of U.S. adults mistakenly believe they can file early for reduced Social Security benefits and then have them restored to a higher level once they reach their full retirement age, according to a 2021 Nationwide Retirement Institute® survey. This isn’t true. Claiming Social Security early locks you in for reduced benefits for the rest of your life.

Another common — and potentially costly — mistake can occur when married couples fail to consider implications for their partner. If your spouse is depending on your benefits to help make ends meet, it’s important to know that this decision could impact their future financial security if you pass away before them.

The fact is, for married couples when one spouse passes, the survivor’s Social Security income will drop significantly. For most people, this is income they need to meet their basic living expenses. That’s why it’s important to consider taking steps to maximize survivor’s benefits.

An Example of How Social Security Survivor Benefits Work

Here’s a hypothetical example of how this can play out:

Married couple Bob, age 66, and June, age 62, have just retired and both have decided to start taking Social Security right away. Bob, who is at his full retirement age, will get $3,000 per month, and June will get $1,900, which means their total household Social Security benefit is $4,900 per month.

If Bob died, June’s monthly Social Security retirement income would take an almost 40% hit. While she would still receive her husband’s $3,000 a month check as a survivor’s benefit, her own benefit would disappear. So, at the household level, her Social Security income would drop by $1,900 — from $4,900 to just $3,000 per month.

That reduction in benefits, unfortunately, is unavoidable. However, the decision many couples make to claim Social Security early can make a tough situation even more difficult for surviving spouses. In our hypothetical example, Bob was claiming Social Security at his full retirement age. But let’s change Bob’s age and see how that affects the equation. Instead of retiring at his full retirement age of 66, say Bob retires at 64, and he decides to claim Social Security benefits early. More than half of people do just that, and many don’t realize the potentially devastating impact that claiming early can have on their spouse.

Assuming that Bob’s full retirement age is 66, claiming at 64 would mean that instead of a benefit of $3,000 per month, his benefit is now about $2,625. And what if he retires even earlier? Claiming at 62 would cut his monthly Social Security benefit down to about $2,250. Those reductions are permanent, and they would also reduce June’s survivor benefit. That’s definitely something to think about before you pull the trigger on your own Social Security benefit.

It’s worth noting that if you claim early, your surviving spouse is entitled to either your reduced monthly benefit or 82.5% of what your full retirement age benefit would have been, whichever is higher. Either scenario will translate to reduced benefits for your partner.

That’s why it’s so important to realize that your decision on when to claim Social Security is more than just a decision about your personal benefits. And if your surviving spouse can’t make ends meet, what are the financial implications for other family members who may find themselves in caregiving duties in the future?

How to Maximize Your Spouse’s Survivor Benefit

So, what can you do to maximize your spouse’s Social Security survivor benefit? The answer can be summed up in one word: Wait. For every year past your full retirement age that you wait to claim Social Security, you earn an 8% delayed retirement credit. Those annual increases continue up until age 70, at which point your Social Security benefit is as big as it can possibly get. In our hypothetical example, if Bob waited until age 70 to claim, his Social Security check would jump to $3,960, compared with just $2,250 if he claimed as early as he could. That higher monthly benefit would, in turn, become June’s survivor’s benefit after Bob dies. So, for the rest of her life, June would get an additional $960 per month.

It’s important to acknowledge that the decision to delay Social Security benefits comes at a cost, namely the loss of Bob’s Social Security income from age 66 to 70. Foregoing $3,000 of monthly income for those four years comes to $144,000. That’s a significant amount, but it could be worth it if June lives into her 80s or 90s, which is not uncommon for women with good health habits. This trade-off could make a lot of sense for:

  • Couples who have the means to delay claiming without depleting their savings to a level that jeopardizes long-term financial goals
  • Couples with significant age gaps
  • Couples where at least one spouse has exceptional health or a history of longevity in their family

The Bottom Line

If maximizing your spouse’s survivor benefits is something that’s important to you, then you have to figure out a way to generate the income you need to allow you to delay taking Social Security and let your benefit grow. By working with a financial professional, you can map out ways to bridge this gap. That could include solutions like annuities or life insurance, which can provide both guaranteed income and death benefits that can replace lost Social Security income in the future.  

Unfortunately, only about half (47%) of the investors Nationwide surveyed said they receive professional guidance on how and when to claim Social Security benefits. There’s no reason to go it alone when trying to figure out the best plan for your family. Building a relationship with a financial professional is a great first step and can make a world of difference, not only for your own confidence, but also the retirement security of those you care about.


Senior Vice President, Nationwide Retirement Institute, Nationwide

Kristi Martin Rodriguez currently serves as Senior Vice President of the Nationwide Retirement Institute® for Nationwide Financial, leading the teams responsible for advocating for and educating members, partners and industry leaders on issues impacting their ability to have a secure financial future. She was a founding member of the Ohio chapter of The National Association of Securities Professionals (NASP), an organization helping people of color and women achieve inclusion in the industry.


How to Create a Retirement Income Stream

During your working years, your largest income stream is generally from employment. When you retire, however, your income will likely need to come from a variety of sources, such as retirement accounts, after-tax investments, Social Security, pensions or even continued part-time work.

For those looking to create a retirement income stream, there are a variety of strategies available depending upon your specific income needs and lifetime goals. Two simple retirement income strategies include the total return approach and the bucket approach.

Total Return Approach to Retirement Income

The total return approach is probably the best-known strategy. With this approach, assets are invested with a focus on diversification, using a portfolio of investments with a varied potential for growth, stability and liquidity, based on your time horizon, risk tolerance and need for current and future income. There are three defined stages within this approach, which are contingent upon how near you are to retirement:

  • Accumulation phase: During peak earnings years, the objective is to increase total portfolio value through long-term investments that offer growth potential.
  • Pre-retirement phase: As you approach retirement this should include a gradual move toward a more balanced growth and income-based portfolio, with an increased allocation toward stable and liquid assets as a means of preserving your earnings.
  • Retirement phase: Once retired, maximizing tax-efficient income while protecting against principal decline may result in a portfolio heavily weighted toward income-producing liquid assets.

Pros and cons: The benefit of adopting the total return approach is that, as a rule, the portfolio should outperform one that is heavily weighted toward income generation over a longer time frame. The largest disadvantage of this approach is that it takes discipline. It is important to remember that the appropriate withdrawal rate should depend upon your personal situation and the economic environment, though many advisers suggest starting with a withdrawal rate of 3%-5%, which may then be adjusted each year for inflation.

Bucket Approach to Retirement Income

This approach behaves similarly to the total return approach throughout the accumulation phase, but as you enter pre-retirement, you divide your assets into smaller portfolio “buckets” with each holding investments geared toward different time horizons and targeted to meet different needs. Generally there are three common bucket types based upon specific needs, but you are certainly not limited to just these three:

  • Safety bucket: This bucket is set up to cover a period of about three years and focuses on relatively stable investments, such as short- to intermediate-term bonds, CDs, money market funds, bond ladders and cash. This portfolio is designed to cover your needs and avoid tapping into the next two buckets when markets are down, since the average bear market historically lasts less than three years.
  • Income bucket: This bucket should focus on seven years of income needs and is designed to generate retirement income while preserving some capital over a full market cycle. This bucket typically includes assets with a focus on distributing income while still providing some growth potential.  Examples might include high-quality dividend-paying stocks, real estate investment trusts or high-yield corporate bonds.
  • Growth bucket: This bucket is used to replace the first two buckets after 10 years and beyond and contains investments that have the most potential for growth, such as non-dividend paying equities, commodities and alternatives assets.  Though holding a higher risk profile, this portfolio has a longer time horizon thus more time to make up short-term losses.

Pros and cons: The benefit of adopting the bucket approach is that it can help create a sense of calm during market storms. Instead of panicking oneself out of growth assets during a downturn, a retiree can feel confident knowing their next several years of income needs are already in a more conservative position.  The difficulty with this approach is deciding when to move assets from one bucket to the next, again requiring discipline.  

Funding Sources for Creating a Retirement Income Stream

Beyond Social Security and pensions, a number of instruments can be used to create retirement income. Which ones you use will depend upon your specific goals.

Interest and dividends: The benefit of this source is that investors can expect to receive a stated consistent monthly or quarterly payment using an instrument like dividend-paying stocks, closed end funds (CEFs) or exchange-traded funds (ETFs) with a long-term track record. The disadvantage of relying on interest and dividends is that most retirees cannot live on these payments alone, especially when yields are low and inflation is high. Additionally, when it comes to dividend payouts, companies can adjust them, cut them, or even stop them altogether.

Bond ladder: This strategy involves building a portfolio of multiple individual bonds that mature at varied stepped dates, often annually. When each bond matures, the ladder is extended by purchasing another bond, or it may fund the income need in that given year. The benefit is that a bond ladder can offer consistent, predictable return on investment. Additionally, it provides protection from some call risk, as it is unlikely the bonds would be called at the same time. The disadvantage of this income source is you may be forced to reinvest at lower interest rates, quality of bonds can vary in risk, and they can have a return lower than inflation, especially if purchased at a premium to the par value.

Certificate of deposit (CD) ladder: Similar to a bond ladder, this type of investment involves purchasing multiple certificates of deposit with stepped maturity dates. A new CD is purchased as each one matures later than the next, extending the ladder, or again used as income at maturity. While this income source is more secure than the bond ladder because CDs are insured by the FDIC, interest is not paid upon maturity.  Also, be aware that some CDs automatically reinvest, which could keep you from receiving the income, so it is wise to look specifically for CDs without this feature.

Annuities:  With immediate annuities that are backed by an insurance company, you pay a lump sum in exchange for a guaranteed payment that starts immediately. With deferred annuities, you invest in a contract, but the payout may not start for several years. While they are reasonably secure and offer tax-deferred growth and potentially tax-advantaged income, there are several disadvantages. The fees can be high, there is a tax penalty for withdrawals prior to age 59½, and they may be difficult to get out of without surrender charges if you later change your mind. It’s important to look for highly rated insurance companies when searching for guarantees because they can be dependent on the claims-paying ability of the insurance company.

Managed payout: A managed payout fund is also known as a Retirement Income Fund (RIF), income replacement fund, or monthly income fund. This source often consists of mutual funds generally created with retirees in mind, which pay regular and predictable income. The caveat being that income is not guaranteed and payments often fluctuate, and the fund manager may use principal to meet the payout schedule.

Real estate investment trusts (REIT): A REIT is a company that owns or invests in income-producing real estate and allows individuals to invest in large-scale commercial real estate or real estate loans. Types of REITs include:

  • Publicly traded: Available on the major stock exchanges.
  • Public, non-traded: Open to all investors, but may lack liquidity and do not trade on the primary stock exchanges.
  • Private, non-trade: Usually not open to the public due to high net-worth and/or high-income requirements.  Again, may lack liquidity and do not trade on the primary stock exchanges

REITs are further broken down by type, including:

  • Equity REIT: Owns income-producing real estate like office, industrial, retail, hospitality, residential, timber, healthcare, self-storage, data centers, and infrastructure.
  • Mortgage REIT (mREIT): Provides financing for real estate.
  • Hybrid REIT: Combines income-producing real estate investments and real-estate backed loans.

The benefit of REITs is that they may offer a reasonable hedge against inflation as most of their taxable income must be distributed to shareholders.

Part-time income: Not everyone is fully ready for retirement, and work can offer a sense of self-worth. The additional income can help hedge against inflation by covering expenses during a down market instead of selling investments at a loss to pay the bills. The chief caveat is the potential reduction of Social Security benefits while earning income due to the Social Security Administration earnings test.

Alternative investments: These investments do not fit into the traditional equity, fixed income or cash options. For this purpose, they generally consist of private equity, venture capital, hedge funds, commodities, tangible assets and real property. 

As you can see, there is no one-size-fits-all approach to retirement income planning. Each of these strategies requires a dramatically different approach. With this in mind, you should seek the advice of your financial adviser to help you construct a customized portfolio that will meet your retirement needs.

President and Founder, Global Wealth Advisors

Kris Maksimovich, AIF®, CRPC®, CRC®, is president of Global Wealth Advisors in Lewisville, Texas. Since it was formed in 2008, GWA continues to expand with offices around the country. Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Financial planning services offered through Global Wealth Advisors are separate and unrelated to Commonwealth.