Effective Strategies to Maximize Income in Retirement
We all love to dream about the lazy days and freedom of retirement when working against a hard deadline or dealing with a difficult boss. In reality, many retirees find that they enjoy continuing to work in some capacity. Part-time work, consulting, and passion projects all become possible when you are no longer locked in to a 9-5 lifestyle. Other retirees abandon paid work entirely, concentrating on hobbies, philanthropic pursuits, or just catching up on a lifetime of books to be read. Even if you are done earning wages from the workforce, you can still continue to generate income throughout your golden years by putting your money to work for you.
Strategy #1: Earn Income from Investments
With interest rates on savings accounts still historically low, money kept in low-yield savings and money market accounts will actually lose value each year due to inflation. A well-balanced portfolio that may include stocks, bonds, and real estate investments, can continue to generate income throughout your golden years. Dividend-paying stocks are particularly useful for retirees. When choosing dividend-paying stocks, look for companies with a record of periodically increasing dividends over time, which can help offset inflation. Beware of chasing the highest yields. Stocks that pay yields of 7% or more may not sustain enough profits to continue such a high yield over time. There are a number of blue-chip stocks offering yields of 2.5-4%. Similarly, you may consider exchange-traded funds (ETFs) and mutual funds that include stocks that pay dividends.
Bonds are another key part of a retiree’s portfolio. As you near retirement, most experts recommend increasing the percentage of bonds in your portfolio to reduce the overall risk. For conservative investors, the percentage of bonds at retirement may be over 40%. Investing in a core bond or bond index fund of U.S. government and high-quality corporate securities may be a good choice for most retirees. If you are in an upper tax-bracket, know that there are not federal taxes on income from municipal bonds. While municipal bonds offered by state and local governments tend to offer lower yields, not owing taxes on the yields is very helpful if you are in an upper tax-bracket.
Real estates investment trusts (REITs) own and manage real estate such as apartments, office buildings, and shopping centers. REITs are required by law to distribute at least 90% of their taxable income to shareholders. Due to this, REITs tend to be among the companies paying the highest dividends. ETFs and mutual funds allow you to invest in REITs. REITs offer unique tax advantages but it’s important to know whether payments from the REIT are in the form of income, capital gains, or a return of capital as all have different tax implications.
Strategy #2: Delay Claiming Social Security
While eligible individuals can begin claiming Social Security benefits as early as age 62, waiting to begin claiming is prudent for many retirees. Your full retirement age for Social Security depends on your birth year and is somewhere between 66-67 for most individuals. Claiming Social Security benefits prior to your full retirement age permanently reduces your payment – a significant loss over a retirement of 20-30 years. Your Social Security monthly benefits are permanently reduced by five-ninths of 1% for every month you start getting benefits up to 36 months before your full retirement age. If you begin claiming more than 36 months before your full retirement age, your benefit is further reduced by five-twelfths of 1% for each additional month. If your full retirement age is 66 and eight months, and you begin collecting Social Security at age 62, you would only get about 71.7 percent of your full benefit.
Delaying claiming Social Security past your full retirement age permanently increases your monthly benefit. Your monthly benefit increases by 2/3 of 1% for every month you delay until age 70, when benefits max out. Compared to beginning collecting benefits at age 62, your monthly benefit will be roughly 24-32% higher than if you began collecting at full retirement age and 76% higher if you delay to age 70.
Of course, other factors influence when it’s best to begin your Social Security benefits, including your life expectancy, current employment, current cash needs, and marital status. For a more detailed discussion of Social Security considerations, see Understanding Social Security and When to Take Your Benefits.
Strategy #3: Earn Extra Income
Retiring from your full-time career does not have to mean leaving paid work entirely. Many retirees find enjoyment and fulfillment in maintaining a connection to the workforce. The extra income from paid work can help bolster savings, fund travel, or defer higher healthcare costs. Some popular employment choices for retirees are:
- Consulting work – Leverage the knowledge and experience you have accumulated over your career to stay involved and earn extra income. Consulting work tends to be high paid, commensurate with experience, and allows for flexibility in how often and how long you work.
- Philanthropic or passion projects – With wages no longer the primary consideration, you can enjoy work in the non-profit sector for a cause dear to your heart, such as fundraising for cancer research, matching companion animals with forever homes, or supporting the arts. The organizations you work with are happy to use your contacts and experience and you get the fulfillment of contributing to a cause you support while earning some extra income.
- Local connection – Retirees often enjoy work that connects them to their local community or family. This could include working at a local museum or bookstore, helping in the business of one of your children, or starting a small business focused on a hobby you love. Retirees who are well-connected to their communities live longer and happier than those who are more isolated.
Continuing to work in some capacity allows you to delay claiming Social Security, thereby increasing your monthly benefit, and gives some financial freedom for fixing up the house, beginning a new hobby, or traveling the world.
Strategy #4: Understand the Pros and Cons of Annuities
Very few workers now have access to a pension. Unless you retired from public service or from one of the few remaining companies that offer a traditional pension, you will not have access to the guaranteed source of lifetime income that a pension once offered. Annuities are a way to create your own guaranteed monthly income for the rest of your life. However, annuities come with significant drawbacks and are not right for many investors. There are two main types of annuities:
- Immediate Annuity – You purchase an immediate annuity from an insurance company with a lump sum of money in exchange for a monthly check (typically for life). Some annuities offer survivor benefits and will continue to pay your spouse after your death. Those annuities offer a lower monthly payment.
- Deferred Income Annuity – You purchase an annuity in your 50s or 60s but payments don’t start for 10 years or longer. In most cases, the longer you wait to claim, the higher your monthly payment will be. If you die before benefits begin, you do not receive any payout unless you opted for return of premium or survivor benefits. Qualified longevity annuity contracts (QLAC) may be beneficial for retirees with a significant amount of money in tax-deferred retirement accounts. You can invest the lesser of $125,000 or up to 25% of your traditional IRA or 401k plan in a QLAC without taking required minimum distributions (RMDs) on the money when you turn 70.5. Your payments must begin by age 85.
Annuities may be right for very conservative investors who cannot handle riskier investments or investors who have a hard time managing their money and may otherwise spend it too quickly. If you fall into one of those categories, purchasing an annuity that, paired with social security can cover your basic expenses, such as your housing costs, utilities, and food, can provide peace of mind that your essential expenses will always be covered.
For everyone else, remember that the primary purpose of an annuity is to make a profit for the insurance company. High fees, rider charges, and insurance charges can push the breakeven point for an annuity far into the future. Unless you are particularly long lived, there are far more effective investments. Many investors are better served by independently investing the money they would have spent on an annuity and taking regular withdrawals. Your financial advisor can help you set this up. For a more detailed look at the pitfalls of annuities, see our article.
Strategy #5: Manage Your Withdrawals
Having a strategy in place to reduce investment withdrawals when the market is down can extend your retirement savings over a longer period. Dividing your investments based on when you plan to use that money can help prevent excessive withdrawals.
Money for the next year of expenses should be easily accessible and in protected holdings, such as FDIC insured savings accounts. Coupled with Social Security and any earned income, this money should be sufficient to cover your living expenses for a year as well as deal with unexpected expenses, such as home repairs or travel costs.
Money that you will need within the next decade can be in an annuity or high-quality bonds. This money is relatively stable and can be withdrawn periodically to fund your account that holds the next year of expenses.
Assets that won’t need to be cashed out for at least 10 years can be invested more aggressively in stocks and REITs as you will have time to recover from a market crash if needed. Deferred income annuities and permanent life insurance policies would also fall into this category. As you age, you’ll move more of your money into less-risky investments to ensure a steady income in retirement.
Strategy #6: Protect Against Inflation
The inflation rate has averaged 2.2% since 2000. According to Bankrate, the national average interest rate for savings accounts was 0.07% for the week of January 27, 2021. While you can find online savings accounts offering higher rates, the rates are still well below inflation. Inflation can eat away at the spending power of your hard-earned retirement savings.
Investing in the stock market is the best way to make sure your investments keep up with the cost of living. The average annual return of stocks on the S&P 500 over the past 90 years has been 10%. While you have more risk holding stocks, possibly losing money during downturns, long term investors will typically well outpace inflation over the long hall. Depending on your risk tolerance, age, and where you are in your retirement, stock holdings may make up 30-60% of your overall portfolio.
Treasury inflation-protected securities (TIPs) can also protect against inflation. These are government-issued bonds that adjust your principal for inflation. You are guaranteed a fixed rate of interest every six months. As your principal rises, so does the amount of interest you will earn. TIPs do have some disadvantages – they typically underperform traditional treasury bonds, the CPI used to calculate inflation may not reflect your actual cost-of-living changes, and TIPs pricing is volatile and not as stable as cash.
Strategy #7: Minimize Your Tax Burden
Minimizing the amount of your retirement savings owed in taxes can help you make the most of your nest egg. There are many perfectly legal strategies to lower your tax bill with careful planning. It’s worth consulting a tax professional to understand how your different retirement accounts are taxed and come up with a plan to withdraw your funds in a way that minimizes your tax burdens.
For taxable brokerage accounts, you have already paid taxes on the money invested. You’ll be taxed on interest and dividends as they are earned and on capital gains when you sell an asset. For tax-deferred accounts, such as traditional IRAs and retirement accounts, withdrawals are taxed at ordinary income tax rates. RMDs kick in when you reach 70.5 years of age. For Roth IRAs that you have owned at least five years, all withdrawals are tax-free. There are no RMDs, so you can leave the money to grow if you don’t need it just yet. Roth IRAs are very helpful when you need to withdraw money for a major expense without triggering a correspondingly major tax bill.
Financial experts typically recommend tapping taxable accounts first, tax-deferred accounts second, and tax-free Roth accounts last.
Strategy #8: Plan for Health Care Costs
Health care costs are often the most surprising expense for retirees. Your health typically declines as you age and the switch from private insurance to Medicare can add some unpleasant surprises. Early retirees should keep in mind that you will not qualify for Medicare until age 65 so you will need to factor in private insurance costs until that age. Retirees are often surprised that Medicare has multiple parts (A, B, C, and D). You will want to price out the different options as you near retirement to determine what options are best for you and what the cost will be.
Health Savings Accounts (HSAs) offer a tax-friendly way to save up for health care expenses. HSAs offer three tax advantages:
- You contribute money on a pretax basis
- Money in the account grows tax-deferred
- Withdrawals are tax-free if used for qualified medical expenses
The maximum contribution for HSAs contributions for 2021 is $3600 for self-plan and $7200 for family-coverage. You must have a high-deductible insurance plan with a deductible of at least $1400 for self-only or $2800 for family plans.
Choosing long-term care insurance that will provide 3-5 years of care can prevent exorbitant costs from a nursing home stay from derailing your retirement savings. The best time to shop for long term care insurance is typically around 60-65 years of age, assuming you are in good health. You may be able to deduct part of your long-term care insurance premiums on your tax return.
Strategy #9: Downsize or Relocate
Moving to a smaller house or cheaper location can free up money previously tied up in your primary home. For example, a couple moving from a $600,000 home in the suburbs to a $300,000 condo in the same area can now access $300,000 that can grow in the stock market and be used to cover retirement expenses. Smaller homes typically come with smaller utility and repair costs, as well as lower property taxes. Moving to a lower cost locale can yield even more savings, or allow you to keep the same size property at a much lower cost. A new home with a lower cost of living can help your retirement dollars stretch further for food, clothing, and hobby expenses.
Before relocating, be sure to visit your potential home and make sure that you will feel comfortable living their long term (not just on vacation). Some states are much more tax-friendly for retirees than others – check how your current and new state will tax your retirement income. If you have children, consider proximity to them when choosing where to live. It’s much easier for your child to help you navigate crutches after a fall or for you to help your child with grandchildren from 30 minutes away than it is from the other side of the country.
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About the Author
Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.
Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.