3 ways to turn your IRA and 401(k) into a lifetime retirement paycheck

(MoneyWatch) I recently  offered an overall financial strategy to help you avoid  years: Don't spend your retirement savings!

Instead, you should think of your savings as "retirement income generators," or RIGs, that deliver a monthly paycheck that lasts for the rest of your life. The goal then becomes to spend no more than the amount of your monthly paycheck.

There are essentially only three ways to generate a monthly paycheck from your retirement savings:

  • Invest your savings and spend just the investment earnings, which typically consist of interest and dividends. Don't touch the principal.
  • Invest your savings, and draw down the principal cautiously so you don't outlive your assets. (In this post and future posts, I'll call this method "systematic withdrawals.")
  • Buy an " immediate annuity " from an insurance company and live off the monthly benefit the insurance company pays you.

These methods are all designed to generate a lifetime retirement income, no matter how long you live. Achieving this goal will help you relax and enjoy your retirement. These methods might also provide protection against inflation, another important goal for many people.

Although these represent the three basic approaches to ensuring steady retirement income, each method has many variations. Here are just a few examples:

  • If you decide to invest your money and only spend your investment earnings, you can invest in a variety of mutual funds, bank accounts, individual stocks and bonds, real estate investment trusts, or rental real estate.
  • If you decide to use the systematic withdrawal method, you can invest your savings on your own and decide how much to draw down, or you can use a managed payout fund that does the investing and withdrawing for you.
  • If you decide to purchase an immediate annuity, you have options. For example, you can buy an annuity that's fixed in dollar amounts, one that's adjusted for inflation, or a variable annuity that's adjusted according to an underlying portfolio of stocks and bonds. You can also buy an annuity that starts at a later age, or you can purchase a hybrid annuity that includes some of the features of systematic withdrawals.

These RIGS each have their advantages and disadvantages; there's not one magic bullet that works best for everybody. Most important, each type of RIG generates a different amount of retirement income:

  • RIG #1, interest and dividends, typically pays an annual income ranging from 2 percent to 3.5 percent of your savings, depending on the specific investments you select and the allocation between stocks, bonds, cash and real estate investments.
  • RIG #2, systematic withdrawals, typically pays an annual income from 3.5 percent to 5 percent of your savings, depending on your investments and how worried you are about exhausting your savings before you die.
  • RIG #3, immediate annuities, can range from 4 percent to 6.5 percent of your savings, depending on the type of annuity you buy and your age, sex and whether you continue income to a beneficiary after your death.

You don't need to use just one type of RIG to generate the income you need. In fact, it might be best to use a combination of a few different types. In addition, there can be good reasons to change your RIGs as you get older. And some financial institutions have been introducing hybrid products and solutions that combine features of two or more of these basic RIGs.

How do you choose which RIG works best for you? In my latest book, "Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck," I discuss the pros and cons of each type of RIG and introduce a method for selecting the RIG or RIGs that will work best for you. I'll also begin covering these topics in my posts so if you follow along, you'll learn how you can set up RIGs that will generate a retirement paycheck that just keeps plugging along.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.

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