IRAs and 401k: 3 ways to generate lifetime retirement income

Last Updated Jul 19, 2011 12:59 PM EDT

The money in your IRAs and 401k plan is not there to spend in your retirement.

Can that be right? Did I actually mean what I just said? Absolutely! My concern is that after you retire, you see that you accumulated a good amount of retirement savings in your IRAs and 401k plan. It looks like a lot of money, so you just spend it on whatever you think you need for your retirement living expenses. But if you're not careful, it won't take too many years to exhaust the balance in your IRAs and 401k. And while you've got plenty of years of living left, now you're broke. This is a situation that, unfortunately, I've seen happen all too often.

To prevent this situation from happening to you, I've got another idea: Instead of spending the money in your IRAs and 401k, think of your retirement savings as a monthly paycheck generator. Then, spend no more than the amount of this monthly paycheck. Most of us live paycheck to paycheck while we're working, so let's not change this financial discipline after we retire.

Your retirement income generators will help you meet the really big goal: To develop reliable sources of retirement income that cover your retirement living expenses for the rest of your life, no matter how long you live and no matter what happens in the economy. If you're married or have a life partner, your retirement income also needs to last as long as both of you are alive. And your retirement income also needs to keep up with inflation. These are all ambitious goals, but nevertheless, they're what you should be planning for.


There's not one magic silver bullet that meets this goal; you'll meet it by piecing together income from four possible sources:

  • Social Security
  • Pensions
  • Retirement savings
  • Work

I've previously written about strategies for getting the most from Social Security and working in your retirement years, and at some point, I'll also cover pensions. This post kicks off a series of posts on the third item -- generating income from IRAs, 401k plans, and other retirement savings. This can be the most difficult retirement planning challenge for many people. Just how do you use your retirement savings to generate a monthly paycheck that lasts as long as you live?

There are basically three ways to generate income from your retirement savings:

  • Invest your savings, and spend just the interest and dividends. I've written previously about this strategy using a diversified portfolio of stocks and bonds.
  • Invest your savings, but draw down principal cautiously, so that you don't outlive your assets.
  • Buy an immediate annuity from an insurance company.

It's important to realize that you don't need to use just one type of retirement income generator -- in fact, it might be best to use a few different types. And there can be good reasons to change your retirement income generators as you get older.

Of course, the underlying investments in your retirement income generators are a very important aspect to consider. You'll want to take into account asset allocation, investment costs, and historical investment performance.

Before we dig into the different types of retirement income generators to see exactly how they work, it's important to understand the retirement income "trilemma." It goes like this: Most people want to maximize the amount of their retirement income and satisfy three goals with their retirement income generators:

  • Potential for growth -- high returns -- so you can keep up with inflation
  • Access to and preservation of capital -- in case of emergencies or for special spending needs, and to pass on a legacy to children or charities
  • Protection from risk -- usually investment risk and the risk of outliving your assets (called longevity risk)

Unfortunately, the most you can usually get with any type of retirement income generator is two out of three of these goals. Your decisions regarding these goals will significantly impact the amount of your retirement income. In selecting a specific retirement income generator, you'll need to trade off between these goals and consider how much retirement income you need. That's one good reason why you might want a combination of generators so you've covered all three goals.

There are a few products or strategies that claim to hit all three of these goals at once and maximize the potential for retirement income. But I'd be cautious when considering such products or strategies; there's often a high cost involved, there may be fine print that can trip you up, or you're being misled or misinformed. I'll take a look at these products and strategies further in this series of posts, so you know what you should watch out for.

Deciding how to use your IRAs, 401k plan and other retirement savings to generate lifetime retirement is a complex topic, and it will take several posts to give it the attention it deserves. Look for subsequent posts each Monday that cover annuities and various strategies to invest and draw down your retirement savings. Given what's at stake -- your retirement security -- it will be time that's well spent.

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An IRA and 401k retirement income road map
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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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