Last Updated Oct 1, 2010 6:18 PM EDT
- Invest your savings, and spend just the interest and dividends.
- Invest your savings, but draw down principal cautiously so you don't outlive your assets.
- Buy an immediate annuity from an insurance company.
You might have seen articles or advertisements for financial products that provide retirement income. They go by various names, such as managed payout funds, monthly income funds, or income replacement funds, and big institutions such as Fidelity, Vanguard, and Schwab all offer them. But before you decide to invest in such a product, you'll need to look under the hood and kick the tires. And you might find you'd be better off setting up your own managed payout retirement income generator. It's not too hard to do that. Let's take a look.
Whether you invest in a product or do it yourself, you'll need to make two very important decisions:
- How to invest your retirement savings, including your asset allocation, and
- How much to withdraw to cover your retirement living expenses.
Many large mutual fund companies and other financial institutions will allow you to set up periodic, automatic withdrawals from your IRAs and retirement savings to your checking account. All you need to do is specify the following items:
- the amount of each transfer,
- the frequency -- monthly, quarterly, etc., and
- the specific investments or funds that the transfers will come from.
Check to see if your 401k plan also offers this automatic payment service; if they do and you like your plan's investment funds, there's no need to roll your 401k accounts into an IRA. Most 401k plans, however, don't provide these services, so if that's your situation, you'll need to roll your money into an IRA with an institution that allows for periodic payouts.
Here's how managed payouts meet the criteria for evaluating retirement income generators that I introduced in my previous post on this topic. As you can see, using managed payouts has the potential for high ongoing monitoring and maintenance.
- Amount of initial income: Moderate
- Potential for growth in income: Depends on your asset allocation
- Access to/preservation of principal: Yes, although you're subject to investment risk
- Protection against investment risk: Depends on your asset allocation
- Protection against longevity risk: No; your level of risk depends on the amount of periodic withdrawals
- Effort to set up: High -- you need to select appropriate investments, calculate the amount of your withdrawals, and the payout mechanism
- Ongoing maintenance: Moderate to high -- periodically, you need to monitor investment performance and check to see if you're depleting your assets too rapidly
- Ability to change to other methods: Yes
With managed payouts, the likelihood of outliving your money depends on your asset allocation and the amount of your periodic withdrawals -- the two important decisions I mentioned above. The financial literature is quite robust on this topic, and I'll summarize the considerations and strategies in future posts. I'll also look at how various managed payout or income replacement funds measure up to the analyses in the financial literature and show you how to look under the hood.
Is it really worth this time and effort? Consider this: Most of us have spent years in school and getting on-the-job training that enabled us to generate income for 30 or more working years. Now we're in training for generating another type of income -- our retirement income -- and we might need it to last for 20 or 30 years as well. You won't be spending nearly as much time as you did your previous schooling and on-the-job training, but I'd say it's equally as valuable.
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