Planning your retirement: The best ways to generate lifetime income

(MoneyWatch) How much retirement income can you get from your 401(k), IRA and other savings? That's a critical question as you piece together your various sources of retirement income, which also includes Social Security, pensions and the salary you'll earn from continued work. Surveys show that many people struggle with the difficult task of generating lifetime retirement income -- this post will help you tackle this challenge. Welcome to week nine of my series, 16 Weeks to Plan Your Retirement.

Here's one way not to manage your retirement income: Many retirees just withdraw what they needfrom their savings to meet their current living expenses, without considering that they'll need to make these savings last for the rest of their lives. And most people withdraw too much and exhaust their retirement savings when they still have many good years of life remaining.

To avoid this fate, set up a method of generating retirement income that's most likely to make your savings last for your lifetime and, if you're married, for your spouse's lifetime as well. I call these methods Retirement Income Generators, or RIGs for short. There are three basic types of RIGs:

  • RIG #1: Invest your retirement savings, and use just the money from interest and dividend.
  • RIG #2: Invest your retirement savings, and withdraw principal carefully, a method often referred to as "systematic withdrawals"
  • RIG #3: Buy an immediate lifetime annuity from an insurance company

There are many variations of each of these methods, and they all have advantages and disadvantages. There's no single magic bullet that works best for everybody, so you'll want to learn more to see which method, or combination of methods, works best for your circumstances.

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.

How much lifetime retirement income can your savings generate? A 65-year-old can reasonably expect to generate an annual retirement income of between 3 and 6 percent of savings. That's quite a wide range, so it pays to learn the benefits and drawbacks of different approaches to find out how to generate as much as you need.

Here are a few ways to research different approaches and figure out how much income they'll generate, based on your portfolio:

  • If you're planning to use interest and dividends without drawing down principal (RIG #1), I suggest investing in a reputable, low-cost no-load mutual fund balanced between stocks and bonds. You can estimate the amount of annual income you'll receive by looking at the dividend distributions from the fund in the past year; make sure to exclude capital gains distributions.
  • If you plan to use systematic withdrawals (RIG #2), an important decision you'll need to make is what percentage of assets you'll withdraw each year. There are several ways to do this: You can use the "4 percent rule" or a variation thereof; you can use a Monte Carlo method, such as the calculator on the T. Rowe Price website; or you can use the simple online tool I've written about previously.
  • If you want to buy an immediate annuity (RIG #3), you'll need to choose between a fixed annuity, an inflation-adjusted annuity and a variable annuity. You can estimate how much you'll receive from each of these methods by using online annuity purchase services such as www.immediateannuities.com, Vanguard's Annuity Access program, or the immediate variable annuity site sponsored by Vanguard. Another type of annuity to consider is a Guaranteed Lifetime Withdrawal Benefit, or GLWB, which is an annuity that combines the features of both traditional annuities and systematic withdrawals. You'll find one cost-effective GLWB annuity through Vanguard.

As with many steps in this 16-part series, your homework this week might take more than a week to complete. That's OK -- it's very important that you take the necessary time to secure a paycheck that will last the rest of your life. You'll thank yourself 20 or 30 years from now when you're still enjoying your retirement income, and your less diligent friends and relatives are broke and needing to return to work.

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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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