Retirement scorecard: Interest and dividends

Market Analyze

(MoneyWatch) How much retirement income can you generate from your 401(k), IRA, and retirement savings? It's a critical question because it will affect just how much money you'll have to spend for the rest of your life. The answer can vary widely, depending on a number of factors, the most important being the method you use to generate retirement income, as discussed in my recent post, "My four favorite ways to generate retirement income." Your age, sex, and marital status also have a significant influence. And your income will depend on a number of economic factors, such as interest rates, dividend payout rates, and annuity purchase rates in effect at the time you retire.

In order to help you discover the answer to the question I posed above, here's the third installment this year of my quarterly retirement paycheck scorecard series. It shows you the amount of retirement income that can be generated from $100,000 in retirement savings as of the beginning of July 2012, for each of the three methods of generating retirement income I summarized in the post mentioned above. You may want to review that post for background and to familiarize yourself with the advantages and disadvantages of each method.

My four favorite ways to generate retirement income
IRAs and 401k: 3 ways to generate retirement income

Method #1: Interest and dividends only

One way to generate retirement income is to invest in a mutual fund that pays a regular dividend and then use just the interest and dividend payments to cover your living expenses. Because you aren't dipping into your principal, there's a very good chance you won't outlive your money. And this method offers the maximum flexibility and access to your retirement savings. The downside is this method produces the lowest amount of retirement income, as you'll see by comparing this scorecard to the next two scorecards in this series.

Here are the estimates of annual dividends paid from various Vanguard mutual funds that have regular dividend payouts. I've also included the payout rate -- the annual income as a percentage of the investment -- for the purposes of comparing it to other methods of generating retirement income.

How has the chart changed since the second quarter?

Compared to last quarter, the payout rates for the Wellesley and REIT funds have declined slightly, while the payout rates for the Wellington, Dividend Growth and Equity Income fund have increased slightly. These changes are due to the net result of changes in dividend payouts and interest rates, and appreciation in the underlying fund values.

Note that these funds have different asset allocations between equity and fixed income investments, which is one important reason for the differences in income. The Wellesley fund is invested roughly 37 percent in stocks, with the remainder in fixed income or cash. The Wellington fund is invested roughly 65 percent in stocks with the remainder in fixed income or cash. The Dividend Growth and Equity Income funds are invested nearly 100 percent in stocks, while the REIT index fund is invested nearly 100 percent in real estate investments.

All but the Dividend Growth fund pay dividends quarterly, while the Dividend Growth fund pays dividends semi-annually. The above amounts assume the payout rates for the past 12 months will continue for the next 12 months. Your actual income will change to the extent that future dividend payments are increased or decreased from the past 12 months.

Finally, please note that the amounts shown above are pre-tax income amounts. Federal and state income taxes will have a significant effect on your after-tax income, and should be taken into account. The income taxes you pay will vary depending on whether your retirement savings have been invested before taxes in traditional IRA or 401(k) accounts, or have been invested after taxes, such as in a Roth IRA, or are eligible for special tax treatment on capital gains, ordinary dividends or municipal bonds.

Stay tuned for my next post that shows the retirement income scorecard for Method No. 2, systematic withdrawals (I've called this method "managed payouts" in previous posts).

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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 Retirement Game-Changers: Strategies for a Healthy, Financially Secure and Fulfilling Long Life and Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck.