Have you heard advertisements about creating lifetime income for a secure retirement? I’m always skeptical about annuities because they are so confusing, even for those of us that pay attention.
Turns out, the term “lifetime income” is a marketing phrase meant to demystify annuities by highlighting their main benefit. Unfortunately, a new marketing campaign doesn’t fix the main problems with annuities: high fees and a lack of transparency.
Though a carefully selected annuity can be part of a diversified retirement plan, you don’t need an insurance policy to create lifetime income. If you pay attention to your finances and set things up correctly, you can build income streams that last a lifetime while accounting for bumps in the road.
A New Alliance
In 2018, a group of financial companies formed the Alliance for Lifetime Income, a non-profit meant to raise awareness of the benefits of using annuities to create lifetime income for retirement planning. Their purpose:
Help Americans address the risk of outliving their retirement income, so they can enjoy their retirement.
Fixed annuity sales hit a record in 2018. But despite the growing population of retiring baby boomers and their desire for secure retirement income, annuities are still misunderstood.
Why? Well, probably the usual — high fees, complexity, and lack of transparency.
So the CEOs of some of the largest annuities providers joined forces to help bring clarity (and more sales) to the industry.
Fixed annuities are financial products that provide guaranteed income a specified period of time — often, for life. When you buy an annuity, you’re purchasing a guaranteed future stream of income.
For example, someone in their 60s might pay $100,000 for an annuity that pays $500 per month until they die.
The annuity provider takes on the investment risk (you “retire your risk”), and in return, you receive a guaranteed income stream.
Schwab and several other financial sites have basic calculators you can play with to see how they work. There are several types of annuities, complicating the landscape.
What are the Fees?
When I started hearing commercials for the Alliance for Lifetime Income on NPR, the publicity made me think of my wife’s former communications career where she supported industry organizations. They also reminded me of a workplace seminar I attended in 2018, presented by one of the founding organizations.
They pitched employees of my company about the benefits of annuities for lifetime income in retirement.
I wasn’t interested as a buyer. But as a blogger and money nerd (and former finance intern), I wanted to experience the pitch.
The presentation wasn’t very compelling. But I stuck around to the end to ask the question, what are the fees?
The presenter said, “Fees, well there are no fees. This is an annuity”.
So I looked at their FAQs, and they said their annuity is not quite an investment product as viewed by federal securities laws. It’s an insurance contract. Therefore, there is no expense ratio or fee disclosure requirement.
They make money on the spread. That makes these products difficult to understand.
The return on investment of money put into the annuity is very low, and the income is not adjusted for inflation. The company takes on the risk but gives itself plenty of spread between what they can earn through investing and what they pay to customers.
As they sell more annuities, the pool of assets grows to allow them to take greater investment risk to expand their spread (and profit).
For the record, most annuities do have fees, easily in the range of 2%-6%, according to The Motley Fool. It’s confusing.
How to Build Lifetime Income for Retirement without Annuities
Annuities have a place in the financial planning universe. But they are complex, and therefore, consumers can be at risk for predatory salespeople that do not have their best interests in mind.
This article at Kiplinger gives a good breakdown of how to determine if annuities are right for you. Buyer beware.
As a DIY investor and retirement planner, I’m not a big fan of annuities. There’s no reason for me to buy one today, and it’s unlikely I’ll ever need to buy one.
My parents are in their 70s on a fixed income. I see no need for them to purchase an annuity.
I plan to create my own guaranteed lifetime income stream from multiple diversified income sources to build both financial security and wealth. Each investment in my portfolio is definitely NOT guaranteed to be a lifetime source of income on its own.
But a diversified array of investments built over time and monitored IS highly likely to provide sufficient income that will last until I die.
It may not be a smooth ride, but with a long-term mindset and careful planning, guaranteed lifetime income is achievable without annuities.
Several investment vehicles can help create income streams that can last a lifetime. Streams may be semi-active or passive. All require some amount of monitoring.
Where possible, as you age, it makes sense to automate income streams when they become your primary source of income. And have a plan in place in the event of your death or inability to manage your money.
Automating ensures income is regular and consistent, and it removes emotion from investment sales and withdrawals.
Here are some of my favorite ways to build lifetime income.
Income derived from dividend growth stocks is a reliable income stream before and after retirement age.
What I love about owning dividend growth stocks is that carefully selected stocks that have a history of paying and increasing their dividends over time tend to continue to do so (such as those on the Dividend Aristocrats list)
The yield of an adequately assembled dividend growth portfolio will typically rise at a faster rate than inflation.
Stocks in a dividend growth portfolio require monitoring, but less maintenance than a volatile growth stock portfolio.
Dividend growth investing requires knowledge and research to be able to pick individual stocks, which may be intimidating. An alternative strategy is to focus on dividend-paying ETFs or total market index funds.
To calculate how much income your investments will provide, multiply the total investment amount by the yield (weighted average portfolio yield or ETF yield).
For example, if you invest $200,000 with dividend yields averaging 3%, your portfolio will provide $6,000 of annual income or $500 per month. Unlike annuities, you keep your money in your accounts as it earns for you.
But you also take on the risk of values and yields decreasing.
You can also measure the average dividend growth rate, which is the average yield increase in your portfolio. A properly diversified dividend portfolio may increase at 6% or more per yield, easily outpacing inflation.
Taxes apply to the income in taxable accounts, but the tax rate is lower than earned income. Dividends are not taxed in retirement accounts. However, account withdrawals from traditional IRAs are.
Roth IRA withdrawals are tax-free, making them an ideal account for dividend income.
With a dividend stock portfolio, you always have the option to sell investments to create an income stream.
Real estate ownership and landlording can be a rewarding post-retirement income stream and activity. Certain types of rental properties make excellent sources of lifetime income in retirement.
People will always need places to live. High-quality homes in desirable locations are guaranteed to generate perpetual income with competent management, regular maintenance, and conservative financing.
Real estate can get risky when the owner uses too much leverage, and the cushion between the rent and expenses is too narrow.
To significantly lower rental risk, own the property outright with no debt. Investing without debt increases profit margins dramatically reduces risk.
Hire a property manager to handle the month-to-month activities and have them transfer the income to your accounts every month.
Update your estate plan and keep your heirs aware of all of your assets.
Read more: Why I’m Selling My Rental Property
Automatic Withdrawals from Retirement Accounts (and RMDs)
Retirement accounts make up the bulk of my net worth. I won’t spend this money until I’m much older than 59 1/2. Keeping my hands off gives it time to grow and compound into significant wealth from which I can live off of during retirement.
Once I start to tap these accounts, I’ll do so using automated asset sales and withdrawals.
Using the 4% rule of thumb, retirees can safely withdraw 4% from the accounts every year for approximately 30 years before running out of money — assuming age-appropriate asset allocation of stocks and bonds.
That gives me at least two ways to nearly guarantee the money will last my lifetime. I can either wait until I’m 70 to start making withdrawals or withdraw less than 4%.
If I wait until I’m 70 1/2 to make withdrawals, required minimum distributions (RMDs) will kick in. The money should still last until I’m 100. I’m optimistic I’ll live that long even though the odds are stacked against me.
If I start withdrawing money when I’m 60 but only withdraw 3% instead of 4%, I can extend how long my nest egg will last.
Bond or CD Ladder
A conservative way to build near-guaranteed lifetime income is through bond and CD ladders. I use the term near-guaranteed because no investments are guaranteed. However, high-quality bonds and CDs are very low-risk investments that are highly unlikely to fail.
Bonds and CDs both provide predictable income, asset growth, and liquidity over time.
The strategy involves buying a series of bonds or CDs with staggering maturity. The longer the maturity, the higher the yields.
The difference between CD and bond ladders is that bond ladders have more investment options (including various types of bonds, yields, risk profiles, etc.) while CDs are similar to high-yield savings accounts. But the ladders work mostly the same.
For example, you can start by purchasing five bonds with maturities of 1, 2, 3, 4, and 5 years with escalating yields. When the 1-year bond matures, you can use that money for spending, or reinvest it at the long-end of the ladder (by purchasing a new 5-year bond).
The investor also receives interest on the bonds throughout their lifespan.
Choose municipal bonds to lower your taxable income.
Depending on bond quality, the income generated is nearly guaranteed, creating another lifetime income stream.
Fidelity has an in-depth explanation of how to build a bond ladder. Fidelity and most of the biggest online brokers have built-in tools to help investors construct the best bond ladder for their needs. Most fiduciary financial advisors should also be able to help.
Read more: 7 Retirement Investments for Stable Returns
Bond Funds and ETFs
At some point in your 40s, you should start reducing exposure to stocks in your retirement accounts. My portfolio target bond allocation is about 10%-15%.
Bond funds and ETFs make this very easy. They can be bought and sold, just like stocks and equity mutual funds. But the underlying assets are bonds, and the types and yields vary based on the kind of bond fund.
Most bond funds are less volatile than stock funds and provide a reliable income. Distributions land in your taxable or retirement account, just like stock dividends, and you can reinvest or use the income for living expenses.
Bonds, of course, aren’t immune to global economic events. Returns are lower than stocks over the long-term. And like all investments, any individual bond is not guaranteed.
However, a broadly diversified portfolio of bonds through funds and ETFs can provide near-guaranteed lifetime income.
Read more: 7 Retirement Investments for Stable Returns
Older people don’t like risk. My parents are in their 70s and have more than $100,000 in a high yield savings account earning interest.
Retirees like to have cash on hand because it’s liquid and secure. Though currencies can devalue due to economic crises (which can make for excellent travel destinations), the US dollar is considered to be a solid asset because it’s backed by the economic strength of the United States.
Interest paid on cash deposits is a primitive passive income stream. It’s the most passive income, and should never be ignored, and always be optimized. Sweep cash from checking into savings when it’s idle. It only takes a few clicks or tabs these days.
Read more: Check rates on savings and CDs.
Alternative investments aren’t necessarily more risky than other traditional investments like stocks or bonds. But they can be less liquid.
However, alternative investments are becoming easier to access and more liquid at the same time.
These investments aren’t new, but technology has enabled ordinary investors to invest in assets with historically high rates of return and relatively low risk.
Exciting platforms such as real estate and farmland crowdfunding sites harness the crowd to purchase investments not previously available to most investors. Investable business bonds are another modern investing alternative.
These may not sound like guaranteed lifetime income sources today because the platforms are relatively new, and they don’t have the track record to prove it.
But I suspect several alternative investment platforms will continue to provide reliable lifetime income because the underlying assets do have a track record. If you can afford the risk today, alternative investments may pan out into your golden years.
One final idea for creating lifetime income is from business ownership. Now, this comes with some caveats. If you own the business yourself, you probably don’t want to run it for your entire lifetime.
So you’ll need to find someone who can run it for you. Preferably, a part-owner who also benefits from its success.
Family businesses make the most sense for this type of lifetime income. I have a friend who is a third-generation business owner. His Dad is retired and helps out sparingly.
Instead of buying the business outright from his Dad, they have a long-term ownership transfer agreement whereby my friend will pay his father a share of profits for the rest of his life. Upon his father’s death, payments end and the transfer completes.
These kinds of agreements are apparently common with family businesses.
Most of us don’t have this luxury. But some retirees own businesses before and into retirement, including family businesses or franchises. Or buy a business in retirement and pay someone to manage it. Depending on the kind of business and the retiree’s ability to monitor operation, it may be a stable source of income.
In my friend’s case, it’s an extremely profitable, community-based, multi-generational service business with a high barrier to entry. Since it’s a gradual transfer of operation and ownership, the business should continue to run smoothly until the next generation. No guarantees, but likely.
What about Social Security?
A reader pointed out that I initially omitted Social Security from this post. For those of us in the U.S. ‘entitled’ to it, we do technically build it through payroll deductions over many years.
But I’m in the camp of people who don’t account for Social Security when planning for retirement. Though its future is likely certain, and it lasts a lifetime once you start taking it, mathematically, the program is currently not financially solvent.
I’d rather plan for retirement on my own and will consider any government subsidy a bonus.
A Familiar D.C. Story
Mrs. RBD used to work in strategic communications.
While working for a small D.C.-area PR firm, someone came up with the idea to start an industry organization to promote workplace flexibility for government employees.
So they created an entity, drew up some bylaws, and organized a group of founding members who were mostly telecommunications equipment makers trying to sell more to the government.
Mobile working was already gaining steam during the mid-2000s. All the PR firm had to do was convince deep-pocketed companies that the annual fee would help them sell more equipment. Then generate buzz around flexible workplaces in government.
For a small PR firm, it was a great business model, attracting revenue some of the largest companies in America.
However, the value created for members was difficult to measure.
The U.S. government is by far the biggest employer in the D.C. area. But industry organizations attract a lot of money to D.C. from all around the world.
Companies that may be competitors have common issues that affect their businesses. It’s often better to advocate for an entire industry or respond to adverse events as one entity.
For example, if a cruise ship capsizes, the whole industry suffers regardless of which company owns the ship.
Nearly every American micro-industry has a presence in the Capitol region, adding billions of dollars to the local economy. Industry organizations are an unsung employment driver in the D.C. area.
Conclusion – Lifetime Income
Collectively, a diversified portfolio of income-producing assets, be it investments or other income sources, can be designed to provide near-guaranteed lifetime income.
If something cataclysmic happens that destroys the value of all dividend stocks, bonds, real estate, and cash, I’m pretty sure guaranteed lifetime income insurance policies won’t survive either.
Companies can always declare bankruptcy, and the government may or may not decide to bail them out or not.
If this scenario sounds over-the-top, remember back to 2009. Financial products and markets can go haywire.
The key is to accept that risk will arrive in the future and plan for it. Take steps today to reduce your risk through diversification.
Don’t put all your eggs in one basket. Diversify your investments. Spend below your needs today and in retirement to give yourself some wiggle room.
With savvy planning and a diversified approach, you can build lifetime income without buying an annuity.
Photo via DepositPhotos used under license.
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