Retirement Income and Investing

The frustrating thing about investments, universally, is the usual way to ensure high returns is to take higher risks. Lower risks generally come with lower payouts.

Figuring out the right balance of risk versus payout is the biggest challenge for any investor. And it’s a particularly critical issue for retirees who can’t afford to lose their savings because they don’t have the time to recover from financial losses.

In general, financial experts advise people saving for retirement to maximize their returns by investing at a risk level they can tolerate. The idea is to build up the largest possible amount of savings.

But the closer you get to retirement, the less you can afford risk. As retirement approaches, you should look to ratchet down the risk so your nest egg is safe.

Stock-heavy portfolios do well historically in the long term, for example, but they can bottom out when the market tanks. And someone needing to live off their savings can’t afford to lose that money in the short term.

Owning a stock means you are a part owner of the company represented by that stock. When the company earns money, it issues dividends to its stockholders.

Investment advisors suggest reinvesting dividends in buying more stock. When people value your stock highly, they pay more for it and your stock’s value increases.

Over time, stocks usually earn higher returns than other investments. But they’re not always predictable and can lose significant amounts of money in the short run. This can be difficult for retirees to absorb when they need to live off their investments.

Another newer investment option that works similarly to investing in stocks is purchasing cryptocurrency. Just like a share of stock, cryptocurrency has a value than can appreciate or depreciate over time within its market, giving you the chance to cash out at a profit. The crypto market is known for its dramatic and volatile swings in both directions.

When governments and corporations need to raise money for operations or projects, they issue bonds. People who purchase bonds are loaning their money to these governments and companies, which pay interest on the loans. The companies and governments promise to repay the loans in specific amounts of time.

Financially sound companies and governments pay lower interest rates on bonds than companies that may be expected to have more trouble with repayment. You should be aware of the bond rating of your investment. Also, longer-term bonds pay higher interest than short-term bonds.

There are also bonds backed by mortgages and bonds that have interest rates reset from time to time, known as floating-rate bonds.

In general, bonds don’t earn as much over time as stocks, but they provide more short-term security and predictability. However, in recent years, bonds have become riskier than they used to be. And their return remains low.

Treasury notes are bonds issued by the U.S. government for terms ranging from two to 10 years. They are considered low risk, and their interest is exempt from state and federal taxes.

However, the rate of return on treasury notes is relatively low. Their stability and safety make them a good option for retirees.

Treasury bills are short-term and often referred to as T-bills. Their terms range from four weeks to a year. They don’t pay interest but are sold at a discount. You might buy a $100 T-bill for $98, and then collect the $100 when the bill matures. These bills pay very low interest.

As their name suggests, Treasury Inflation-Protected Securities, known as TIPS, provide protection against inflation. They also carry lower interest rates to compensate for this protection. These are sold for terms between five and 30 years.

Certificates of deposit, also known as CDs, are a low-risk investment vehicle that allows you to build interest within a fixed term. So, if you invest $10,000 into a one-year CD with a 3% interest rate, you will earn $300 in interest by the time your CD reaches maturity.

Interest rates will vary depending on when you buy the CD, but the average rate is 1.36% for one-year terms in February 2023, according to the FDIC. However, you may find rates as high as 5% during times of high inflation.

The interest rate and maturity date are set when you purchase the CD, and typically, you cannot deposit more money into the CD after you’ve opened it.

There are also several types of CDs to choose from, so it’s important to pick one that suits your financial needs.

CDs can be purchased from a bank, credit union or brokerage firm, and can be insured up to $250,000 depending on where it is purchased. 

Annuities are contracts between you and an insurance company. In exchange for your payments, the annuity provider generally agrees to provide a reliable stream of income to support your retirement.

In general, annuities are insurance against outliving your savings. In fact, research by the nonprofit Employee Benefit Research Institute found that deferred income annuities can “provide an effective hedge against outliving retirement savings.”

Using 20 percent of a 401(k) balance to purchase a deferred income annuity at age 65 and then delaying payments for 20 years results in an overall improvement in retirement readiness when no death benefits are added to the annuity, the institute found.

The report recommended against using 25 percent or more of 401(k) savings, saying this decreases retirement readiness because of long-term health care costs.

Like a lot of other investments, real estate can be risky. In recent years, real estate prices have skyrocketed and crashed. People have gotten rich and have lost everything.

Still, anyone who has owned a home has some understanding of real estate and may feel more comfortable with this as an investment.

If you decide you want to use real estate to fund your retirement, make sure you study and learn the market. You should have a thorough understanding of your own skills before jumping in.

Mutual funds are used to pool investors’ money to purchase financial products such as stocks, treasury bills, bonds or real estate.

By having a variety of products in a mutual fund, the risk can be mitigated. The funds are also managed by professionals who keep track of the performances and buy and sell to get the most advantage for investors.

Companies that manage the funds charge fees of up to 2.5 percent a year. They may also charge for other expenses and fees.

Interest-only retirement is the idea of living solely off the interest of your investments and savings. As you might expect, this concept requires a large amount of savings.

For example, if you have $1 million in savings and can invest in a portfolio that pays 5 percent interest, that gives you $50,000 a year of income, in addition to whatever Social Security income you receive.

But if you have to dip into your savings for any reason, such as medical bills or repairs on your house, then your interest income will diminish for the rest of your retirement.

A general rule for retirees living off savings is to withdraw 4 percent from their retirement account the first year to live on, and to adjust each year after that for inflation. This is known as the 4 percent rule.

Its inventor actually later adjusted it to recommend a 4.5-percent withdrawal the first year. The rule was created based on the performance of various financial portfolios in the past.

The 4 percent rule is designed to allow retirement savings to last 30 years. But it can’t account for changes in the market and interest rates that depart from history.

This rule also limits the amount of your money that you can use to live a comfortable retirement, imposing a frugality that may not be necessary, unless you have a high priority of leaving money to your heirs.

If you need extra income in retirement, one option is to work in a part-time job if you’re able. Although Social Security places some limits on your earnings, the limits apply only before you reach full retirement age. And even before that, the limits may be more generous than you think.

According to the government, if you are collecting Social Security before full retirement age, the government will deduct $1 from your benefit payments for every $2 of your income above the limit. In 2022, the limit was set at $19,560.

The year you reach full retirement age, Social Security will deduct $1 in benefits for every $3 you earn above the limit in the months before you reach full retirement age. This limit was $51,960 in 2022.

After reaching full retirement age, there is no limit to your earnings and your benefits will not be reduced, no matter how much you make.

Since your Social Security benefit is calculated using your highest 35 years of earnings, the government will determine whether your earnings after retirement require your monthly benefits payments to be increased when you reach full retirement age.

After you reach full retirement age, you will also get credit for any months in which your job income resulted in a loss of benefits.

These calculations do not count income from pensions, annuities, investments, interest or government or military retirement benefits.