For those who don't have a traditional pension they can count on, turning retirement savings into income can be a tricky proposition. The financial industry has come up with several strategies and products to help the average Jane and Joe produce income from savings pooled in 401(k)s, IRAs or other retirement vehicles.
You can use annuities, which are mutual funds designed to produce retirement income or a withdrawal strategy to milk income from your investment portfolio. If you tap into your savings, experts recommend withdrawing no more than 4 percent of the total amount annually. That amount could be lower or higher, depending on how many years the portfolio needs to last as well as estate planning considerations.
"Morningstar has done some good work on withdrawal rates of portfolios and they say there is an 83 percent chance that you will not run out of money -- or put it another way, a 17 percent chance that you will run out of money if you need to withdraw from a portfolio made up of 75 percent stocks and 25 percent bonds at a rate of 5 percent for 25 years," says James Parks, a CFP from North Haledon, N.J., and member of the Financial Planning Association.
"So that is kind of a scary thing," he says. "People may be retired for more than 25 years, and you're starting with a 17 percent chance of running out of money."
The objective is to make the money last as long as you do. What's best for you depends on your age, goals and tolerance for risk. You might strongly consider hiring a financial planner for guidance.
Immediate annuities guarantee payments for a certain amount of time, usually until you die. Basically, you hand over a lump sum to the insurance company and they start giving it back to you right away in monthly installments. If you die the next day, they generally keep all or part of the money, but if you hang on for another 40 years, the payments will continue until you draw your last breath.
"That's really all it is," says Certified Financial Planner Eric McClain, with Clark Financial Advisors in Birmingham, Ala. "You're trading a block of money for a lifetime stream of income and they come in many different flavors. For instance, inflation-adjusted or not-inflation-adjusted. And they might have a joint provision or a return-of-premium provision."
The joint provision means the income payments continue until the death of the second spouse, though the dollar amount of the monthly payments will be lower than for a single life. A return-of-premium provision means that besides getting a guaranteed payment for life, the recipient's beneficiaries will get back at least the amount of the premium paid in the event of the recipient's premature death. You can also get annuities where income payments go to beneficiaries for a certain term, such as 10, 15 or 20 years.
Immediate annuities can offer a fixed rate of return or a variable rate of return. Fixed-rate annuities carry a fixed interest rate while variable rate annuities are invested in stocks, mutual funds and bonds and can fluctuate in value.