How to Turn Savings into Retirement Income
Robert had spent 35 years contributing diligently to his 401(k). After his retirement last month, he felt proud seeing that final statement showing $850,000 in savings. Now sitting in his kitchen with a calculator, reality was setting in. How exactly do you turn a lifetime of savings into a monthly income that can last 20 or 30 years?
This transformation from accumulation to distribution represents one of retirement’s biggest challenges. After decades of saving, the time comes to actually start spending down the assets you’ve accumulated, while making them last a lifetime. It’s a mindset shift that requires strategy, planning, and often professional guidance.
There are manageable approaches to convert your savings into steady, reliable income. The key is to understand your options and create a plan that matches your needs, risk tolerance, and longevity expectations.
The “Three Legs” of Retirement Income
Most successful retirees build income from multiple sources, creating what financial counselors call a “three-legged stool” of retirement security. According to Federal Reserve data, 80% of retirees had one or more sources of private income beyond Social Security.
1. Social Security
While Social Security forms a financial foundation for most retirees, it will probably make up only a portion of total retirement income needs.
It’s important to note that if you decide to start collecting benefits before your full retirement age (which ranges from 65 to 67, depending on the year you were born), there’s a major drawback to consider: Your monthly retirement benefit will be permanently reduced.
2. Employer-Sponsored Retirement Plans
While Traditional pensions are becoming rarer, 56% of retirees still receive pension income.
In a traditional pension plan (also known as a defined benefit plan), your retirement benefit is generally an annuity, payable over your lifetime, beginning at the plan’s normal retirement age (typically age 65). Many plans allow you to retire early (for example, at age 55 or earlier). However, if you choose early retirement, your pension benefit is actuarially reduced to account for the fact that payments are beginning earlier and are payable for a longer period of time.
Without a traditional pension, prioritizing 401(k) and similar accounts can be a smart employer-sponsored alternative.
3. Personal Savings and Investments
Your personal savings are funds that you’ve accumulated in tax-advantaged retirement accounts like 401(k) plans, 403(b) plans, 457(b) plans, and IRAs, as well as any investments you hold outside of tax-advantaged accounts.
The idea is that you want to maximize the ability of your personal savings to provide annual income during your retirement years. This type of savings can act as a buffer between your projected annual income need and the funds you may receive from Social Security and pensions.
The 4% Rule: A Starting Point, not a Destination
The traditional 4% withdrawal rule suggests withdrawing 4% of your retirement portfolio in the first year, then adjusting for inflation annually. So, someone with $800,000 would withdraw $32,000 in year one, then adjust that amount for inflation in subsequent years.
This rule emerged from historical market analysis showing that portfolios could sustain 4% withdrawals for 30 years in most market conditions. However, the 4% rule has significant limitations in today’s environment.
With bond yields below historical norms and life expectancies increasing, retirees face new challenges in generating sustainable income.
Creating Your Bond and Dividend Income Foundation
Fixed-income investments can offer a measure of stability and predictable income, which some retirees may find appealing. Treasury and corporate bonds typically pay interest on a set schedule, and dividend-paying stocks can help supplement income.
However, the value of these investments and the income they produce may fluctuate with market conditions. A diversified approach across multiple dividend-paying investments helps reduce this risk.
Annuities: Converting Savings to Guaranteed Income
Annuities allow you to convert a lump sum into guaranteed monthly payments, similar to creating your own pension. While annuities have gotten mixed reviews due to high fees and complexity, they can play a valuable role in retirement income planning.
The primary benefit of annuities is longevity protection. You can’t outlive the payments, which provides peace of mind for people worried about running out of money. However, annuities typically offer limited liquidity and may not keep pace with inflation unless you purchase inflation riders.
Managing Risk: The “Bucket” Strategy
One of the biggest threats to retirement income isn’t average investment returns, but the sequence of those returns. Experiencing poor market performance early in retirement can reduce a portfolio’s ability to sustain income over time, even if long-term returns are favorable.
This is why many retirees benefit from a “bucket strategy” approach to help manage this risk:
Bucket 1
Contains about 1-2 years of expenses in cash or short-term bonds. This provides near-term liquidity and may help reduce the need to sell long-term investments during market downturns.
Bucket 2
Holds 3-10 years of expenses in intermediate-term bonds and conservative investments. This bucket may help balance income needs with moderate growth potential.
Bucket 3
Includes long-term growth investments like stocks and real estate. These assets can carry higher risk but may offer greater potential for growth to maintain purchasing power over a longer retirement period.
As you spend from Bucket 1, periodically refill it from Buckets 2 and 3, ideally selling assets that have performed well. This approach helps manage sequence of returns risk while maintaining long-term growth potential.
Planning for Healthcare and Long-Term Care Costs
Healthcare represents one of retirement’s largest and most unpredictable expenses. Health Savings Accounts (HSAs) provide excellent tools for managing healthcare costs in retirement. HSA funds can pay for Medicare premiums, long-term care expenses, and other qualified medical costs. After age 65, non-medical withdrawals are taxed as ordinary income but aren’t subject to heavy penalties.
Long-term care costs can quickly deplete retirement savings. Long-term care insurance or self-insurance strategies should be part of your retirement income planning.
Creating Your Personal Income Strategy
Your retirement income strategy should evolve as circumstances change. Market conditions, health issues, family situations, and spending patterns all influence optimal withdrawal approaches.
“Turning savings into reliable retirement income requires a personalized approach that considers your unique circumstances, risk tolerance, and income needs,” says Joanne Farace, Senior Vice President, Investments at David Lerner Associates.
“It’s not about finding the perfect strategy; it’s about creating a flexible plan that adapts to changing circumstances. Regular reviews and adjustments help ensure your strategy remains appropriate for your situation.”
Start by calculating your essential expenses and how much income you’ll need from Social Security and pensions. Then determine how much additional income your savings must provide.
Consider working with an investment counselor who specializes in retirement income planning. The complexity of investment options and withdrawal strategies often benefits from professional guidance, especially given the permanent nature of many retirement income decisions.
The transition from saving to spending represents retirement’s biggest financial challenge, but with proper planning and professional guidance, your savings can provide decades of financial security and peace of mind.
Material contained in this article is provided for information purposes only. It is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities. These materials are provided for general information and educational purposes, based on publicly available information from sources believed to be reliable. We cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.