This is kind of like asking “Who makes the best pizza in Chicago?”, Ask 5 people and you are bound to get 5 different opinions.
So let’s look at 3 common ways that people get income from their retirement accounts. We’ll also look at the Pros and Cons of each, and then you can decide.
1) Put your money in the bank and live off the interest
This is the most conservative approach. Many seniors who remember hard times seem to go with this one. I knew a really nice lady named Mildred who just passed away at age 96 and this is what she did.
It’s not a bad strategy if you can get 5% interest at the bank.
The obvious problem right now is that the banks are not paying much interest at all. With 1 year bank CD’s paying 0.20% and 10 year bank deposits paying around 1.0%, you cannot generate enough income without dipping into principal.
The more you dip into principal, the less money you have earning future interest and you get on the slippery road to running out of money, or getting less future income which will affect your lifestyle.
Summary: Put your money in the bank and live off the interest
- Safety. You have FDIC insurance
- You know exactly what interest rate you are going to get
- It’s pretty simple
- Doesn’t generate enough income currently
- If you withdraw too much principal you start the slippery slope of running out of money
- Tough to keep pace with inflation
- Interest is taxable even if you don’t spend it
2) Keep your money in mutual funds or managed accounts and take withdrawals
While you are working, many people have a 401k or IRA. They add money to it over time and invest the money in the mutual funds that are offered in the plan.
The goal is to grow the money over time so you have a nest egg when you retire.
But is this a good income strategy for after you retire?
A general rule of thumb has been:
- Keep your money in mutual funds after you retire
- Start withdrawing 4% per year as retirement income
This is called the 4% Rule or the Prudent Man’s Rule.
As long as the stock market cooperates and goes up, this strategy can work out well. It could allow you to take out income, and pass along a balance to your family when you pass away.
The problem with this strategy is a lack of guarantees and certainty.
Recently, academics have done studies on how safe the 4% Rule actually is for retirees.
In this study from The Journal Of Financial Planning titled “Can We Predict The Sustainable Withdrawal Rate For New Retirees”, they determined that 4% withdrawals cannot be considered safe. They say that starting at a 2% withdrawal is better.
In this article “4% Rule Called Into Question” you can see a bunch of advisors, all with different opinions on how much the withdrawal should be. It’s like the “Who has the best pizza in Chicago question?” Only the retirement income question has more severe consequences if you are wrong.
Summary: Keep your money in mutual funds and take withdrawals
- If the market keeps going up you can take your withdrawals and pass some money on to your kids
- It’s fairly flexible meaning you are not locked into anything
- The growth of the market in many time periods, has beat inflation
- No guarantees on income
- No guarantees on principal (you can lose money)
- May have to adjust income downward or stop it all together if investment returns are bad
- Taking income out of an account that is going down accelerates the decline
3) Build Your Own Personal Pension With an Annuity
Even just the word itself, “Annuity”, seems to disgust and revolt certain people. In the past, the biggest complaints about annuities have been:
- There are big penalties
- There is no liquidity if I need my money
- The fees and expenses are too high
- I lose control of my money
- If I die, my family doesn’t get anything
So, over the past few years insurance companies have worked to improve their retirement income products. What they have come up, fixes many of those complaints listed above.
Because of these improvements, billions of dollars of IRA and 401k money are going into a product called an Indexed Annuity with an Income Rider.
I call them Hybrid Personal Pensions.
They do some things that the older annuities could not do and they can make sense for a portion of your money.
To learn more about how Hybrid Personal Pensions work, watch this 8 minute video called “Paycheck For Life” by clicking here.
Summary: Build your own personal pension with an annuity
- Protect Your Principal
- Growth Potential With Downside Protection
- Stay in Control of your money
- Contractually Guaranteed Income For Life
- Long Term. Plan on a 7 to 12 year contract.
- Some limits on liquidity
- Don’t get all the up’s of the market
- Income Rider has a cost
- Surrender penalties if you get out of the contract early
So what’s the “best” way to get income from your IRA? I’ll let you decide.
In my mind it comes down to this.
Do you want guarantees, or not?
Click here (Carl Ostenson) to see more of this author’s articles.
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