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Academics and financial professionals have extensively analyzed the concept of an optimal retirement portfolio withdrawal rate, and the consensus often hovers around 3% to 4% of the initial portfolio plus an inflation adjustment each year. This figure, which includes any dividends and interest you receive, represents the percentage of a portfolio's value that experts generally believe you can safely withdraw yearly in retirement in average market conditions. Everyone's situation is different and your spending might be higher or lower.
If you withdraw significantly more than 4%, you could increase the risk of running out of money later in retirement. But if you need more income, consider the following seven ways to potentially boost your income and maximize assets.
1. Act Your Tax Bracket
When you are working and are in a higher federal income tax bracket, holding tax–free investments may make sense. Yes, taxable investments might offer higher yields, but once you factor in the taxes involved, those types of investments could leave you with less money in your pocket. If you are interested in figuring out the tax equivalent yield for a municipal bond, first determine the reciprocal of your tax rate (i.e., 1 – your tax rate). Then divide this reciprocal into the yield on the municipal bond to find out the tax–equivalent yield. For example, if you have an income tax of 32%, then your reciprocal would be 0.68 (i.e., 1 – 0.32). If you have a municipal bond yield of 5%, the tax equivalent yield is 7.35% (i.e., 0.05 divided by 0.68).
Once you are retired, that may no longer be true, since you will likely be in a lower tax bracket. Would taxable investments give you more after–tax retirement income than tax–free investments? Maybe it's time to run the numbers to see and speak with your tax advisor.
2. Smooth Your Income
Once retired, you will likely have more control over your annual taxable income. You may have a pension, Social Security retirement benefits, or the dividends and interest generated by your taxable–account investments. You may also need to take required minimum distributions from any Traditional IRA and certain other types of retirement accounts after you turn age 72, to avoid tax penalties.
But that may still leave you with a fair amount of financial flexibility, and you might want to discuss your situation with a tax professional. For instance, in years when your taxable retirement income is relatively low, you might consider seizing the opportunity to realize capital gains or consider converting part of your Individual Retirement Account to a Roth IRA.
3. Spread It Around
A diversified portfolio is important at any time in your life and retirement is no different. While a diversified portfolio will not completely relieve you from the market's ups and downs, it could reduce your risk by spreading your portfolio over many asset classes and sectors. A retirement portfolio composition may include developed market stocks and high–quality bonds, both in the United States and overseas. Depending on your appetite for risk and your needs, you may also consider higher risk investments.
A diversified portfolio is important at any time in your life and retirement is no different. While a diversified portfolio will not completely relieve you from the market's ups and downs, it could reduce your risk by spreading your portfolio over many asset classes.
4. Cut Costs
You could also potentially accumulate more for retirement and increase retirement income by favoring lower–cost investments. That might mean thinking about exchange–traded funds (ETFs) or mutual funds with lower annual expenses and paying careful attention to the mark–up on individual bonds and lower commissions. Keep in mind that lower expenses and fees do not guarantee that an investment will generate income.
5. Look into Lifetime Income
It might be risky to use a retirement withdrawal rate higher than 3% to 4% because of the danger that you might outlive your savings, and even then, the rate may need to be adjusted depending on market conditions. But what if you could somewhat reduce that longevity risk? One approach to consider is the creation of a lifetime stream of income through an annuity. For example, with immediate fixed annuities, you contribute a lump sum of money to an insurance company in return for a check every month for the rest of your life, the rest of two lives, or for a certain number of years, depending on the option you select. Keep in mind that there are fees and expenses associated with annuities which may be higher than for other types of investments, so be sure to inquire about them. In addition, bear in mind that guarantees, including interest rates and subsequent payouts, are based on the claims–paying ability of the issuing insurance company, among other risks.
An income annuity may pay you more than 4%. With a single–life income annuity, the older you are when you purchase it, and the higher the prevailing level of interest rates, the more income you may receive. But that income comes with a big risk: If you die at a relatively young age, you will have received relatively little income in return for your big annuity contribution. However, in exchange for a lower monthly payment, there are several income annuity options that allow you to pass on income to beneficiaries. There are other ways to potentially generate income through bond portfolios or other income-generating investments, all of which carry various degrees of risk.
6. Wait a While, Maybe
A withdrawal from a retirement account before the age of 59 1/2 in most instances will result in a penalty assessment unless an exception applies. For example, early withdrawals from an IRA account before age 59 1/2 would be penalty-free in the case of certain medical situations or qualifying first time home purchases or college tuitions. You should consider consulting your tax advisor before an early withdrawal.
If distributions are made as part of a series of substantially equal periodic payments over your life expectancy, certain taxes may not apply, but there are additional requirements and restrictions.
You could also increase your retirement income by waiting a little longer up to your full retirement age to claim your Social Security retirement benefit. Indeed, you can think of Social Security as similar to a lifetime–income annuity. You might be able to claim Social Security as early as age 62 and as late as age 70. Delaying can boost your monthly benefit. But as with the single–life income annuity, that increased Social Security benefit comes with risk: If you die early in retirement, you may have missed years of Social Security checks and received little or nothing in return. You also should keep in mind the potential for the federal government to alter the rules and payouts on Social Security.
7. Think About Getting a Job
Consider the benefits of working part–time in retirement. You can supplement your Social Security benefits or income annuity, or perhaps delay withdrawals if your part–time salary sufficiently covers your expenses. Working part–time will keep you busy and active in the community. There may be a job you are passionate about and will enjoy, along with the extra income. If you are younger than the full retirement age and you decide to both collect Social Security and work, your benefits may be reduced, so check with the Social Security Administration.