In an ideal world, you'd know exactly how much income you could count on after you retire. But even as traditional sources of guaranteed income dry up fast, some alternatives you can use aren't giving you the results you'd want. To earn enough income, you need to do some creative thinking.
Big changes, big problems
Retirement is already a lot different from what it looked like a generation ago. Back then, workers could count on their employers to give them monthly pensions to supplement their Social Security payments. That gave many workers enough money in combined monthly payments that you didn't even have to have accumulated much of a retirement nest egg on the side. As long as those payments were coming in, you had enough to cover all but the biggest financial emergencies.
Now, though, it's mostly up to you to figure out where to get your supplemental income during retirement. Most workers can't count on their employers to provide a pension, as 401(k) plans and similar new arrangements force workers to be responsible both for accumulating enough of a nest egg to provide for their retirement as well as figuring out how to turn that nest egg into a stream of ready cash to meet living expenses after they retire.
Recently, the government has started pushing people toward buying immediate annuities with their retirement savings in order to replace the guaranteed income that employer pensions used to provide. Yet the financial policies that those same government entities are supporting make immediate annuities a less than perfect solution to retirees' income woes.
The mechanics of annuities
Immediate annuities look like a great answer to meet income needs. In exchange for a payment upfront, you can lock in a fixed monthly payment for the rest of your life. Other choices let you provide for a spouse or others after your death, although payments will be smaller than if you're the only one receiving them.
The problem, though, is that the payout you receive is tied to where interest rates are at the time you buy the annuity. With the Federal Reserve's low-rate policy, monthly payments from immediate annuities are relatively low. Put another way, for every dollar of income you want to guarantee for the rest of your life, you have to pay much more for it when interest rates are low than when they're higher.
So if annuities aren't necessarily the smart move right now, what's a better choice? Buying bonds presents the same concerns: If interest rates rise, then you could either suffer loss of principal or be stuck earning low rates until your bonds mature.
A conservative allocation to some higher-yielding investments, however, may give you some relief. Let's look at some of the choices available:
- Real estate investment trusts (REITs) are specialized investments that own pools of assets related to various real-estate interests, including commercial and residential properties. Some of the top-yielding REITs come from the mortgage sector, where Annaly Capital Management (NYSE: NLY ) and American Capital Agency (Nasdaq: AGNC ) have earned big profits by investing in mortgage-backed securities and pay double-digit yields back to shareholders.
- Master limited partnerships capitalize on the energy sector to produce cash flow. Kinder Morgan Energy (NYSE: KMP ) and Enterprise Products Partners (NYSE: EPD ) , for instance, operate pipelines that earn revenue from energy companies transporting their oil and gas to market. Their 6% yields are largely protected from fluctuations in energy prices.
- Even among blue-chip stocks, you can find great income producers. Philip Morris International (NYSE: PM ) and Altria (NYSE: MO ) are two complementary halves of a global tobacco empire, with Altria focusing on the U.S. market and Philip Morris reaching out to the rest of the world. Kimberly-Clark (NYSE: KMB ) , meanwhile, makes consumer products that millions of people rely on. All of them have dividend yields above 4% and have a track record of raising those payouts from year to year.
Find the right balance
Of course, retirees shouldn't put all of their money into risky assets like stocks. The 2008 market meltdown reminded everyone of just how much damage a bear market can do even to conservative investments.
But putting all your money into an immediate annuity right now would be an equally dangerous move. Locking in income at today's low rates could create a financial catastrophe for you down the road. The best approach mixes annuities with other investments to create an income stream you can live with.
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