Americans are living longer these days, and while that's a good thing in theory, it poses a certain challenge from a retirement savings perspective. Since the typical senior can't survive on Social Security alone, it's critical to develop an income strategy for retirement. Here, we'll review some of the best ways for retirees to generate income when they need it the most.
1. Max out your 401(k) or IRA
One of the best ways to guarantee monthly income in retirement is to save enough during your working years to allow for generous monthly withdrawals. Whether you have an IRA or an employer-sponsored 401(k), maxing out your contributions will give you the most flexibility when the time comes to use that money.
Currently, workers under 50 can contribute up to $5,500 a year to an IRA and $18,000 to a 401(k). If you're 50 or older, these limits increase to $6,500 and $24,000, respectively. And though most workers can't easily max them out, saving even a small amount each month can produce some pretty significant results, provided you start early enough and invest that money wisely.
Imagine you're able to sock away $300 a month for retirement starting at age 30. If you invest in stocks and your portfolio delivers an average annual 7% return, you'll be sitting on $577,000 by age 67. On the other hand, if you wait until age 45 to start saving, all other things being equal, you'll end up with only $176,000 -- still more than respectable but not nearly as impressive as $577,000.
2. Invest in dividend stocks
You'll often hear retirees being advised to move away from stocks because of their volatile nature. And there's some truth to that -- overloading your portfolio with stocks puts you at risk in the event of a major market downturn. But if you hold dividend stocks in retirement, you'll get the benefit of quarterly payments that can serve as a steady source of income.
Of course, not all dividend stocks are created equal, and you'll want to choose companies with a solid history of rewarding investors. But if you focus on the right dividend stocks, you'll have a means of generating income even during periods when the market performs poorly on a whole.
3. Buy municipal bonds
The beauty of bonds is that barring defaults, which are rare among highly rated issuers, you'll get a reliable stream of income in the form of semiannual interest payments. And while there's nothing wrong with investing in corporate bonds, municipal bonds offer the added benefit of interest payments that are always tax-exempt at the federal level. If you buy bonds issued by your home state, you'll avoid state and local taxes as well.
Now if you're not worried about taxes in retirement, you may want to look at corporate bonds, which traditionally offer higher yields. But if you're looking for a way to bring in some income without increasing your tax burden, municipal bonds are the way to go.
4. Purchase an annuity
Many of today's employees aren't eligible for pensions, which is a shame because that means missing out on guaranteed income for life. If you're looking for a pension substitute of sorts, you might consider buying an annuity.
An annuity is a contract between a purchaser and an insurance company. Typically, you'll pay a certain sum of money in exchange for regular payments, either immediately or in the future. Though there are different types of annuities, a fixed-income annuity is a good way to generate virtually guaranteed income, either for the rest of your life or for a preset period of time.
Now the reason that income is "virtually" guaranteed versus "absolutely" guaranteed is that annuities are only as good as the companies that sell them. If you're going to go this route, you'll need to vet your annuity provider, or consider divvying up your investment dollars among a few different insurance companies to increase your chances of ultimately getting paid.
There are a lot of different avenues you might explore for generating monthly retirement income, so the more planning you do, the better you're likely to fare once your career comes to a close. If you've yet to do much thinking about retirement, now's the time to sit down with a financial advisor or map out a strategy of your own. Your future self will thank you for it.