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Retirement Income Planning: The Basics

By Dan Caplinger - Nov 27, 2012 at 2:00PM

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Make sure you have enough money when you retire.

After spending your entire career preparing and planning for retirement, you might feel like when you retire, you deserve just as much of a break from all the financial planning you've had to do along the way as you do from your day job. But when your job ends, the work of retirement income planning begins, and these days, it's more challenging than ever to make your portfolio pay you the income you need to make ends meet after you retire.

But even in a low-interest rate world, retirement income planning doesn't have to be complicated. By mixing and matching elements from the three strategies discussed below, you can count on having cash available to cover living expenses without having to sacrifice your entire financial plan.

1. Hold onto dividend stocks longer.
Until recently, conventional wisdom suggested that by the time you retired, you should have a much less aggressive allocation to stocks in your portfolio. Yet with many retirees facing 20 or even 30 years ahead of them, eliminating growth prospects from your investments is a big mistake.

Moreover, these days, conservative stocks have the added benefit of paying healthy dividend yields. In the past, you could expect bonds to pay more in income than stocks, because bonds didn't have growth potential that stocks offered investors. Therefore, investors demanded more income to offset the lack of growth.

Nowadays, though, you can find many stocks that yield more in dividends than bonds issued by the same company. Nucor (NUE 3.51%), Philip Morris International (PM -1.02%), and Pfizer (PFE -0.15%) are just a few of the stocks with long track records of rising dividends (when you include Philip Morris' former parent, Altria) whose yields exceed that of their corporate bonds. Holding onto relatively safe stocks like these isn't as secure as holding Treasuries or bank CDs, but it'll help put more money in your pocket.

2. Look at return of capital as an option.
For many investors, the one rule to follow is never to spend down principal. But that can be a mistake if it pushes you into high-income securities that aren't safe.

Increasingly, a variety of investments offer stable payouts regardless of how much income the underlying portfolio produces. For instance, closed-end funds Adams Express (ADX 2.51%) and Petroleum & Resources (PEO 2.07%) both established guidelines calling for distributions of at least 6% annually, despite the fact that their holdings fail to produce anywhere near that much cash. In essence, part of the dividends you get from these funds is a return of your principal, but it's done in a way that is predictable. That's especially useful if you're living on a fixed income and need to be able to count on money coming in.

3. Build a cushion.
One thing many retirees learned during the market meltdown in 2008 is that they had no choice but to sell stocks at low prices to provide income. But if they'd built a cash cushion, they could have avoided that fate, instead waiting out the bear market and replenishing reserves when stocks had rebounded.

A cash cushion can have anywhere from two to five years of expenses available. Although that cash obviously doesn't earn a high return, having it available prevents you from having to sell other assets when you don't want to. Consider having a cash cushion as insurance against market crashes.

4. Be smart with retirement accounts.
After accumulating assets in IRAs and other retirement accounts for decades, your retirement is when you should start drawing income from them. But keep in mind that deciding how much to take and which accounts to draw from can have tax consequences.

In particular, pulling money out of traditional IRAs and 401(k) plans boosts your taxable income. That in turn can have collateral effects, including making more of your Social Security benefits subject to income tax, or pushing you over certain thresholds for higher tax brackets or the loss of certain tax advantages. If you have a Roth IRA, on the other hand, those withdrawals are usually tax-free. By managing where you get money from, you can make sure you won't increase your tax bill more than you'd expect.

Get planning today
The best time to plan for your retirement income is before you retire. By setting up your portfolio to make a seamless transition into retirement, you can ensure that you won't have to shift gears abruptly and throw your investments into chaos.


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Stocks Mentioned

Pfizer Inc. Stock Quote
Pfizer Inc.
$53.91 (-0.15%) $0.08
Nucor Corporation Stock Quote
Nucor Corporation
$137.74 (3.51%) $4.67
Philip Morris International Inc. Stock Quote
Philip Morris International Inc.
$106.97 (-1.02%) $-1.10
Adams Diversified Equity Fund, Inc. Stock Quote
Adams Diversified Equity Fund, Inc.
$16.72 (2.51%) $0.41
Adams Natural Resources Fund, Inc. Stock Quote
Adams Natural Resources Fund, Inc.
$23.17 (2.07%) $0.47

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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