We all know that there is no one-size-fits-all retirement. You may want to travel the world. Your neighbor may want to garden and read. Likewise, there is no one-size-fits-all retirement plan. Finding the right mix for you depends on a myriad of factors including your savings, expenses, health, family, and values.
The good news is that whatever your situation, you can help improve your retirement readiness (and potentially your retirement lifestyle) by learning about 3 essential building blocks for retirement income plans. Combining them can provide a combination of growth potential, guaranteed income,1 and the flexibility to adjust as your needs change, or life throws a curveball.
We believe a solid retirement income plan should provide 3 things:
- Guarantees to ensure core expenses are covered
- Growth potential to meet long-term needs and legacy goals
- Flexibility to refine your plan as needed over time
1. Use guaranteed income1 to help pay for your essential expenses
When you create your plan, first and foremost, you'll want to make sure your day-to-day expenses—nonnegotiable costs, such as housing, food, utilities, taxes, and health care—are covered by lifetime guaranteed income sources. There are essentially 3 sources of guaranteed income.
Social Security: This is a foundational source of income for most people. When you decide to take it may have a big impact on your retirement. It can be tempting to claim your benefit as soon as you're eligible for Social Security—typically at age 62. But that can be a costly move. If you start taking Social Security at 62, rather than waiting until your full retirement age (FRA), you will receive reduced monthly benefits. (FRA ranges from 66 to 67, depending on the year in which you were born.) If you wait until age 70 to claim, you'll receive your highest possible monthly benefits. Find out your full retirement age, and work with your financial professional to explore how the timing of your Social Security benefit fits into your overall plan.
Pensions: Although pensions used to be commonplace, they aren't so much anymore. Indeed, only about 13 million currently employed people have a defined benefit pension plan in the US, according to the Pension Benefit Guaranty Corporation.2 If you're one of those people, you'll want to weigh the pros and cons of how you withdraw the money—as a lump sum or stream of income. If you don't have a pension, there are other ways to create a pension-like stream of income.
Income annuities: An income annuity is a contract issued by an insurance company that, in return for an upfront investment, guarantees1 to pay you (or you and your spouse) a set amount of income either for the rest of your life (and the life of a surviving spouse in the case of a joint and survivor annuity) or for a set period of time. Generally, there are different types of income annuities you may consider:
- immediate income annuity
- deferred income annuity
- annuities with a guaranteed lifetime withdrawal benefit (GLWB)
Each allows you to buy an annuity now that would provide payments for the rest of your life to supplement retirement income and to manage longevity risk. Immediate income annuities begin paying income immediately; deferred income annuities start at a date you determine in the future. Fixed payments continue and don't decrease regardless of what happens in the financial markets.
There are a few things to keep in mind, though. You may give up access to the savings you use to purchase an immediate or deferred income annuity, so you'll need to have other money available for unexpected expenses.
When you purchase an annuity with a GLWB, your future income amount can increase on each contract anniversary for a set period of time or until your first lifetime withdrawal begins, whichever comes first. Some annuities with a GLWB are based on a fixed rate, while others may allow growth via an underlying investment option similar to a mutual fund. Either way, you are guaranteed a minimum income stream that will pay you, or you and a spouse, for life.
Lastly, fixed immediate or deferred income annuities do not offer market exposure: You invest in them for the sole purpose of getting guaranteed income. A variable annuity3 with a GLWB offers exposure to the market and lifetime income payments, typically for a fee. There is a trade-off, as the initial income amount for a fixed income annuity is typically higher; however, a variable annuity with a GLWB could exceed the cash flow generated if the market performs well.
Tip: While each type of annuity can offer an attractive blend of features, work with your financial professional to help determine which annuity or a combination of annuities is appropriate for you in building a diversified income plan.
Read Viewpoints on Fidelity.com: Create income that can last a lifetime
2. Seek growth potential to meet your long-term needs
As you build your income plan, it's important to include some investments with growth potential that may help keep up with inflation through the years.
You'll want to consider how you can pay for those fun things you've always dreamed about doing when you finally have the time—things like vacations, hobbies, and other nice-to-haves. It's a smart strategy to pay for these kinds of expenses from your investments. That's because if the market were to perform poorly, you could always cut back on some of these expenses.
It's important to consider a mix of stocks, bonds, and cash that takes into account your time horizon, financial situation, and risk tolerance for market shifts. An overly conservative strategy can result in missing out on the long-term growth potential of stocks, while an overly aggressive strategy can mean taking on undue risk during volatile markets.
Creating and managing your investments in retirement requires some effort along with the discipline to stay on plan even during volatile markets. You need to carefully research investment options and choose ones that match your goals. You also need to monitor your investments, and rebalance the mix of stocks, bonds, and cash when needed. It’s important to manage taxes on your investments too.
An employer stock plan may also help fund your retirement, but don’t forget these investments often trigger an income tax event, which can affect Social Security payments, and other aspects of your retirement plan. So always include your stock awards in your planning with your financial professional.
Tip: If you don’t have the time or inclination to manage your own portfolio, a professionally managed account might be a better option.
3. Be flexible and refine your income plan over time
You want to have a plan that can adapt to life's inevitable curveballs. Five years into your retirement, you might receive an inheritance, have your parents move in, or experience another significant life event. When these things happen, you need a plan that gives you the ability to make adjustments along the way.
That's why it's important to combine income from multiple sources to create a diversified income stream in retirement. Complementary income sources can work together to help reduce the effects of some important key risks, such as inflation, longevity, and market volatility.
For example, taking withdrawals from your investment portfolio gives you the flexibility to change the amount you withdraw each month, but does not guarantee income for life. On the other hand, income annuities provide guaranteed income for life, but may not offer as much flexibility or income growth potential.
Tip: Flexibility may also be important when you begin to take required minimum distributions (RMDs) once you reach age 73, starting in 2023 (and, in 2033, age 75). If you're planning to spend your RMDs to cover your ongoing retirement expenses, you may want to work with a financial professional to determine tax-efficient ways to take those withdrawals, year after year.
A note on principal preservation As part of your overall financial plan, you may also wish to preserve some principal for use in an emergency or to leave a legacy for heirs. You can accomplish this separately from, or in conjunction with, a diversified income plan.
But remember, investments that aim to preserve your principal,4 such as money market funds, CDs, or Treasury bonds, come with a different sort of risk. These investments generally offer relatively low yields—and your principal might not be large enough to generate enough income from interest or dividends to fund your desired retirement lifestyle. Plus, if you invest too conservatively, your savings may not grow enough to keep pace with inflation.
Understanding the tradeoffs as you build your income strategy
Everyone's situation is unique, so there’s no one income strategy that will work for all investors. You'll need to determine the relative importance of growth potential, guarantees, or flexibility to help you pinpoint the strategy that is right for you in retirement. Of course, there are tradeoffs. For instance, more growth potential can mean settling for less guaranteed income. With more guarantees, you get less growth potential and less flexibility. If you have an employer stock plan then there are the risks of concentrated positions to compare against the benefits of potential long-term incentives. Consider, too, your family's history regarding longevity and whether you plan to leave a legacy to your heirs.
5 steps to consider
So, how do you get started? Here are 5 steps to consider taking to help create a diversified income plan:
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