Income, Income, Income
By Joe Allaria
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In the good old days, many people were fortunate to retire with a pension that provided guaranteed income for the rest of their lives. Today, that is not the case. Fewer companies are offering defined benefit plans, (pensions). As a result, you are responsible for building your own retirement plan to make sure you do NOT outlive your money, which happens to be a chief concern of many pre-retirees I meet. Fortunately, there are plenty of options to choose from. Here are just a few:
You may be familiar with the concept of a bond. You loan a company, government institution or municipality a lump sum of money. In return, that institution agrees to pay you interest payments at a stated interest rate (coupon rate) and that will serve as an income stream for you for over a certain period of time. At the end of that period of time (usually 10-30 years), that institution will return your principal to you and those interest payments will terminate. Bonds can be a very useful source of income. The pros are that bonds can offer decent interest rates while generally not being considered “risky” investments. If interest rates drop before your bond’s maturity date, your bond will be worth more if you sell at that time.
The cons are that bonds often have lengthy time commitments. And if interest rates go up before your bond matures and you need to get to your principal, your bond will be worth less than what you purchased it for. Also, only certain bonds offer a guarantee on your principal and interest payments. Even highly rated corporate bonds have left investors high and dry if those companies fail or declare bankruptcy (i.e. Lehman Brothers, Washington Mutual, General Motors). Investors should be aware of where interest rates are heading before investing in a bond.
Preferred stocks and dividend-paying stocks could be another positive source of income. On the positive end, preferred stocks offer dividend potential as well as the potential for capital appreciation. Preferred stocks offer liquidity as well. At any time, you could sell some of the shares you own if you need extra cash on hand.
The cons of preferred stocks are simple. Your money is invested in the stock market and is at risk. Based on the stock price and what happens in the market, you could lose any amount of your principal at any time. Also, your dividends are not guaranteed and could decrease or terminate at any time. It’s important to understand these things so that you are properly allocated in a way that reflects your goals and risk tolerance.
Fixed/Fixed Indexed Annuities (FIA)
An annuity is a contractual agreement between you and a life insurance company and there are tons of different types of annuities (fixed, variable, indexed, immediate, etc.). The pros for using an annuity for income are that fixed annuities provide guarantees. Annuitization payments can be set up for a “period certain” payout or can be sometimes be paid out with a lifetime guarantee based on the annuitant’s age.
Fixed or fixed indexed annuities can be great for taking care of fixed living expenses because they provide guaranteed income. They can also be effective for individuals who do not own a pension or individuals who are looking for a consistent income stream they can never outlive. Since annuity guarantees are backed by the financial soundness of the issuing company, make sure you check out strength ratings before you purchase any annuity.
The cons are that annuities are also long-term agreements (usually 5-15 years). There is limited liquidity offered with an annuity and taking all of your money out early could come with surrender charges.
Identify your lifestyle goals, find out how much you would need in a monthly income stream to live and do the things you want to do in retirement, and educate yourself on all of the options available to you. If you work with a financial adviser, find one that understands income planning, Social Security and is obligated to find the best option for you based on what YOU need!