When it comes to retirement, you need to have enough money coming in to cover your expenses to avoid cannibalizing the principal balance of your retirement savings.
However, not all forms of retirement income are the same in the eyes of the IRS. Some can be partially or even fully taxable, and some can impact the way your Social Security benefits are taxed.
Discover the 9 Things You Need To Know About Retirement Income.
What is Retirement Income
As many Americans are enjoying 20 to 30 years in retirement, it has become imperative for anyone close to retirement age to establish their own streams of income they can count on to cover their living expenses in retirement. That’s basically what retirement income is all about: having enough money coming in to cover your expenses, so that you don’t have to tap into the principal balance of your retirement savings.
Retirement income can come from a wide range of sources, including:
- Social Security benefits
- Annuity payouts
- Retirement or profit-sharing plans
- Insurance contracts
- IRAs, 401(k)s, and 403(b)s
When it comes to retirement income, not all sources will be treated the same by the IRS. Some forms of income in retirement can be fully or partially taxable. That’s why it is important to work with a financial advisor who is familiar with the best ways to generate lasting income for your retirement—while helping you minimizing the amount of tax you’ll have to pay on that income.
What is a Fixed Income Investment
Fixed income investing is an investment approach focused on helping you preserve your capital and generate income in the form of interest or dividends. Fixed income investments can offer a steady stream of income, often with less risk than stocks.
Fixed income investments are ideal for more conservative savers who feel more comfortable knowing exactly what their investments will provide for them in the future. This way, they can know what they have to work with and avoid unnecessary stress. These conservative savers are interest rate investors who mostly place their money in fixed income investments such as government and corporate bonds, preferred stock, Certificates of Deposit (CDs), and money market funds.
Understanding Fixed Income Investments
Fixed-Income investments are debt instruments that have a fixed interest payment and a fixed amount that has to be repaid at maturity (par value). The fixed interest payments are made to investors in the form of coupon payments.
The coupon, or coupon payment, is the interest rate paid to investors, while the par value returns to the investor at maturity—assuming there have been no defaults. Why do they call it a coupon rate?
Well back in the day, when someone would invest in a bond, they would actually receive coupons worth whatever the agreed upon interest payment would be, that would be paid on a fixed schedule. That way, bond holders would know how much they can expect to receive and when they will receive it. And, that’s why many people believe that fixed income investing is such a viable option for retirees.
Something else that makes fixed income investing a good option for investors at or near retirement is the par value. As we mentioned earlier, when you place your money in fixed income investments, you get a par value.
For example, individual Bonds are one common type of fixed-income securities. They have a fixed interest payment and a fixed amount that has to be repaid at maturity—known as the par value.
So, if the market value of an individual bond happens to drop below the par value, bond holders, still receive the par value at maturity. So, for bond holders that plan on holding their bond until maturity, a loss in value is really just a paper loss, since they will still get their par value back at maturity, as long as the issuer is still solvent.
What is an Example of a Fixed Income Investment?
As we mentioned, bonds are one of the most common types of fixed income investments, but there are many other types. In fact, the universe of fixed income investments is actually much bigger than the universe of stock market investments.
One of the first things that comes to mind when people hear the term fixed income investing is government bonds.
Government and agency bonds are debt securities issued by a government to fund government spending. Government bonds that are issued by national governments can be considered lower risk since they are backed by the government that issues those bonds.
For example, debt securities issued by the United States and backed by the U.S Treasury Department include US Treasury Bills, Notes, and Bonds. The main difference between Bills, Notes, and Bonds, comes down to the length of their term:
- U.S. Treasury Bills (T-bills) are short-term debt obligations backed by the U.S. Treasury Department with terms of one year or less.
- U.S. Treasury Notes (T-notes) have stated interest rates that are paid semi-annually until maturity. US Treasury notes are issued in two-, three-, five-, seven-, and ten-year terms.
- U.S. Treasury Bonds are debt obligations backed by the U.S. Treasury Department that have maturities of 10 years or longer.
Types of Fixed Income Investments
Many stock market-based financial advisors will tell you that the best way to achieve your financial goals for retirement is to invest for growth in the stock market. What they won’t tell you is that there’s another way—fixed income investing. That doesn’t mean that you’re limited to investing in government bonds, either.
Besides government and agency bonds, there are many other types of fixed income investments. Here are a few examples:
- Savings Bonds—a type of bond issued by a government that offers a fixed rate of interest over a fixed period of time
- Municipal Bonds—debt securities issued by state and local governments to fund public works including things like parks, roads, libraries, and other infrastructure.
- Corporate Bonds—debt securities issued by corporations.
- Preferred Stock—a class of equities that have a fixed dividend and a par value. So, if the market value of the share drops below the par value, investors will still receive the fixed dividend payment. Also, if that company ever wants to redeem or call those shares, those shares get called back at par value or above.
- Mortgage-Backed Securities (MBS)—comprised of a bundle of home loans bought from the banks that issued those mortgages. Investors who place their money into an MBS receive periodic payments similar to bond coupon payments.
- Business Development Corporations (BDCs)—although BDCs do not have a par value, they do have loans to businesses inside their portfolios, and those loans have a par value.
- Certificates of Deposit—many people forget that CDs are another type of fixed income investment. They pay a fixed rate of interest and once the term of that CD is up, the investor receives all of their principal back.
- Money Market Accounts—sometimes called money market deposit accounts or money market retirement savings accounts, these types of accounts also fall into the category of fixed income investments. They generally offer a higher rate of interest than a traditional retirement savings account, and offer account holders the benefit of occasional withdrawals
When it comes to managing a portfolio of individual fixed income investments, there are a wide range of strategies that investors and their advisors can take to maximize the income generated by their investments.
One such strategy is a laddered portfolio of bonds. A laddered portfolio is made up of individual bonds, where an individual’s investment is split up among different bonds with varying maturities. An investor might choose a laddered strategy to try to maximize the interest generated by their bonds, while minimizing their exposure to interest rate fluctuations.
What is the Average Retirement Income?
According to data gathered in 2017 and compiled in 2018 by the US Census Bureau, the average retirement income for Americans over the age of 65 was $67,238, or $5,603 per month.
In 2019, the average monthly retirement income from Social Security was $1,470, according to the Center on Budget and Policy Priorities. That’s just $17,640 per year in Social Security benefits.
As you can see, there’s quite a difference between the average income from Social Security and the average overall retirement income for Americans over the age of 65. That’s because Social Security was never intended to be the sole provider of income for retirees; it was intended to serve as part of the three-legged stool comprised of Social Security, a pension, and individual retirement savings.
With pensions becoming more of a rarity these days, that means that Americans must now take it upon themselves to make sure to maximize their retirement savings and the benefits available to them through Social Security. That’s where fixed income investing can play a valuable role.
However, in order to get it right, you have to make sure you’re working with a financial advisor who not only understands the complexities of planning and saving for retirement, but also has the knowledge to help you make the most of your Social Security benefits.
Understanding the best time and method to claim your Social Security can be a complex decision, since there thousands of ways for a couple to claim their benefits. To make matters worse, the difference between the best method and the second-best method of claiming your Social Security benefits can mean a big difference on the amount of benefits you’re able to collect.
That’s just one issue you’ll need to address. That’s why when it comes to making sure you’re making the best decisions about your Social Security benefits, you need to speak with a financial advisor who is familiar with navigating the complexities of planning and saving for retirement.
By working with an Income Specialist from The Retirement Income Store®, you can be sure you are working with a financial advisor who is also a fiduciary, and understands the best ways to help you maximize this important resource that can serve as the bedrock for a financially sound retirement.
What is a Good Monthly Retirement Income?
The plain and simple truth is that when it comes to planning and saving for retirement, there is no “one-size-fits-all” solution. It’s the same with the amount of income you will need to enjoy the lifestyle you’ve always envisioned for your retirement.
For example, a certain amount of income might be right for someone who likes to stay close to home and enjoys spending their time gardening. That same amount might not be right for someone who likes to travel and eat out at restaurants quite often.
When it comes to making sure you have the right amount of monthly retirement income, as a general rule, you should be able to satisfy your day-to-day expenses with the interest and dividends from your portfolio without having to tap into your principal. That’s because if you end up having to liquidate shares of your investments to pay for things, especially during a downturn in the market, you could end up cannibalizing your retirement fund.
The worst example of this happens when an investor has to sell shares from a mutual fund to cover expenses during a stock market downturn. Since the value of the shares of that fund will most likely be down, it means the investor will have to sell more shares to get the amount they need to cover their expenses—thus eating away at a greater percentage of their retirement savings.
This is known as “reverse” dollar-cost averaging, and it’s what many consider to be one of the biggest financial mistakes a retiree could make. The good news is that you can avoid these types of situations by working with an advisor who understand the best ways to invest for income.
What Percentage of Income Should Go To Retirement?
Once again, everyone’s situation will call for a different amount, but as a general rule of thumb, you should try to save at least 15% of your pre-tax income towards your retirement. That’s assuming you save for retirement from age 25 to age 67.
But what about if you have a large amount of outstanding debt? Should you still save 15%, or would you be better off paying off that debt first? What about if you didn’t start saving for retirement until age 40?
These are the types of questions that a qualified financial advisor can help you with, preferably one who specializes in helping clients who are at or near retirement.
What Will My Monthly Retirement Income Be?
To find out more about your monthly retirement income and what you can do to help prepare yourself for retirement, click here, fill out the form, and an Income Specialist from The Retirement Income Store® will call you within 24 hours.
Every single Income Specialist who is part of our national network of advisors has been personally mentored by our Founder, David J. Scranton, on the best ways to use fixed income investments to better protect clients from stock market risk and help them establish ongoing streams of income for retirement.