If you’re currently in your 60s or early 70s, there’s a good chance you’ll need to generate retirement income for 20 to 30 years. If you take care of your health and have above average income and educational attainment, you could easily live into your 90s or even reach age 100.
As a result, it’s a good idea to plan as if you’ll need to generate sufficient retirement paychecks to meet your living expenses for a long retirement. Your goal should be to build a portfolio of retirement income that lasts the rest of your life, no matter how long you live, and hopefully protects against inflation and stock market crashes, which are inevitable over a long period.
Such a portfolio would include maximized Social Security benefits, a pension if you have one, and possibly a lifetime annuity, which you could purchase using a portion of your savings. All these sources are guaranteed to be paid to you for the rest of your life, no matter how long you live, and they can be a good source of paying for your basic living expenses—your “needs.”
For this post, let’s focus on investing a portion of your retirement savings to generate a variable retirement paycheck that has the potential to grow to protect against inflation. You could use this paycheck to pay for your discretionary living expenses—your “wants.” An important part of this strategy is developing a careful plan to withdraw from your savings so that it lasts for the rest of your potentially long life.
Investing for a long retirement
If you have a sufficient floor of guaranteed retirement income that won’t drop if the stock market tanks (see the examples above), then you could invest a substantial portion of your remaining retirement savings in investments that have provided returns that have outpaced inflation over long periods of time. Examples include low-cost mutual funds that invest in stocks and real estate investment trusts (REITs), which are offered by many 401k, 403b, and 457 plans. If your retirement savings are currently in an IRA, many large financial providers offer low-cost index funds with these investments.
Another possibility is to buy and hold Treasury Inflation-Protected Securities (TIPS). These investments pay interest every six months and also adjust the principal amount for increases in the Consumer Price Index (CPI), so you realize a positive return above inflation. For example, interest rates for 10-year TIPs have recently ranged from 1.5% to 2.0% that are earned in addition to the inflation adjustments.
Many 401k, 403b, and 457 plans offer funds that invest in TIPS. If you’re investing with an IRA, you can only buy TIPS in the secondary market through a brokerage firm. However, if you’re investing outside an IRA, you can also buy TIPS directly from the TreasuryDirect.gov website. In this case, the earnings are subject to federal income taxes each year but not to state and local income taxes.
Withdrawal strategies for a long retirement
Deciding how much to withdraw from your retirement savings to generate a regular retirement paycheck is a “pay me now or pay me later” proposition. If you’re planning as if you’ll live for a long time, it’s smart to start off being cautious when making withdrawals in the early years of your retirement, and then increase your withdrawals later if your savings have grown.
Determining your withdrawal amounts using the IRS requirement minimum distribution (RMD) is one technique that accomplishes this goal. The RMD isn’t required until age 72, but you can use the same methodology for earlier ages using tables that publish the withdrawal rates. For example, the current withdrawal rates using the RMD methodology are 2.9499% at age 65, 3.4247% at age 70, and 4.0650% at age 75.
Research I conducted at the Stanford Center on Longevity in the past few years analyzed the RMD as a viable retirement withdrawal strategy that generates a retirement paycheck for the rest of your life while often providing growth to protect against inflation. The forecasts in the report my colleagues and I published projected the retirement paychecks that were expected to keep up or exceed inflation up to age 99 under different investment scenarios.
When you use the RMD as a withdrawal strategy, you’d determine the amount to withdraw for the coming year by applying the withdrawal rate applicable for your age to the value of your assets at the beginning of the year. As a result, your withdrawal amount could fluctuate from year to year, increasing if your investments have grown sufficiently but also decreasing if your investments lose money. That’s why it’s important to have a floor of guaranteed retirement income that provides a steady source of retirement income.
The strategies described here can be used by “do it yourself” retirees who have money invested in 401k, 403b, and 457 plans or IRAs without needing the help of a financial advisor. However, you may want to work with a retirement advisor who is trained in retirement income strategies and is paid to have no financial conflicts so they can have your best interests at heart.
You’ll enjoy the years ahead if you spend the time now to build a portfolio of retirement income that can last a long time. By doing so, you won’t need to worry about reaching your 80s or 90s with no savings left and needing to rely on family and friends for support.