The idea of having a retirement nest egg of $1 million is a lot of money, but can you make it work these days? Sean Dowling (@seandowlingtv) has more.
Like flip phones and floppy disks, pensions are largely a thing of the past.
According to an analysis from global advisory firm Willis Towers Watson, the percentage of Fortune 500 employers offering a defined benefit pension plan to new hires dropped from roughly 50% in 1998 to just 5% in 2015.
Today’s workers are more often offered a defined contribution plan, such as a 401(k). The difference is evident in the name: A defined contribution plan lets employers and employees contribute to an investment account. A defined benefit plan promises employees a set benefit at retirement and puts the responsibility of providing that benefit — including the investment risk — on the employer.
It’s easy to see why people without pensions are envious of older generations. But it’s still possible to create pension-like income on your own. Here’s how.
Consider an immediate annuity
With an immediate annuity, you give an insurance company a lump sum and receive monthly payments for life. The amount of those payments depends on a few factors, including the size of the lump sum, your age and interest rates.
These annuities can address the fear that your money will dry up, but they aren’t for everyone, says Neal Frankle, a certified financial planner and blogger at WealthPilgrim.com. “The No. 1 problem is that you give up access to that money. If you die tomorrow, it goes away.”
You can structure the annuity so that if you die before receiving an amount equal to the lump sum, the balance goes to your beneficiaries — but electing that option will lower the amount you get each month.
Keep some stocks; start an income plan
Some say that it’s best to invest in stocks only pre-retirement; post-retirement, it’s all about bonds and fixed income. In reality, shunning equities after you’ve stopped working might be one of the quickest ways to run out of money. You need your money to continue to grow in retirement, and stocks provide that growth.
Once you have a properly allocated portfolio, you can work with a financial adviser to create an income plan that details how you’ll approach withdrawals.
A tip from Frankle: Ask to receive monthly distributions. “It’s only natural that when people get to the stage of not getting a paycheck, it’s scary. Rather than setting up a once-a-year withdrawal, set it up so it’s almost like a paycheck.”
Monthly distributions also make it less likely that you’ll pull more than you need from a 401(k) or an individual retirement account. It can be hard to return unused money due to the contribution limits on those accounts.
Bank on your home
If you own your home, you can use a reverse mortgage to take advantage of the equity you’ve built. These mortgages allow you to stay in your home and convert that equity into a stream of monthly payments. As long as you remain in the home, you don’t have to pay back the loan. If you move, sell it or die, the loan is typically repaid from your estate or the proceeds of the sale.
These loans have historically gotten a bad rap due to high costs and variable interest rates, but in recent years, they’ve grown better in these respects. Still — like immediate annuities — they’re not the right choice for everyone. Before you consider one, Frankle suggests another option: downsizing.
“If you need a reverse mortgage, chances are very good you’re living beyond your means, and you’re spending more than is coming in,” he says. “A reverse mortgage doesn’t solve that core problem. Many people would be better off downsizing and reducing expenses.”
Downsizing might not give you additional income, but it does make more of your income available for other expenses.
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Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: [email protected] Twitter: @arioshea.
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