Retirement means freedom from work, but it also means living on a fixed income for an extended period. Since you don’t want to run out of money too soon, you need a plan to make your nest egg last as long as possible.
Everyone’s situation is different, so retirement income strategies will vary. Here are eight common strategies that retirees use to make the most of their savings.
1. The Bucket Strategy
The bucket approach divides retirement savings into three buckets based on when you’ll need access to the money. The goal is to balance investment growth with easy access to funds.
- The first bucket holds emergency funds and money for living expenses or major purchases in the next few years. Keep this money in a high-yield savings account so it remains liquid and isn’t affected by market fluctuations.
- The second bucket is for money you’ll use in the next 3 to 10 years. Place these funds in safe investments like bonds or certificates of deposit (CDs). Once the first bucket is depleted, you can sell assets from the second bucket to replenish it.
- The third bucket contains money you don’t plan to use for at least 10 years. Invest this money in stocks and other assets with higher growth potential. Periodically, sell some of these assets and reinvest them in safer investments for the second bucket.
2. Systematic Withdrawals
With the systematic withdrawal method, you withdraw a fixed percentage of your retirement savings in the first year and increase it annually to keep up with inflation. One common rule of thumb is the 4% rule, which suggests limiting your annual withdrawals to 4% of your nest egg.
While this rule works in some cases, it has limitations. It assumes investment performance and retirement duration that may not apply to everyone. If your investments take a big hit, you may need to reduce withdrawals, while strong returns may allow you to withdraw more. Use the 4% rule as a starting point but explore different scenarios to determine the best withdrawal rate for you.
3. Annuities
An annuity is a contract with an insurance company where you pay a lump sum, and in return, the company sends you guaranteed monthly payments for the rest of your life.
There are different types of annuities. Immediate annuities start payments right after a lump sum is paid, while deferred annuities allow you to pay now and start receiving payments after a few years.
Annuities provide a guaranteed retirement income in addition to Social Security, but they’re not for everyone. They often have high fees, may not offer as high returns as other investments, and can be difficult to exit once purchased. Consider all these factors before deciding if an annuity is right for you.
4. Maximizing Social Security
The Social Security Administration provides guaranteed income in retirement, but your benefit amount depends on your earnings history and the age at which you start claiming benefits. To receive your full benefit amount, you must wait until your full retirement age (FRA), which is 66 or 67, depending on your birth year.
If you claim early at age 62, your benefits will be reduced. If your FRA is 67, you will only receive 70% of your scheduled benefit if you start at 62. However, if you delay claiming, your benefit increases. If your FRA is 67, waiting until age 70 could result in 124% of your scheduled benefit.
5. Earning Money After Retirement
To supplement retirement savings, you can continue working part-time. This strategy helps if you fear running out of money too soon and can also keep you active and engaged.
If you don’t want to work, consider other income sources like renting out property or investing in local businesses. Keep in mind that these earnings may be taxable, so you should set aside money for taxes to avoid overspending.
6. Tax Efficiency
Different types of savings accounts are taxed differently, and understanding these tax rules can help you keep more of your money.
- Withdrawals from traditional tax-deferred accounts (like traditional IRAs and 401(k)s) are subject to income tax.
- Withdrawals from Roth IRA and Roth 401(k) accounts are tax-free, as long as you’ve held the account for at least five years and are at least 59½ years old.
- Withdrawals from a taxable brokerage account may be subject to long-term capital gains tax, depending on your income.
Each year, consider your tax bracket and adjust your withdrawals accordingly. If you’re close to reaching the top of your tax bracket, rely more on Roth savings to minimize taxes. In low-income years, you might convert some of your tax-deferred savings into a Roth account to avoid future tax burdens.
Additionally, keep an eye on Required Minimum Distributions (RMDs), which start at age 72. Failing to withdraw enough from your tax-deferred accounts can result in penalties.
7. Health Savings Account (HSA)
A Health Savings Account (HSA) is primarily designed for medical expenses but can also be used for non-medical expenses in retirement.
- Before age 65, non-medical withdrawals incur a penalty.
- After age 65, non-medical withdrawals are taxed as ordinary income, similar to traditional IRAs, but medical withdrawals remain tax-free.
- HSAs also have no RMDs, meaning you aren’t required to withdraw a certain amount each year.
To contribute to an HSA, you must have a high-deductible health plan (HDHP). The contribution limits for 2020 and 2021 were:
- Individuals: $3,550 in 2020 and $3,600 in 2021
- Families: $7,100 in 2020 and $7,200 in 2021
8. Downsizing
Downsizing reduces living expenses and helps stretch your retirement savings. You might:
- Move into a smaller home
- Relocate to a cheaper area
- Rent out extra space to offset costs
However, consider whether downsizing makes financial sense. If home values have risen significantly, selling and moving elsewhere may not save much money.
Not all of these strategies may appeal to you, but using a combination of them can help extend your retirement savings. Take time to evaluate your options, and your transition into retirement will be smoother.
