During your working years, your largest income stream is generally from employment. When you retire, however, your income will likely need to come from a variety of sources, such as retirement accounts, after-tax investments, Social Security, pensions or even continued part-time work.
For those looking to create a retirement income stream, there are a variety of strategies available depending upon your specific income needs and lifetime goals. Two simple retirement income strategies include the total return approach and the bucket approach.
Total Return Approach to Retirement Income
The total return approach is probably the best-known strategy. With this approach, assets are invested with a focus on diversification, using a portfolio of investments with a varied potential for growth, stability and liquidity, based on your time horizon, risk tolerance and need for current and future income. There are three defined stages within this approach, which are contingent upon how near you are to retirement:
- Accumulation phase: During peak earnings years, the objective is to increase total portfolio value through long-term investments that offer growth potential.
- Pre-retirement phase: As you approach retirement this should include a gradual move toward a more balanced growth and income-based portfolio, with an increased allocation toward stable and liquid assets as a means of preserving your earnings.
- Retirement phase: Once retired, maximizing tax-efficient income while protecting against principal decline may result in a portfolio heavily weighted toward income-producing liquid assets.
Pros and cons: The benefit of adopting the total return approach is that, as a rule, the portfolio should outperform one that is heavily weighted toward income generation over a longer time frame. The largest disadvantage of this approach is that it takes discipline. It is important to remember that the appropriate withdrawal rate should depend upon your personal situation and the economic environment, though many advisers suggest starting with a withdrawal rate of 3%-5%, which may then be adjusted each year for inflation.
Bucket Approach to Retirement Income
This approach behaves similarly to the total return approach throughout the accumulation phase, but as you enter pre-retirement, you divide your assets into smaller portfolio “buckets” with each holding investments geared toward different time horizons and targeted to meet different needs. Generally there are three common bucket types based upon specific needs, but you are certainly not limited to just these three:
- Safety bucket: This bucket is set up to cover a period of about three years and focuses on relatively stable investments, such as short- to intermediate-term bonds, CDs, money market funds, bond ladders and cash. This portfolio is designed …….