By Jason Epps, CFP®, CRPC®
When you’ve built up a portfolio of investments, the next question that often comes to mind is how to generate income from it. After all, the purpose of investing is not just to accumulate wealth, but also to enjoy the benefits of your hard-earned money. But how do you go about getting income from your portfolio?
Let’s explore 5 strategies and options that can help you generate income from your investments. Whether you’re nearing retirement or simply looking for ways to make your money work for you, understanding how to create income from your portfolio is an important step toward financial stability and success.
1. Determine How Much You Can Safely Spend
Before making any decisions about how to withdraw from your portfolio, it’s crucial to first understand how much you can safely spend. The last thing you want is to spend too much based on a general rule of thumb and risk running out of money later in retirement. There are a number of factors to consider when determining how much you can safely spend, including long-term goals, lifestyle expenses, expected life span, and healthcare needs. Working with a qualified financial professional is a great way to determine the right amount for your needs.
2. Understand the Different Withdrawal Strategies
Once you have determined how much you can safely spend, it’s time to examine the different withdrawal strategies available. In general, there are two main methods for turning your savings into income:
Systematic Withdrawal Approach
With the systematic withdrawal approach, you withdraw a fixed percentage of your retirement savings each year, typically between 3% and 5%. The general rule of thumb is 4% in the first year of retirement and increase the amount each year to account for inflation. The withdrawal rate is based on the value of the portfolio at the start of each year, so the amount of income can fluctuate depending on market performance.
This strategy allows you to generate a steady stream of income while still allowing for flexibility and potential growth of your investments. However, it’s important to monitor the withdrawal rate to ensure the portfolio can last throughout retirement.
Bucket Approach
Another way to optimize your portfolio longevity is to divide your savings into different buckets to match different time horizons. Each bucket will have investments tailored to that time horizon in terms of asset class, risk level, and liquidity.
One common approach is to divide your portfolio into three buckets:
- A short-term bucket will be invested conservatively in cash, bonds, and other low-risk assets. This bucket is for your expenses over the next 1-3 years.
- A medium-term bucket will be slightly more aggressive, investing in a mix of stocks and bonds to generate growth and income over the next 3-10 years.
- A long-term bucket will take on much more volatility by investing primarily in stocks or other growth-oriented assets for expenses that are 10-plus years away.
By dividing your portfolio into buckets, you can potentially generate income from your medium-term and long-term buckets while ensuring you have the funds you need for near-term expenses. Keeping the long-term bucket invested in growth assets also increases your odds of keeping pace with inflation over time.
3. Maintain Tax Efficiency
You may not think much of it, but the order in which you withdraw from your investment accounts can significantly impact the longevity of your portfolio. Your age, tax environment, time horizon, and income objectives ultimately dictate the order at which you should withdraw from your portfolio, however, there is a generally accepted framework. In general, it’s best to spend your taxable accounts first, followed by your tax-deferred (or pre-tax) accounts, and finally your tax-free (Roth) accounts last.
Spending your taxable accounts first can help minimize your tax liability in retirement. This is because withdrawals will be taxed as capital gains rather than ordinary income as long as the underlying investments were held for longer than a year. This strategy also allows your investments to grow tax-deferred longer.
Once you spend down your taxable accounts, you can begin withdrawing from your tax-deferred accounts. Since these accounts are subject to ordinary income taxes, it’s important to plan your withdrawals carefully to minimize the tax hit. Pulling from tax-deferred accounts earlier on can also be a valuable strategy to help reduce the tax burden from future required minimum distributions (RMDs).
Lastly, begin withdrawing from your tax-free accounts like Roth IRAs and Roth 401(k)s. Qualified withdrawals from Roth accounts are not subject to income taxes, making them a valuable source of tax-free income for future use. Keep in mind there are many nuances to when and how to withdraw from accounts with different tax statuses, so it’s important to consult with an advisor to develop a tailored strategy.
4. Consider Annuities
Another strategy used for generating retirement income is annuities. Deferred annuities with living benefit income riders can provide you with a more reliable source of income in retirement. Annuities can be a good option for retirees who want the stability that comes from a consistent income stream. However, it’s important to consider the fees associated with annuities, which can potentially be higher than other traditional investment options. Additionally, it’s imperative to select an annuity that fits your needs and goals, as there are many different types of annuities available with different features and benefits.
Working with a financial advisor can help you determine if an annuity is a good option for you and which type of annuity is best suited for your retirement income plan.
5. Don’t Forget About Long-Term Growth
Many people are quick to assume that retirement means your portfolio must become ultra-conservative, consisting only of cash and bonds as a way to safeguard against market volatility. While your portfolio should become slightly more conservative, you may still need assets geared toward long-term growth.
As tempting as it is to invest solely for income, you may want to avoid investing your entire portfolio in income-producing assets like bonds or dividend-paying stocks. The interest payments received can fluctuate wildly from year to year and your payments are unlikely to keep up with inflation.
Those looking to maximize their retirement savings should consider investing in a diversified portfolio that includes both income and growth-style investments. Of course, the specific allocation that’s right for you depends on your individual financial goals, risk tolerance, and other factors. This is something our team can help you determine.
We Can Answer Your Retirement Questions
Navigating the shift from saving for retirement to using your retirement savings can be daunting, particularly for pre-retirees and retirees, who may not have a well-defined withdrawal strategy.
At KFA Private Wealth Group, we understand the unique challenges you may face and are here to assist you. Our team can evaluate your retirement income requirements and create a customized plan to optimize your savings. Take control of your retirement journey today by emailing jepps@kfapwg.com or call 571-386-2022 to schedule an appointment and explore the possibilities for your financial future.
About Jason
Jason Epps is vice president and private wealth advisor at KFA Private Wealth Group, a registered independent advisory firm founded on the premise of providing sound financial and investment advice. With over 17 years of experience, Jason possesses the unique knowledge and expertise necessary to provide his clients with the financial guidance to help them find confidence in their financial future. Jason is a CERTIFIED FINANCIAL PLANNER™ practitioner and a Chartered Retirement Planning Counselor℠, CRPC®, and believes that a financial plan is only as strong as the advisor’s understanding of the core values and beliefs of each client. He serves a diverse range of clients, from young accumulators to pre-retirees and retirees, including business owners and professionals in a variety of fields.
Jason graduated cum laude from Mount St. Mary’s University, where he currently serves on the university’s Board of Trustees. While at Mount St. Mary’s, Jason played four years of Division I college basketball. In his spare time, he enjoys traveling, trying new restaurants, and cheering on the local D.C. sports teams. To learn more about Jason, connect with him on LinkedIn.
