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How to Build Passive Income for Retirement

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Planning for retirement involves more than just saving enough money—it’s about creating retirement income strategies that will provide a sustainable stream of income that will last through your non-working years. That requires strategic planning ahead of time, so you know what to save, how to invest, and ultimately what being financially prepared for retirement looks like.

What Are Your Retirement Income Goals?

Before looking at strategies, first define what your retirement income goals are. Retirement doesn’t look the same for everyone, and income needs during non-working years vary. You can only begin strategizing once you know the target.

Rather than arbitrarily picking a number that sounds good, think about what you’re hoping to do. What lifestyle would you like? Where do you want to live, and do you need to buy a house? Any hobbies or travel that you’ve been looking forward to doing? How about major expenses like healthcare and long-term care? What do you want your financial legacy to be like?

Answering questions like these will help you define goals, and then you can calculate how much your retirement will cost.

How Much Will Retirement Cost?

Estimating the cost of retirement is complex and influenced by many factors, not the least of which are your answers to the questions above. You should also take into account inflation, unexpected costs, and taxes when determining how much you’ll need.

The following is a general guide that you can follow to get a rough estimate of your retirement costs:

  1. Living Expenses: Start by estimating your living expenses. The 80% rule is a general rule of thumb that suggests your retirement living expenses might be about 80% of your current living expenses. Yours could be more or less. A budget, cost of living calculator, and other precise numbers will yield a more accurate estimate.
  2. Discretionary Expenses: Add on any hobbies, trips, or other fun that you’re looking forward to. Some of this might already be included in living expenses if you currently travel or enjoy a hobby. Many retirees take up new (and sometimes expensive) hobbies or take once-in-a-lifetime trips, though.
  3. Medical Expenses: You might consider major healthcare costs separately from regular income, but you do need to account for routine medical expenses. Include health insurance premiums, copays, coinsurances, and non-covered expenses. These are often different during retirement than when working. 
  4. Inflation: You’ll need to account for inflation, which has been variable in recent years. A financial advisor can review historic inflation data with you, and make an informed guess as to future inflation rates.
  5. Housing Costs: If you plan on relocating or downsizing, determine what your future housing costs might be. These could include a mortgage, property taxes, home insurance, maintenance, and other housing expenses.
  6. Paid-Off Debt: If you have any major expenses that’ll end, make sure they’re included in your calculations. Some retirees pay off debt, a mortgage, or other debt, before they stop working.

You should also take into account major healthcare costs, long-term care costs, and any legacy you hope to leave. These might be considered major costs that you need to save for, as opposed to ongoing retirement expenses you need regular income for.

Your total estimate will only be as accurate as the numbers you use. A financial advisor can help you calculate these different factors as precisely as you can. If you don’t have a financial advisor to assist with this process, our financial advisor matching tool can pair you with a qualified advisor who knows how to calculate retirement costs.

How Will You Pay for Retirement?

Most retirees draw from multiple income sources to cover their retirement expenses. You might rely on:

  • Social Security: Social Security is likely the most common income stream for retirees in the U.S. The longer you delay taking payments, the more you’ll probably receive per month (up to age 70). A Social Security calculator or financial advisor can check how much you should expect.
  • Pension: If you have one, then a pension can account for a good portion of your retirement income. These are becoming less common, though. HR should be able to detail how much your pension should pay.
  • Personal Investments: Your own investments may provide ongoing income if you withdraw from them in a responsible way. Target a sustainable withdrawal rate, which would let you take withdrawals but not actually reduce principal.
  • Other Income: Some retirees have passive income sources that will continue during retirement. Include any book royalties, oil royalties, land lease payments, structured settlement, or other less common income sources that you rely on.
  • Part-Time Work: Part-time work isn’t a bad way to supplement income during retirement. You might command top dollar as a consultant in your field. Alternatively, you might look for a job at a travel destination or one that serves as a creative outlet. A more physical job could help you stay in good health.

Determining What You Need From Your Portfolio

Many retirees don’t fully fund their retirement without using at least some of their investment portfolio. 

To determine how much income you need from your portfolio, subtract your estimated expenses from your anticipated income sources. You’ll likely have a negative amount, which is the amount you need from your portfolio.

8 Strategies to Generate Income in Retirement

There are several ways of setting up your investments for regular withdrawals or income. You could use one or several of the following methods.

1. Sustainable Withdrawals

You simply take withdrawals from your portfolio. Your withdrawals are within an estimated sustainable withdrawal rate. This is an amount that’s expected to be covered by your portfolio’s continued returns. 

A common guideline is a withdrawal rate of 4%, which should be sustainable based on historical data. Depending on your situation, your investments, and market conditions, you might want to use a higher or lower withdrawal rate. A financial advisor can help you decide what rate is right for your portfolio.

Advantage: Taking sustainable withdrawals means that you don’t necessarily need to change your investments. For example, you may still focus on growth but also access income.

Disadvantage: Investments carry risk, and your portfolio balance could go down. Historic data isn’t a guarantee of future results.

2. Dividend Payments

Some retirees prefer to focus equity (e.g. stock) investments in dividend stocks. This can be done by purchasing individual stocks with long dividend histories, or mutual funds focused on dividends.

With this strategy, you typically leave the stock alone but use the dividend as income.

Advantage: Dividend stocks tend to be more stable than growth stocks, and long dividend histories are often fairly reliable (although not guaranteed).

Disadvantage: Dividend stocks are still stocks that can decrease in value. Their potential growth tends to be lower than that of growth stocks.

3. Bond Payments

Bonds can be used similarly to dividend stocks. The bond itself is left alone, while the interest paid is used as income. The bond amount can easily be reinvested once a bond reaches maturity.

As an added benefit, U.S. Treasury bonds usually aren’t subject to state income tax (federal still applies). 

You can do this with certificates of deposit (CDs) as well, but bonds might pay slightly higher interest rates. 

Advantage: Most bonds that retirees use are essentially guaranteed, and some of the most secure investments you can hold.

Disadvantage: Bonds typically don’t appreciate like dividend stocks or other investments can. Although they technically can increase or decrease before maturity, most retirees hold bonds until maturity when the principal paid is returned.

4. Annuities

Annuities usually provide predetermined payments while also offering some growth potential.

There are many different types of annuities, including life annuities, lump sum annuities, fixed annuities, and variable annuities. These vary in how payments are disbursed and how potential returns are calculated. 

A financial advisor can help you determine which kinds of annuities might make sense for you. To speak with a financial advisor who knows annuities, you can find a financial advisor that we at Invested Better work with.

Advantage: The combination of potential growth and regular payments is attractive to many retirees.

Disadvantage: The growth potential is often capped, and some annuities come with notable fees.

5. Real Estate

Real estate properties can be leased out for regular rental income. Rent generally needs to cover all costs associated with a property, but any additional rent could be used as income.

Owning rental properties diversifies into the real estate market. Additionally, rentals may appreciate in value, provide tax benefits, and generate regular income. (Although there’s a long track record of most real estate appreciating, property values can also go down.)

Advantage: Diversifying into real estate can better stabilize a portfolio that largely consists of stocks and mutual funds, in case there’s a market correction.

Disadvantage: Rentals require a more hands-on approach than dividend stocks or bonds, even if you hire a property management company.

Alternative Investment Income Sources

In addition to the more traditional investment income sources, there are some others. These alternative investment income sources aren’t as widely recommended or available, but they have their place in some retirees’ income strategies.

6. Reverse Mortgage

Part of your equity in a residence is transferred to a reverse mortgage company, in exchange for a lump sum or ongoing payments. 

This allows retirees to leverage what’s often their most valuable asset, their home. Most reverse mortgages have long — but finite — terms, and it’s possible to outlive a reverse mortgage. No retiree wants to be forced out of their house because a reverse mortgage ends.

7. Business Venture

If you currently hold an interest in a business, your share could generate regular income through distributions. 

This is usually only available to entrepreneurs who have successful businesses. Many entrepreneurs would rather sell their share for a lump sum, rather than keep it for regular distributions. It can take a while to find someone who’ll buy a small business, though.

8. Life Settlement

A life settlement lets retirees sell their life insurance policy, in exchange for a lump sum payment. The buyer then takes over the policy, being listed as the beneficiary and paying premiums. 

The amount paid for a life insurance policy depends on a retiree’s age and health, as well as the life insurance policy. You’ll also receive only a portion of the policy’s face value.

This can be a good way to utilize a life insurance policy that you’d otherwise not benefit from. It means that your heirs will receive much less, however. 

How Financial Advisors Can Help You Reach Your Retirement Income

A financial advisor can help you with each step of strategizing how you’ll pay for retirement. They have the expertise necessary to estimate retirement costs, determine your income sources, and structure your investments accordingly. With their aid, you may be set up well for retirement.

To find a financial advisor who can help you develop a retirement income strategy, use our free financial advisor matching tool.

General Disclaimer: The information provided on this site is for informational purposes only and should not be construed as financial advice. Invested Better does not guarantee the accuracy or completeness of the information provided. Please consult with a licensed financial advisor before making any financial decisions.

Investment Risk Disclaimer: Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results.

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