7 Strategies To Generate Sufficient Cash Flow In Retirement
The question I receive most from soon-to-be retirees is “where should I invest my money to generate sufficient income in retirement?” The focus on generating a high level of income may have been appropriate in decades past when rates were at more reasonable levels. For many investors, simply laddering a portfolio of government or AAA municipal bonds may have been sufficient to live comfortably in retirement. However, with current rates at historic lows, folks may need to rethink the question of high income and instead focus on cash flow.
The distinction between income and cash flow is important. Generating income in retirement is focused on finding investments that pay a high yield, which necessarily means taking on more risk. Focusing instead on cash flow allows investors to take a broader perspective, assessing various aspects of their finances to determine how to creatively produce the money required for expenses. Cash flow strategies may allow retirees to reach their financial goals while not necessarily taking on a higher level of risk.
Below are seven areas for consideration to help investors address their cash flow needs in retirement.
1) Work longer: The first, and most obvious, method of improving one’s cash flow in retirement is to work longer. Retiring from your job later or continuing to work part time enables retirees to delay relying primarily on their investment portfolio to pay their bills. Holding off on tapping into one’s investments has a dual benefit. It allows one’s investments to continue to grow for longer. Compound interest will have a longer time to work its magic on your nest egg. The second benefit is shortening the time horizon for needing to rely on the investment money. If one retires at 65 and anticipates living another 30 years, that’s quite a long time to draw down on one’s portfolio. However, if the same person continued to work part time until 75, he’d only need to rely on the investment money for a 20 year time horizon. That 10 year difference can relieve a tremendous amount of financial pressure.
It’s also important to consider the non-financial benefits of working longer. It provides daily structure, social interactions, and intellectual stimulation. All three of these factors can help keep one healthy for longer and may minimize lifetime healthcare related expenses as well.
2) Nontraditional investments: The days of purchasing AAA municipal bonds and living off the interest are over. Yields are too low on asset classes that have long been popular amongst retirees. However, if you are willing to consider other areas of the market, there are attractive yields available.
Asset classes with relatively high yields, even in this market, include high yield corporate and municipal bonds, international and emerging market debt, Real Estate Investment Trusts (REITs), Master Limited Partnerships (MLPs), preferred stocks, non-traditional lending, international dividend paying stocks, option strategies and others. Investors need to understand that these yields are high because they carry more risk than traditional high-grade fixed income. The risk may come in the form of illiquidity, default, high volatility, or all three. Exclusively chasing high yielding investments is ill-advised and may derail your finances. Investors should work closely with a knowledgeable financial advisor or tax professional to determine how these investments make sense within the context of their overall portfolio and help determine the amount of risk.
3) Total return approach: Interest and dividend payments are not the only way to generate cash flow. Investors can also sell their appreciated stocks to help meet their income needs. Supplementing dividend and income payments with long-term capital gains is known as a “total return” approach. In recent years, with the markets hitting all-time highs and yields continuing to fall, this has proven to be a strategy worth considering.
Investors can implement this strategy through annual portfolio rebalancing. They’d sell stocks that have gone up, pay long-term capital gains tax, and use the proceeds to meet their financial expenses. This rebalancing strategy has the added benefit of keeping the overall portfolio allocation in line with the investor’s risk tolerance. If a position grows too large, trimming that position should help bring the portfolio back to its original allocation and minimize overconcentration in one security.
4) Social Security strategies: A strategic, well-thought-out approach to claiming social security can make a meaningful difference on your cash flow for the rest of your retirement years. When deciding how and when to claim your benefits it’s important to evaluate your earnings history. This can be done on the social security website. Your spouse’s earnings history and age will also impact the decision, as would any considerations from a divorce.
A professional advisor may provide useful guidance on the optimal strategy for claiming your benefits. One option is deciding to wait until one’s full retirement age (or later) to claim social security benefits in order to receive higher payments for the rest of your life. There are not many things in the realm of financial planning that can be considered “guaranteed”, but increasing your cash flow by delaying social security is one of them.
5) Alternative financial resources: There are some less common ways to generate cash flow that may be worth considering. One example is a reverse mortgage, which is available to homeowners aged 62 or older. The homeowner can borrow against the equity they have in their home and receive funds as a lump sum, fixed monthly payment, or line of credit. The homeowner does not make any loan payments. Rather, the entire loan balance becomes due when the homeowner dies, moves away permanently or sells the home.
This can be a useful approach for those with a home but few other financial assets. However, there are a lot of considerations when it comes to reverse mortgages and it’s imperative that investors understand that it is not a good option for everyone.
Another alternative income source to consider is the cash value in one’s life insurance policy. If you no longer have a need for life insurance, it’s worth evaluating the level of cash in the policy against the fees and process to take it out. This may provide retirees with another pool of assets to meet their financial goals.
An added benefit of both of these approaches is that they can help mitigate sequence of returns risk in retirement. Sequence of returns can be a risk if one retires at the start of bear market. In that case, the portfolio is falling in value while the investor is withdrawing funds, which can have a devastating effect on one’s long-term financial future. The ability to use money from a reverse mortgage or life insurance cash value can minimize this risk impact by providing a financial cushion and requiring a smaller portfolio withdrawal during a market downturn.
6) Utilize an annuity to offset risk: Annuities provide the unique benefit to investors of transferring certain risks to an insurance company. Offsetting risk provides guarantees to the client such as lifetime income, death benefit, principal protection, and tax deferral on nonqualified assets. Annuities should be viewed as long-term financial products and are typically purchased five to ten years before retirement.
Various products such as variable annuities and fixed index annuities can provide the client with lifetime income. One popular income generating annuity amongst retirees is a Single Premium Immediate Annuity (SPIA). For a SPIA, you pay an insurance company a lump sum premium upfront in exchange for the guarantee of periodic payments to you for life. Purchasing a joint annuity guarantees the income stream for life for both you and your spouse. Knowing that certain basic expenses will be covered through guaranteed income can offer retirees a great deal of comfort. An added benefit of transferring some risk to an insurance company is expanding the investor’s flexibility to take on more risk in other parts of their portfolio to potentially achieve a higher rate of return. This can be beneficial for leaving a legacy for one’s heirs.
As with other financial products, it’s important for investors to perform due diligence before entering into an annuity contract. Annuities have a bad reputation from their jungle of high fees, moving parts, and lack of transparency. While those are true concerns, an appropriate annuity product can be an immensely beneficial component of individual retirement plans under the right set of circumstances. However, purchasing an annuity when it is an inapposite solution can be a very costly mistake.
7) Geographic arbitrage: If you spent most of your career in a large and expensive city, geographic arbitrage may be a lifestyle change worth considering. The concept is to take advantage of one’s higher career earnings associated with living in cities (e.g. New York or San Francisco) by retiring to a location where the cost of living is cheaper, including lower real estate prices and taxes. For those who are open to retiring abroad, there may be a benefit from capitalizing on the strength of the US dollar relative to the local currency. The decision to relocate to cheaper pastures can help your nest egg last longer.
One of the most important traits amongst successful investors, and the advisors who serve them, is the ability to adapt. The financial planning landscape, and markets in general, change overtime. Today’s high-flying stocks may not be the winners of tomorrow. Financial products are constantly being innovated. Tax laws evolve over time. Current low yields may linger for a long time or may shoot up in in a few years. As long as investors are willing to tweak their financial plan based on market dynamics, they will be positioned for the highest probability of financial success regardless of the challenges that lie ahead.
Disclaimer: This article authored by Jonathan Shenkman a financial advisor at Oppenheimer & Co. Inc. The information set forth herein has been derived from sources believed to be reliable and does not purport to be a complete analysis of market segments discussed. Opinions expressed herein are subject to change without notice. Oppenheimer & Co. Inc. does not provide legal or tax advice. Opinions expressed are not intended to be a forecast of future events, a guarantee of future results, and investment advice. Any payment guarantees are based on the claims paying ability of the insurance company. Adtrax #:3291280.1