Investment Options to Generate Income in Retirement | U.S. Bank (2024)

The average life expectancy for a person who reaches age 65 in the U.S. is roughly 85 years.¹ And that’s just the average.

About one out of every three 65-year-olds today will live past age 90, and about one out of seven will live past age 95.¹ If you plan on retiring in your 60s, as many people do, you still need to make your retirement savings last almost 30 years. That’s a lot of pressure to place on a traditional retirement account.

Social Security retirement benefits, which tend to play a more important role for lower wage earners, will replace only about 40% of your pre-retirement earnings; for a retiree who earned $100,000 a year, Social Security will only replace 33% of their pre-retirement earnings. You'll need to supplement your benefits with a pension (if available), savings or investments.

Retirees seek part-time employment for all kinds of reasons, including the financial and mental benefits of staying active and involved in their communities. Still, it’s important to have a plan in place for generating additional income during your retirement and making sure future income streams can keep pace with rising living costs.

“People are realizing that they can reduce volatility in their portfolio while generating more competitive income in today’s interest rate environment,” says Rob Haworth, senior investment strategy director at U.S. Bank. “In light of the significant upturn in interest rates, investors building a retirement income strategy need to reconsider their options.”

Here are four common investment options to help you generate income in retirement, listed generally in order from lower to higher risk.

1. Income annuities

An income annuity is a contract between you and an insurance company where you pay a sum of money, either all at once or monthly, in exchange for regular income payments. Annuities can help you set up a guaranteed income stream for a certain period of time or for the rest of your life. You can also choose to have this income paid through your own lifespan or through the lifespan of you and another person (e.g., your spouse).

You pay a specified amount to an insurance company with the understanding that funds will be distributed to you either immediately or at a later date, depending on the type of annuity it is. While the money is held by the insurance company, it has the potential to accrue on a tax-deferred basis. When you start taking disbursem*nts, you can choose a specific dollar amount regularly or adjusted for inflation. A financial professional can help you determine which type of annuity best fits your needs.

Annuities may provide safety, long-term growth and income for a portion of your retirement assets. Retirees often use annuities to supplement other guaranteed sources of income (such as Social Security) to offset non-discretionary expenses. Since they provide income guarantees, they're often considered as a form of insurance against the risk of outliving your retirement savings.

Annuities can provide:

• A steady, predictable source of income in retirement, regardless of market fluctuations.
• Tax-deferred growth and tax-advantaged income.
• Flexibility both in how you save for and receive money in retirement.
• The potential for payments to continue for beneficiaries after you die.

Challenges of annuities:

• Guarantees are subject to the claims paying abilities of the underlying insurance company.
• Liquidity may be limited.
• Withdrawals from annuities prior to age 59 ½ may be subject to a 10% tax penalty.
• Risks can be higher if your annuity isn’t underwritten by a highly-rated insurance company.

2. A diversified bond portfolio

Fixed income instruments such as bonds were, until recently, considered less competitive as a source of income for retirees. However, as the Federal Reserve raised the short-term interest rate, bond yields followed suit. For example, the 5-year U.S. Treasury note yielded 1.37% at the beginning of 2022; by the end of May 2023, the yield was 3.74%.²

Bonds are available in many forms. You can invest directly in individual bonds such as U.S. Treasury securities, municipal bonds, debt instruments issued by corporations, bonds offered by government entities, mortgage-backed securities, and bonds that originate in overseas markets. Yields will vary based on the credit quality of the issuing entity, the duration of the bond (years to maturity), and current market conditions. Many investors choose to invest in bond mutual funds, a professionally managed, diversified portfolio of bonds from different issuers.

You receive periodic income payments from the bond issuer based on the stated annual yield effective at the time you invest. You can choose to hold the bond to maturity, at which time principal will be repaid by the issuing entity. Alternatively, you can choose to sell bonds on the open market prior to maturity.

The market value of a bond may vary from its face value, depending on the interest rate environment the remaining bond term. If current market rates are higher than an existing bond’s yield, the bond will be required to sell at a discount to attract buyers. If current interest rates are lower than the bond’s yield, the bond will sell at a premium. This reflects an important point often overlooked by bond investors – bonds, while often considered a lower-risk investment, can fluctuate in value.

Bonds can provide:

• A steady stream of income with potentially competitive yields.
• Liquidity that allows flexibility to make timely changes to a portfolio mix.
• Access to a wide range of fixed income instruments with different yields and risk characteristics.
• The ability to provide effective diversification to help offset risk in a portfolio that includes equities and other asset classes.

Challenges of bonds:

• Except for tax-free municipal bonds, income paid to you is subject to tax at ordinary income tax rates.
• The risk of principal loss should interest rates move higher and the investor needs to sell the bond.
• Difficulties generating comparable income in the future when replacing maturing bonds.
• Lack of inflation protection as income streams established in a bond portfolio remain consistent.

3. Total return investment approach

A total return approach provides income from your investment portfolio in the form of interest, dividends, and capital gains. This type of portfolio invests in a balanced and diverse mix of stock and bond funds.

In this context, “total” return means spending a portion of the average annual rate of returns — income and appreciation — over a longer period (10-20 years), rather than focusing on specific annual return rates or just drawing income generated by holdings in the portfolio. The aim is that this total return meets or exceeds your withdrawal rate.

“This is a way to grow a retirement portfolio to assure that it continues to meet the needs of people preparing for a retirement that could last 20 to 30 years or longer,” says Haworth. “It may offer a way to generate a superior total return compared to other investment approaches traditionally pursued in retirement.”

Related to withdrawal rate, a total return approach follows a “systematic withdrawal” strategy, in which a certain percentage of your investment is taken as a distribution each year. The distribution amount generally ranges between 3 and 5% of the total value of the portfolio.

A total return approach can provide:

• A way to meet your immediate cash flow needs while continuing to build savings for future expenses, which are likely to rise over time due to inflation.
• The ability to utilize a broader range of assets than is the case with more typical approaches to retirement income.
• A stream of portfolio withdrawals that may be generated primarily by capital appreciation, potentially a more tax-efficient form of income.

Challenges of a total return approach:

• There is no guarantee that funds will last throughout retirement.
• The value of your return can vary from year to year (there is no specific withdrawal rate).
• Assets may run out prior to the end of retirement, particularly in circ*mstances where investments suffer significant declines in the early years of retirement.

4. Income-producing equities

While people primarily invest in stocks to generate capital appreciation in a portfolio, some equities provide income in the form of dividends. Publicly traded companies frequently share their profits with shareholders by paying dividends. Not all stocks pay dividends, and of those that do, certain stocks tend to pay higher dividends than others.

“Stock dividends became much more attractive when we experienced an extremely low interest rate environment in the bond market,” says Haworth. “Today, dividend yields of most stocks are not as competitive as bond yields, but still offer the potential for capital appreciation.”

Companies typically pay dividends on a quarterly basis. At times, companies may pay a “special dividend” due to unusual circ*mstances, but those are uncommon and not something you should count on. Unlike most bonds, however, stock dividends can vary with each payout period and sometimes companies discontinue dividend payments. You need to be prepared for a degree of uncertainty with dividend payouts.

If your primary focus is to invest in a stock for income, it’s important to review its dividend-paying history. Stocks with a reliable history of consistent or steadily increasing dividend payouts are likely to be the most attractive to consider for this purpose.

Publicly-traded real estate investment trusts, or REITs, are a type of income-producing equity that can further diversify a portfolio made up primarily of stocks and bonds. A REIT is a corporate entity that owns, operated or finances income-generating real estate.

Publicly-traded REITs are listed on major stock exchanges, so you can buy and sell this type of REIT as easily as you can trade stocks. Prices fluctuate on a daily basis. “This price fluctuation is a consideration for investors, because it isn’t just the underlying value of the assets held in the REIT that affects the price,” says Haworth. “What you pay for a REIT or the price you receive when you sell a REIT may be affected by outside factors that impact the broader investment environment.”

Income-producing equities can provide:

• A regular stream of income paid by companies that generate strong earnings and make consistent dividend payouts.
• The opportunity to benefit from the capital appreciation potential of stocks that also generate income.
• A “built-in return” on your equity investment, represented by dividend income, not reliant on the stock’s price performance.
• A diversified source of income for a retirement portfolio; publicly-traded REITs provide diversification for a portfolio made up primarily of stocks and bonds.

Challenges of income-producing equities:

• Principal value is subject to more fluctuation than other, traditional income vehicles such as bonds.
• Not all companies are reliable and consistent in their dividend payouts.
• Stock dividends may become less attractive as interest rates move higher.
• Dividend income is subject to tax at higher, ordinary income tax rates.

Finding the right strategy for you

The investment options you select in retirement should take into account your time horizon and risk tolerance level. A financial professional can help you better understand these options and determine if one or more are appropriate for your retirement income strategy. Taking the time to understand your options and overall financial picture can better equip you to head into (or continue in) your retirement years with confidence.

Learn how we can help you plan your retirement income strategy.