I am always curious about the nitty-gritty details of how real-world financial planners guide their clients. Krueger & Catalano has shared some unique insights on their website, including the topic of creating retirement income in How Much is Enough?:
Financial Freedom occurs when multiple streams of income exceed all expenses (needs and wants), and can last until the age of 100.
They call this “mailbox money” – stable sources of income that show up reliably and automatically at predictable intervals. Here are four different streams of income that they include:
Social Security: Optimize to best navigate hundreds of claiming rules
Pension: Either corporate pension or a personal pension
Municipal & Treasury Bonds: Safest most liquid form of mailbox money
Dividends: Inflation beating mailbox money
You’ll note that there is no mention of “safe withdrawal rates”, where you keep taking out some percentage because it has worked out historically 95% or 99% of the time (but you still check your statements nervously if the value goes down).
Let’s take a closer look at these four sources of retirement income.
Social Security. Social Security benefits are paid monthly, and it increases with inflation each year for the rest of your life (backed by the US government, so safer than an insurance company). In addition, you can delay claiming up to age 70, which increases your monthly payment (and thus all future payments). This means you can effectively “buy” a bigger inflation-adjusted annuity by spending down your personal savings for the years that you are delaying Social Security. Smart people have done the math and shown it’s a good deal relative to private annuities.
(It can be even more complex than this, especially for couples with different incomes and ages. There are paid services devoted to optimizing your Social Security benefit.)
Pension and/or annuities. Whether through a corporation, government, municipality, or private insurer, these are all sources of monthly income that will last for life. Some adjust with inflation, some don’t. Some have full joint survivorship benefits, some are limited. There is still some risk if you have a flat payout, as the purchasing power will decrease over time as inflation eats away at it.
You can create your own pension using immediate annuities from a private insurance company. For a male/female couple that are both 65, a recent sample quote showed a 5.74% payout rate. That means a $1 million lump-sum payment would pay out $57,400 per year for as long as one of you are alive. However, this also means that your heirs get nothing from that lump sum.
Municipal and Treasury bonds. They stick with the safest bonds, which means US Treasury bonds and AAA-rated municipal bonds. They don’t like any mutual funds or ETFs, so they buy individual issues.
I am partial to the idea of sticking with the safest bonds available. I don’t want to take risk with bonds either. However, I prefer the diversification and convenience benefits of low-cost Vanguard Treasury bonds and/or muni bond funds over individual holdings, especially if you are a DIY investor and don’t want to manage that additional complexity (or keep paying an advisor to manage that complexity).
The average 10-year Treasury yield is now under 2.5%. That’s roughly $25,000 per year on $1 million invested. Individual Treasury bonds pay out interest semi-annually, although mutual funds can pay out more often. If you choose to spend all the interest as “mailbox money”, then your monthly purchasing power will also probably decrease slowly over time due to inflation.
Dividends. They like to take the dividends from individual stock holdings picked from high-quality companies. They use the Dividend Aristocrats list as an example, which are companies that have grown dividends for at least 25 consecutive years. (I prefer to bank the dividends from low-cost Vanguard funds.)
I believe that dividend investing has a behavioral advantage if an investor can focus on the income showing up and then allow themselves to ignore swings in the share price. The only way to realize the higher total returns of stocks is to hold on during the downturns. (I would concede that the future total return of Dividend Aristocrats might be lower than the S&P 500. The question is whether the greater peace of mind is worth any difference?)
If you take the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) and add back in the 0.35% expense ratio (because you self-manage), the dividend yield is currently 2.5%. That’s roughly $25,000 per year on $1 million invested. The good news is that this form of mailbox money should increase faster than inflation over time.
I think it is helpful to visualize all of these different options when planning out your own retirement income plan. How much of your personal savings do you put towards delaying and thus increasing your Social Security benefit? Creating a bigger steady annuity paycheck but with no estate leftover? Creating a smaller paycheck with bonds but with high safety and full liquidity? Creating a smaller paycheck with dividends but with higher future growth? I also like the idea that each of these streams are designed to minimize the stress from reading news headlines. Definitely food for thought.
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Mailbox Money in Retirement: Social Security, Pensions/Annuities, Bond Interest, and Stock Dividends from My Money Blog.
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