4 investment options to help generate retirement income

Did you know that 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. Today, about one out of every three 65-year-olds will live past 90, and about one in seven will live past 95.¹

This means if you plan on retiring in your 60s, as many people do, your retirement savings might need to last for three decades.

You also need to keep in mind that over time, living costs will increase. For example, if inflation averages 2.6% per year, your living costs could double in less than 25 years. That’s a lot of pressure to place on a traditional retirement account.

Social Security and post-retirement work

Social Security retirement benefits, which tend to play a more important role for lower wage earners, will replace only about 40% of pre-retirement earnings for people who earn less than $100,000 a year. Higher earners will receive only 33% of their pre-retirement earnings. Unless you plan to live extremely frugally in retirement, you’ll need to supplement this income.

One option is to find part-time work after retirement. Retirees seek employment for all kinds of reasons, including the financial and mental well-being of staying active and involved in their communities.

However, having a plan in place for generating additional income during your retirement can help ensure your future income streams can keep pace with rising living costs. You’ll need to supplement your benefits with a pension, savings or investments.

“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 today’s higher interest rates, it’s a good time for people to revisit their retirement income options.”

4 investment options for generating retirement income

Here are four common investment options to help you generate income in retirement. Everyone’s risk tolerance is different, so these options are listed 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. While the insurance company holds your contributions, that money has the potential to accrue on a tax-deferred basis.

Annuities can help you set up a guaranteed income stream that is designed to last for a certain period or for the rest of your life. You can also choose to have this income paid through your own lifespan or through both your and another person’s lifespan (for example, your spouse).

When you start taking disbursements, typically after you turn 59 ½, you can choose to receive a specific dollar amount regularly or payments that are 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 annuities provide income guarantees, they're often considered a form of insurance against the risk that you will outlive your retirement savings.

Benefits of annuities:

• A steady, predictable source of income in retirement, regardless of market fluctuations
• Tax-deferred growth and tax-advantaged income
• Flexibility in how you both 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 before 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, when the Federal Reserve raised the short-term interest rate, bond yields followed suit. For example, the 5-year U.S. Treasury note yielded 1.26% at the end of 2021; by April 2024, the yield was 4.68%.²

Bonds are available in many forms. You can invest directly in individual bonds, including:

• U.S. Treasury securities
• Municipal bonds
• Debt instruments issued by corporations
• Bonds offered by government entities
• Mortgage-backed securities
• Bonds that originate in overseas markets.

This is where bond diversification is important. Yields will vary based on the credit quality of the issuing entity, the duration of the bond (how long before it matures) and current market conditions. Many investors choose to invest in bond mutual funds, a professionally managed, diversified portfolio of bonds from different issuers.

“In a period such as today, when the economy remains strong, investors should feel more comfortable taking on some marginal risk in their bond portfolio to earn higher yields,” Haworth says. This can include adding more positions in corporate debt securities.

As far as how you receive income from bonds, you receive periodic 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 the issuing entity will repay the principal. Alternatively, you can choose to sell bonds on the open market before maturity.

In this case, the market value of a bond may vary from its face value, depending on the interest rate environment and the remaining bond term.

• If current market rates are higher than an existing bond’s coupon, bond issuers will need to offer bonds at a discount to attract buyers.
• If current interest rates are lower than the bond’s current coupon, the bond will sell at a premium to reflect that difference.

This raises an important point that investors often overlook: Bonds, while often considered a lower-risk investment, can fluctuate in value.

Benefits of bonds:

• A 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:

• Tax at ordinary income rates on bond income, except for tax-free municipal bonds
• 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 diverse mix of stock and bond funds adjusted for your risk tolerance.

In this context, “total” return means you spend a portion of the average annual rate of returns — income and appreciation — over a longer period (10 to 20 years), rather than focusing on specific annual return rates or just drawing income generated by holdings in your 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 with other investment approaches traditionally pursued in retirement.”

Haworth gives the example of 2022, when both stocks and bond suffered declines. “In such an environment, it’s costly to take withdrawals from assets that have suffered a setback,” he says, “because once that money is pulled out, it’s not possible to recoup losses when markets recover.”

This can be particularly challenging early in retirement, depleting assets to a level that potentially puts long-term retirement security at risk.

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

Benefits of a total return approach:

• It can meet your immediate cash flow needs while continuing to build savings for future expenses, which are likely to rise over time due to inflation.
• It gives you the ability to utilize a broader range of assets than you can do with more typical approaches to retirement income.
• It generates a stream of portfolio withdrawals primarily through by capital appreciation, which is 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 before the end of retirement, particularly in circumstances 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. 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,” Haworth says. “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. They occasionally pay a “special dividend” due to unusual circumstances, but those are uncommon and not something you should count on. Unlike most bonds, 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. However, depending on the market environment, dividend-paying stocks may not generate total returns comparable to other types of stocks.

“In recent times, a high proportion of dividend-paying stocks are those that have been most hurt by the current higher interest-rate environment,” Haworth says. These include utilities and real estate investment trusts (REITs).

Utility stocks and REITs tend to be attractive to investors who want to generate income from an equity position. Both can help further diversify a portfolio made up primarily of stocks and bonds.

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. Note that prices fluctuate daily.

“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,” Haworth says. “What you pay for a REIT or the price you receive when you sell a REIT may be affected by outside factors that affect the broader investment environment.”

Benefits of income-producing equities:

• 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 may be 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.