I was having lunch the other day and began a conversation with the fellow next to me. Turns out he recently retired. “Are you lucky enough to have a pension?” I asked. “Sure,” he said, “My employer paid half and I paid half.” Ahh, that doesn’t sound like a pension plan.
Turns out he was talking about a 401k plan which sadly, while often referred to as a pension plan, is a far cry from the traditional defined benefit pension (which provides a steady stream of income for life).
“Now it’s up to you to make sure it lasts for life,” I, perhaps insensitively, observed. “Yeah,” he quietly agreed.
Somehow, some way everyone needs a steady stream of income in retirement. How to accomplish that is the question. Social Security is big part of that income for most people, but it’s not enough. Buying an annuity with accumulated assets is scary for most people. But the good news is that annuities are starting to appear as an investment within 401k plans so keep an eye out for that option.
Here’s another possible option and one that I use as part of my retirement income strategy.
Buy shares in good quality dividend paying stocks that also offer dividend reinvestment. Do so outside of a qualified retirement vehicle such as an IRA. This gives you more flexibility using the funds in retirement.
Allow the reinvested dividends to compound until retirement thus building up the number of shares owned and the amount of dividends paid. Yes, you will pay taxes on the dividends as they are paid.
At the same time also invest in low cost municipal bond mutual funds and reinvest those interest payments (which will be federal and perhaps state income tax free). Low interest, yes, but that tax free income will come in handy in the years after you retire.
Over a working life you will have accumulated shares of stock and mutual funds. At retirement you have several options with one of those being to stop reinvesting dividends and interest and instead have them create a regular stream of income throughout the year. The bond mutual fund typically pays interest monthly.
I am not a financial advisor or claim to be an expert so you might want to check with the real deal, but I find it comforting to know I can supplement my retirement income when I need to without selling assets and that my wife as a survivor can do the same.
Oh yes, if you consider this strategy, start early and with as much money as you can. And add to the number of shares you own when possible.