Four Ways For Retirees To Create Income
For many retirees, converting a nest egg into a predictable source of income proves far more challenging than it ever was investing for growth.
It’s harder still in an environment where bond yields and bank rates are wallowing well below the rate of inflation , offering seniors little more than a loss of purchasing power for their fixed income investment.
As such, many have been forced to explore new strategies to give themselves a paycheck. Here are five to consider:
Those 62 and older may be able to convert a portion of their home equity (usually no more than half) into cash by taking out a reverse mortgage.
As the name implies, such loans work in the reverse order from a typical mortgage, in that you receive a monthly check from your lender based on the amount of equity you own.
There are generally no income restrictions for eligibility, and according to the Federal Trade Commission, the proceeds from your home are tax-free and do not affect your Social Security or Medicare benefits.
Better still, you do not have to repay the loan as long as you live in your home, though it must be repaid when the last surviving borrower dies, sells the home or no longer uses it as a primary residence.
That said, reverse mortgages are not for everyone, says J. Michael Collins, faculty director for the Center for Financial Security at the University of Wisconsin-Madison.
“Someone who is cash poor and house rich is a good candidate for a reverse mortgage, especially if you’ve racked up some debt and it’s eating away at your ability to meet other expenses,” says Collins, who urges homeowners to avoid tapping their home equity for nonessential expenses like a vacation or new car.
Consumers considering a reverse mortgage — also called Home Equity Conversion Mortgages, HECMs— however, should shop around for the best deal, since fees vary dramatically.
Some lenders charge an origination fee and mortgage insurance premium along with closing costs, which can be substantial.
“The problem with reverse mortgages has always been the fees,” says Collins. “These products are marketed through brokers and lenders who have a huge incentive to push the products on people who may not be a match for them, and they often come with a lot of fees that get buried into the loan.”
Reverse mortgages are sold by both private lenders and the federal government, each offering a variety of payout structures from a one-time lump sum, to a line of credit, to a fixed monthly payment.
“I’ve seen loans where you might pay $15,000 to borrow 50 percent of a $100,000 home,” says Collins, noting homeowners should realistically look to pay anywhere from $3,000 to $5,000 for a HECM.
Life insurance policies that generate monthly payments in exchange for an upfront deposit, called an annuity, are another option.
Annuities come in two varieties — fixed and variable.
The fixed version offers guaranteed payments in exchange for upfront cash, either over a period of, say, 25 years, or for life, depending on what you’re willing to pay for.
Greg Olsen, a partner with Lenox Advisors wealth management firm in New York, notes the biggest risk with annuities is the loss of liquidity, since the dollars you invest are no longer available for financial emergencies, or for other investment opportunities that could potentially yield a higher return.
Keep in mind, too, that you generally won’t get your principal back if you die shortly after purchasing the annuity, and neither will your spouse unless you purchase a joint and survivor benefit.
“The great thing about an annuity, especially the single premium immediate annuity, SPIA, is that it does exactly what you need it to do, create a pool of money that will last as long as you live,” says Olsen. “The risk is that you die too soon.”
Fixed income annuities, however, can be pricey, often requiring an investment of six figures or more to secure benefit payments large enough to supplement your savings.
Keep in mind, too, that because the return is fixed, your purchasing power drops if inflation starts to climbs.
As such, the inflation adjustment rider offered by some insurance companies is well worth the higher prices, says Christine Benz, director of personal finance for mutual fund tracker Morningstar.
Variable annuities are different.
Such products allow retirees to chase returns by investing their annuity balance in a selection of sub-accounts that consist mainly of mutual funds.
Payments can begin either immediately or at a future date, but the value of your payment is not guaranteed.
Like other securities, the rate of return is determined by how well the investments you select perform.
Such products do provide a death benefit, however.
If you die before payments begin, your beneficiary is guaranteed to receive a specified amount, usually at least the amount of your purchase payments.
Stocks & Bonds
Blue-chip stocks that pay a consistent dividend can also create predictable cash flow.