Keep cash rolling in after you retire

November 8, 1999

Here are seven ways to enjoy healthy retirement income without taking a penny from your nest egg.

Keep cash rolling in after you retire

Jump to:Choose article section...My Best Financial Move

Here are six ways to enjoy retirement income while depletingyour nest egg as little as possible.

By Susan Harrington Preston, Senior Associate Editor

If you're close to retirement, no doubt your parents or some of yourolder relatives remember the Great Depression. The era seared thriftinessinto those who lived through it, making the idea of blowing through assetsfor ordinary living expenses about as palatable as the shoe Charlie Chaplinate in The Gold Rush.

In fact, though, there's nothing terrible about spending some of thoseassets in retirement, to supplement whatever you get from your pension orKeogh plan and Social Security—especially if you've amassed a largenest egg. But wouldn't it be nice to have other income sources, so you candeplete your kitty a bit more slowly, or not touch the principal at all?Here's a look at some investments that can keep the checks coming in.

Income stocks. If you're concerned about a market downturn butwould still like to keep some money in stocks, consider income stocks--thosethat primarily reward investors with dividends rather than capital gains.They can provide dependable income and greater price stability than stocksthat aim for appreciation. That's especially comforting when the marketgets rocky.

Granted, income stocks may not pay as much as they used to. Once, youcould count on a 3 to 4 percent dividend, but now that's not always true.In October 1999, only two of the 10 Dow Jones stocks that pay the highestdividends yielded more than 3 percent (Philip Morris and JP Morgan), andonly three others yielded more than 2.5 percent (General Motors; Sears,Roebuck; and Chevron). Utilities, the sine qua non of income stocks, stillpay better: The Dow Jones Utilities averaged almost 3.9 percent in mid-October.

You'll probably forgo much appreciation with income stocks, however,because they generally underperform growth stocks (the majority of whichpay no dividends) as well as the broader market. For example, in the 10years through September, the Dow Jones Utility Average rose 9.3 percentannually, while the Standard & Poor's 500 Stock Index gained 16.8 percentper year, on average.

Preferred stocks. Preferred stocks offer some advantages overincome stocks. Their dividends can't be reduced (unless they pay an adjustablerate), and they must be paid before common-stock dividends. For this reason,nonconvertible preferreds--which can't be exchanged for common shares--areoften compared with bonds. If the company gets into financial trouble, itcan postpone paying the dividends, but they'll accumulate. You'll probablyget the money eventually.

Preferreds do carry risk, despite the practically guaranteed dividendstream. The stock's value can rise or fall with the issuing company's fortunes.If the firm goes bankrupt, preferred stockholders' place in the creditorline is ahead of common stockholders, but behind lawyers, bondholders, andthe IRS.

Bonds. The term "coupon clippers" used to refer to retireeswho lived on coupon bonds' twice-yearly interest payments. The bonds hadcoupons attached, which the holders cut off and redeemed for cash.

Nowadays, most bonds are registered in the owner's name and held by theissuer, or they're kept in a brokerage account. "If you know you'reearning $2,400 a year in interest, then just figure you can spend $200 amonth," says Leonard Bailin, a CPA in Great Neck, NY.

One drawback to buying individual bonds is that to get the highest yields,you have to invest long term. "If I tell a retiring doctor to holda 30-year bond till maturity, he'll say 'I won't even be on the planet in30 years,' " says J. Michael Martin, a financial adviser with FinancialAdvantage of Columbia, MD.

Yields also vary based on the type of bond and the issuer's credit quality.They start at around 6 percent, the recent yield for 10-year US Treasuries.

Bailin predicts that investors will be able to purchase their choiceof hundreds of individual bonds directly via the Internet within a few years.Indeed, when US Treasuries are offered for sale, you can buy them onlinevia the government's Treasury Direct program ( www.treasurydirect.gov.)

But unless you're well-versed in the numerous available types of bonds,let a fixed-income specialist select them for you. Or invest through mutualfunds, generally the simplest and cheapest way. (For a full discussion ofbonds and bond funds, see "Wake up that sleepy bond portfolio,"in this issue. See also Howto boost your profits from bonds," Nov. 9, 1998, and "Whyyou need bonds—and how to buy them," July 27, 1998).

Certificates of deposit. CDs are safe investments, but they generallywon't beat the yield of a good individual bond or bond fund. In October,a typical one-year CD yielded about 5.3 percent; a five-year CD, about 5.9percent. (A garden-variety money-market account yielded about 3.1 percent.)To earn $75,000 a year from CDs paying 5 percent, you'd need to sock away$1.5 million.

For security, however, CDs are hard to beat. The federal government considersthese highly liquid investments to be equivalent to traditional bank accounts,so the Federal Deposit Insurance Corporation insures CDs up to $100,000per investor, per bank. So to fully FDIC-insure $1.5 million worth of CDsin your name alone, you'd have to distribute them among at least 15 banks.

Rental property. If you're selling your practice but not the buildingit's in, leasing the property out to someone else can make good sense.

"Usually, such a building is completely amortized, so if you sellit you'll get hit with a big capital gains bill," says Martin. "Butif you lease it out during your lifetime, you'll be able to leave it toyour children on a 'stepped-up' cost basis when you die. That can save abundle in tax, especially if the property is likely to rise in value."

Martin explains why: "If your children inherit the property, thecost basis for tax purposes is its value on the day you die. So if the kidsthen sell the building, they won't have to pay nearly as much in capitalgains tax as you would have if you sold it."

In general, however, owning a rental property other than your medicalbuilding is more trouble than it's worth. "You get income, sure, butyou also get the phone calls in the middle of the night when something breaks,"says William B. Howard Jr., a Memphis-based financial adviser.

Residential rentals are particularly difficult for the uninitiated. "Ialways ask people if they're willing to put a family out on the street atChristmastime," says Martin. Even with commercial real estate, you'llhave the headaches of collecting the rent and making repairs, just likeany other landlord. And, yes, you might have to evict someone.

"With any type of rental property, you have to ask yourself howmuch of a return you'll need to make that hassle worthwhile," Martinadds. "Would you do it for a 10 percent return when you can get 6 percentfor a government bond you never have to think about? Probably not."

Private loans. One measure of a financial strategy's worth iswhether the experts follow it themselves. Len Bailin, who's semiretired,uses this one: He issued a $130,000 private loan to the owner of a six-unitapartment building in Queens, NY.

"When you own an apartment building but don't live in it, you can'tgo to a bank and get a good interest rate on a loan," he says. "Evenif your credit is perfect, the bank will give you a business loan, whichwill typically run a couple of percentage points higher than a home mortgage."

Hence, for a $130,000 investment, Bailin receives a monthly check forprincipal and 8 percent interest on the loan, which has a 5-year term. "It'stotally secured against default by the building itself," Bailin says."This particular building could sell for twice that amount."

You can also finance the sale of your own investment property--"takeback" a mortgage--as long as your buyer has the liquidity and credithistory that assures you of regular payments. Enlist your financial adviser'shelp in assessing the risk associated with the buyer, and be sure to havea lawyer who specializes in real estate draw up the loan.

"When you take back a mortgage, you can often get a better pricefor your property," says Michael Martin. "That's because the buyermay be willing to trade a higher sale price for lower closing costs anda better interest rate from you than he could get from a commercial lender."And if the buyer defaults? "You get the property back," Martinsays. "The only downside is the risk that the property value wouldfall in the meantime. But then you'd still have had the payments he didmake."

Say No to annuities. You may have heard annuities touted as anothergood source of retirement income. But many carry high insurance fees andsurrender charges, plus portfolio expenses similar to those charged by mutualfunds. Moreover, annuities are generally less liquid than many other investments,and their earnings are taxed as ordinary income when withdrawn. So retiringphysicians can usually do better with other investment options. "Irarely recommend annuities," says William Howard. "When I do,it's usually because the person hasn't got much in assets, so he doesn'thave a safety net if the market turns down."

Whatever income-bearing investments you're considering, discuss themwith your adviser now. Plan in advance, and you can have the secure retirementthat you've always dreamed about.

My Best Financial Move

"I bought a home in a Sun City, AZ, retirement community. I've alwaysloved the area, and I enjoy visiting friends who live nearby. I can stayin the house for up to a month each year, even though I don't meet the minimumage requirement for residence. And when I'm ready to retire, I'll have alovely place to live.

In the meantime, I rent it out for four to six months a year for $1,500to $1,800 a month. I'm too busy and too far away to manage the propertymyself, so an agency does it, for 9 percent of my rental price; that's worthevery penny.

On average, I recoup about 90 percent of my annual expenses, which runclose to $8,500, including the mortgage, property taxes, homeowners insurance,and utilities. The home's appreciating, too: I paid $106,000 for it fiveyears ago, and it's worth about $125,000 now."

­Jacqueline C. Tuttle, MD

Sue Preston. Keep cash rolling in after you retire. Medical Economics 1999;21:121.