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Congratulations! You’ve built a retirement savings balance of $1 million. You’re ready to retire. And you want $100,000 a year of retirement income, including your Social Security benefit, without liquidating a cent of your savings principal.
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Why $100,000? That’s what you’re earning right before retirement, and you don’t want to dampen your lifestyle in retirement.
So, is that retirement income possible without taking on excessive risk? Many investors doubt it. After all, high-yield investments can be volatile. Many of those securities face higher risk of default.
But reaching that income goal is possible without resorting to “high-yield,” higher-risk strategies. We can show you how.
Retirement Savings With Diversification
Better yet, we’ll show you solutions that use funds, so you’d get built-in diversification. Leading financial advisors cite the funds for consideration.
The advisors all emphasize that the right mix of funds depends on what you consider reasonable risk in your unique circumstances — given your risk tolerance, time frame and goals. As for the $1 million retirement savings balance, that too may be easier to achieve than you thought.
Customers Fidelity Investments owned 818,100 IRAs and 401(k) accounts with balances of $1 million or more as of the end of 2021.
How Much To Expect From Social Security
So how much is enough retirement income? To figure it out, start by getting a handle on how much of your $100,000 annual income would come from Social Security benefits.
Let’s say you’re 65. That’s the average age at which Americans expect to retire, according to the Employee Benefit Research Institute.
If you retire this year, you’d probably be in line to receive $24,876 in annual Social Security benefits, according to the Social Security Administration’s quick calculator. That’s how much a 65-year-old worker would be entitled to, based on a typical career. Remember, Social Security benefits are based on your 35 highest years of income.
Sources For Retirement Income
So if you want $100,000 of annual retirement income, you’d have to generate $75,124 of it from other sources, such as your retirement savings.
From a $1 million retirement nest egg, that would be a yield of 7.51%. Let’s round it up to a yield of 7.52%.
You can make it easier to generate retirement income by taking one extra, small step. Rather than retire right now, wait until age 66 and 6 months. If your birthday was June 1, 1957, you’d reach 66 years and 6 months in 2023.
The significance of that age is that it’s what the Social Security Administration calls the full retirement age (FRA) for someone born when you were. It matters because benefits before FRA are hit with a penalty, which reduces them. But if you wait until FRA, your benefits would jump to $2,353, or $28,236 a year. That’s based on current rules.
That would trim the amount of income you need each year from your $1 million nest egg to $71,764. Rounded up, the yield would be 7.2%.
And if you wait until age 70, your monthly benefits peak at $3,247. Beyond that, you could not earn any additional benefits just by delaying the start of benefits.
Doable Retirement Savings Strategy
So how doable would it be to generate 7.2% yield with your $1 million retirement savings balance?
If you put your $1 million into an ETF that tracks the S&P 500, such as SPDR S&P 500 ETF (SPY), right now you’d only get a yield of 1.39%, going into Friday. That’s far short of your 7.2% target.
Advisors we queried suggest funds whose yields easily top SPY’s. Crucially, none of them is a high-yield fund. That means none of them has the higher risk that tends to go with high yield. None of our funds focuses on stock in wounded companies or companies with shaky credit.
Which, if any, that you could pick depends on your circumstances when you retire. At that point in your life, how much volatility would you be able to put up with? Would the income be enough to pay your bills?
Cutting Through Wall Street Jargon
In weighing these funds, judge their key factors. Some of those factors are coached in Wall Street jargon. Here’s what some key terms mean:
Total distribution rate: Total distribution rate (or distribution rate) is similar to yield. It is cited by closed-end funds (CEF), which are similar to regular open-end mutual funds. The distribution rate is a combination of dividends, interest and capital gains. It also includes return of principle, if that occurs. You should always find out if a CEF’s yield includes cannibalized principle. If you’re in doubt, ask the company that sponsors the investment.
For more advice about retirement planning.
What Is ‘Standard Deviation’?
Standard deviation: This is a method for measuring a fund’s volatility. It tells you how much and how often a fund tends to veer away from its average performance.
Compare that volatility to ups and downs by the SPDR S&P 500 ETF (SPY). SPY tracks the S&P 500 index. Its three-year standard deviation (SD) as of May 31 was 18.07.
SPY’s three-year average annual return was 16.38% as of May 31. So its 18.07 SD means that 68% of the time over the past three years, SPY’s return was between negative 1.69% and positive 34.45%. And 95% of the time, its returns were between a loss of 19.76% and a gain of 52.52%.
Fund data are per Morningstar, through June 8 except when month-end is indicated.
TIPS ETF With Higher Yield
IShares TIPS Bond ETF (TIP). This $31 billion fund holds inflation-protected U.S. Treasury bonds, known as TIPS. Those bonds’ face values rise with inflation. With U.S. inflation rising quickly, TIPS’ yields have shot skyward, without the credit risk of traditional high-yield bonds or funds.
Faron Daugs, a wealth advisor who is founder and chief executive officer of Harrison Wallace Financial Group, calls the TIPS ETF “our go-to ETF” in this space.
But Daugs warns that inflation will not climb forever. He expects to transition out of TIPS-focused ETFs in 12 to 36 months.
- SEC yield: 12.36% (highest yield in this analysis)
- Trailing 1-year total return: -1.52%
- 3-year avg. ann. return (on price): 4.20%
- 3-year standard deviation: 4.62 (lowest rate in this analysis)
Mutual Fund With Yield Muscle
First Trust Enhanced Equity Income Fund (FFA). This $357.3 million fund is a closed-end fund (CEF). It aims to generate high equity income from dividends as well as premiums from the sale of covered calls, Daugs says.
With a covered call, an investor (such as an ETF) buys a stock and at the same time sells the stock’s potential price gain above a specific, agreed-to price to another investor. The sale of that potential gain provides the first investor with income.
Daugs said, “While the NAV can fluctuate with market conditions, the fund has been successful in maintaining a solid level of current income and gains.”
- Total distribution rate: 6.92%
- Trailing 1-year total return: -1.34%
- 3-year avg. ann. return (on price): 15.90%
- 3-year standard deviation: 17.79
JPMorgan Equity Premium Income ETF (JEPI). The fund, which is only two years old, has $10.0 billion in assets. Adam Lampe, chief executive officer of Mini Wealth Management, said, “The (fund’s) yield is appealing.”
- SEC yield: 11.76%
- Trailing 1-year total return: 4.80%
- 3-year avg. ann. return (on price): N.A.
- 3-year standard deviation: N.A.
Mix, Match Retirement Savings
Each fund we cite currently offers enough yield on its own to generate your target of 7.2% yield. But if you want to use some other fund that does not provide enough yield, what then? That’s one more reason to consider using more than one fund.
At current rates, you could put 50% of your $1 million into JEPI, with its 11.76% yield, and 50% into a lower yielding fund. You’d aim for a situation where their yields would average at least 7.2%.
If your combined funds yielded more income than you need, you could leave the extra income in your retirement savings accounts. There, they could keep growing and building a cushion as a shock absorber to make up for bad years in the market, unexpected expenses or future largesse to loved ones or charity.
Risk
Remember, there’s no such thing as a free lunch. Price volatility can offset yield, at least in the short run. Take TIP. The fund’s year-to-date decline of about 6% is about half of its SEC yield. And over extended periods such as 10 years, its 1.83% average annual return is a shadow of the S&P 500’s 14.40%.
“Once inflation begins to subside, the holders of this ETF will likely exit en masse,” Daugs said.
And Daugs says shareholders in any fund whose income is included in total distribution rate must be careful about determining how much consists of return of principal. Check out FFA. “The total distribution rate for 2021 was comprised of 40% return of capital and 40% long-term gains, not exactly something one who is asking not to touch their principal can be assured of occurring every year,” Daugs said.
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and active mutual fund managers who consistently outperform the market.
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