I am always curious about the nitty-gritty details of how real-world financial planners guide their clients. Krueger & Catalano has shared some unique insights on their website, including the topic of creating retirement income in How Much is Enough?:
Financial Freedom occurs when multiple streams of income exceed all expenses (needs and wants), and can last until the age of 100.
They call this “mailbox money” – stable sources of income that show up reliably and automatically at predictable intervals. Here are four different streams of income that they include:
Social Security: Optimize to best navigate hundreds of claiming rules
Pension: Either corporate pension or a personal pension
Municipal & Treasury Bonds: Safest most liquid form of mailbox money
Dividends: Inflation beating mailbox money
You’ll note that there is no mention of “safe withdrawal rates”, where you keep taking out some percentage because it has worked out historically 95% or 99% of the time (but you still check your statements nervously if the value goes down).
Let’s take a closer look at these four sources of retirement income.
Social Security. Social Security benefits are paid monthly, and it increases with inflation each year for the rest of your life (backed by the US government, so safer than an insurance company). In addition, you can delay claiming up to age 70, which increases your monthly payment (and thus all future payments). This means you can effectively “buy” a bigger inflation-adjusted annuity by spending down your personal savings for the years that you are delaying Social Security. Smart people have done the math and shown it’s a good deal relative to private annuities.
(It can be even more complex than this, especially for couples with different incomes and ages. There are paid services devoted to optimizing your Social Security benefit.)
Pension and/or annuities. Whether through a corporation, government, municipality, or private insurer, these are all sources of monthly income that will last for life. Some adjust with inflation, some don’t. Some have full joint survivorship benefits, some are limited. There is still some risk if you have a flat payout, as the purchasing power will decrease over time as inflation eats away at it.
You can create your own pension using immediate annuities from a private insurance company. For a male/female couple that are both 65, a recent sample quote showed a 5.74% payout rate. That means a $1 million lump-sum payment would pay out $57,400 per year for as long as one of you are alive. However, this also means that your heirs get nothing from that lump sum.
Municipal and Treasury bonds. They stick with the safest bonds, which means US Treasury bonds and AAA-rated municipal bonds. They don’t like any mutual funds or ETFs, so they buy individual issues.
I am partial to the idea of sticking with the safest bonds available. I don’t want to take risk with bonds either. However, I prefer the diversification and convenience benefits of low-cost Vanguard Treasury bonds and/or muni bond funds over individual holdings, especially if you are a DIY investor and don’t want to manage that additional complexity (or keep paying an advisor to manage that complexity).
The average 10-year Treasury yield is now under 2.5%. That’s roughly $25,000 per year on $1 million invested. Individual Treasury bonds pay out interest semi-annually, although mutual funds can pay out more often. If you choose to spend all the interest as “mailbox money”, then your monthly purchasing power will also probably decrease slowly over time due to inflation.
Dividends. They like to take the dividends from individual stock holdings picked from high-quality companies. They use the Dividend Aristocrats list as an example, which are companies that have grown dividends for at least 25 consecutive years. (I prefer to bank the dividends from low-cost Vanguard funds.)
I believe that dividend investing has a behavioral advantage if an investor can focus on the income showing up and then allow themselves to ignore swings in the share price. The only way to realize the higher total returns of stocks is to hold on during the downturns. (I would concede that the future total return of Dividend Aristocrats might be lower than the S&P 500. The question is whether the greater peace of mind is worth any difference?)
If you take the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) and add back in the 0.35% expense ratio (because you self-manage), the dividend yield is currently 2.5%. That’s roughly $25,000 per year on $1 million invested. The good news is that this form of mailbox money should increase faster than inflation over time.
I think it is helpful to visualize all of these different options when planning out your own retirement income plan. How much of your personal savings do you put towards delaying and thus increasing your Social Security benefit? Creating a bigger steady annuity paycheck but with no estate leftover? Creating a smaller paycheck with bonds but with high safety and full liquidity? Creating a smaller paycheck with dividends but with higher future growth? I also like the idea that each of these streams are designed to minimize the stress from reading news headlines. Definitely food for thought.
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Hi,
I always look forward to your unique takes on personal finance issues.
Are there any better(lower cost) etf alternatives to the Proshares Dividend Aristocrats,(NOBL)?
One alternative is the Vanguard Dividend Appreciation ETF which is similar but includes companies that have paid a dividend that has grown in 10 or more consecutive years. It has an expense ratio of 0.09%.
Hopefully they also factor in tax brackets in jockeying the income. In the lower two brackets, (qualified) stock dividends are tax free while pensions and most of social security is taxed at marginal rates. One has to watch the “stock dividend” classification though since I have been surprised how much of some mutual fund dividends are non-qualified dividends (so marginal tax rate). Keep track of the dividend status when you do your taxes to get the insight on this.
Not bragging, just saying, but now I realize we’ve got mailbox money.
Which doesn’t mean we’re rich (at least, in dollars), just that what’s coming in is more than what’s going out.
No house or car payment, Medicare and Tricare, empty nesters, modest lifestyle, etc.
Low expenses wasn’t mentioned in the article, but I see it as at least half the equation.
Mentioned but deserving much more attention, in my opinion, is inflation getting out of control. Or SS, government pensions, etc, not keeping up with inflation. It’s supposed to, we know, but it depends on how inflation is measured, and that can change.
I also worry about those of us with mailbox money, mostly boomers or older, handing the bill for our lush life to our children and, especially, grandchildren. At some point, the piper will have to be paid.
Same boat as Steve Kohn, blessed with comfortable stream of mailbox money. Currently holding out one spouse’s SS til 70.5, but often suspecting the advantage in that. With the missed payment of 4 years, it takes approximately 10 years (have I calculated this incorrectly?) to catch up. Who in the right mind would do that?
Forgive my ignorance, not quite understand Steve’s point on “handing the bill for our lush life to our children…. At some point, the piper will have to be paid.”. Why would that be a case to worry about?
To JP, who said ‘…not quite understand Steve’s point on “handing the bill for our lush life to our children…. At some point, the piper will have to be paid.” Why would that be a case to worry about?’
What I’m saying is that those of us in the senior citizen age group are getting comfortable payments from all levels of government for which the government must borrow in order to send us our monthly checks.
Foremost may be Social Security, but also Medicare, Medicaid (not just for seniors, of course), and pensions – military (like me), police, fire, teachers, etc.
I can hear the screams now, “But we paid into those programs” or “We served 20 years, and the government promised us …”
Please.
No government program is, or will remain, solvent. Some of them, like SS, were created when the average life span was about 65. Now it’s 85. Unless we die young, we’ll collect much more from these programs than we put in.
Our national debt is over 22 trillion dollars, as of April 2019, per Wikipedia. If the government tries paying off that debt, then it uses money that could have gone to our grandchildren’s education, their country’s infrastructure, a stronger military, and other worthy causes.
But more likely is that the government will use inflation, cheapening the value of the dollar, ie, paying off the debt with cheap dollars, AKA inflation, maybe hyperinflation.
So while the party’s hardy, we’re all dancing. The problem comes when the music stops. Those of us who were savers (like me) will find our life’s savings worthless. Those of us who were debtors will be delighted, able to pay off debts with cheap money. Please see Zimbabwe, Venezuela, Argentina and many more, not to forget, of course, Germany after WWI for those who say it can’t happen in a first-world country.
OK, enough on this. My dear wife says, “Don’t worry, be happy. If America goes broke, so does the rest of the world.” I hope she’s right.
On holding actual US bonds versus some fund or ETF, often folks look at the impact on value as well. The thinking is that if you hold the bonds to maturity, then the value will hold no matter what happens in between. The same may not true with funds or ETFs who often do not hold their bonds to maturity. Is the added exposure worth it? It’s a tradeoff like everything else, and I think it will depend on the unique situation and goals of each person.
For most passive bond funds, I think of them as more of a CD ladder. Sure, the value of the fund fluctuates, but so does the individual bond value (although it may not show up as such on your monthly statement). There is no “end” date, but inside the fund is constantly buying new bonds after the old ones mature. When your individual bond matures, you also have to reinvest at prevailing interest rates (or at least buy something else). I think of this automatic laddering as a feature, not a bug.
The bad thing about funds in my opinion is the expense ratio. I wouldn’t want to pay 0.50% for US Treasury bonds because you don’t need extra diversification if all the bonds are equally safe. However, under 0.10% and I am barely okay with it because of the convenience feature of above. I don’t really want to spend my retirement looking at US Treasury auction dates or checking if the bid/ask spread is high right now. I definitely don’t want to make my spouse do it if something happens to me.
If the government does nothing to Social Security, it should remain solvent until 2034, after which, again if the government does nothing, it could pay out 79 percent of promised benefits until 2090, There have bipartisan studies and proposed solutions to address the problem, which can help, but there has been no movement towards that end.
It’s impossible to predict the future, but I think you should try to plan for multiple possibilities. My own retirement planning has always included an option, what if I didn’t have Social Security. I also think about what could medical expenses be in retirement. What if I have kids. What if I’m married, or get divorced. What about inflation. What about taxes. There are all good variables to consider.
I have a friend who’s all doom and gloom when it comes to the future– the world is going to end, the dollar is going to be worthless, everything is going to collapse. While I enjoy a good discussion, it’s not my view. I just do what I can for my own retirement and I also talk to with others about planning retirement, assuming they want to talk about it, so we can share ideas.
“While I enjoy a good discussion, it’s [“doom and gloom”] not my view. I just do what I can for my own retirement.”
That works well if you live by yourself up in the mountains, but not if you live in a town or city. When society around you collapses, you feel the effects, too. Consider Zimbabwe, Venezuela, Argentina, and more. For that matter, imagine you’re a Jew in Germany in the 1930s and the author of “Mein Kampf” has just come to power. You’d be just “sharing ideas” with your friends and family until you were put on rail cars.
I see America’s unwillingness to set our financial house in order as a failure in our character, and I don’t know the cure for that.