4 Ways To Create Stable Cash Flow In Retirement
Whether it is your desire to have a steady stream of income for your retirement, to fund philanthropic ambitions or to generate independent cash flow, this article provides 4 ways to create stable cash flow in retirement.
1. Purchase An Immediate Annuity
The most-direct way to create stable cash flow in retirement is to purchase an immediate annuity. Immediate annuities are an insurance product sold by insurance companies—an annuity is a contract between an individual (the annuitant) and an insurance company in which the insurance company gives the annuitant a guaranteed stream of income starting almost immediately after the lump sum purchase. Payments are generally fixed for the term of the contract and the annuitant can choose monthly, quarterly, or annual income payments. Variable and inflation-indexed annuities are also available for purchase. Advantages include long-term stability, tax-deferred income, and recurring income payments according to contract terms for a set period, which could be the annuitant’s lifetime.
In addition, an annuity may provide an opportunity for income splitting between spouses after age 65, much like a traditional RRIF or a pension, thereby creating an opportunity to equalize marginal tax brackets between spouses and reduce the overall household tax bill. Further, this type of income may allow a tax payer to claim the Pension Income Tax Credit to deduct up to $2,000 from their taxable income.
2. Build A Bond Ladder
Another method to generate stable cash flow in retirement is to build a bond ladder. This can be done by buying bonds of different maturities arranged so that the bonds mature on a staggered basis. Bonds generally make interest payments twice a year, therefore a portfolio with six bonds could generate a steady monthly cash flow. Since interest rates paid by the bond are locked at the time of purchase, periodic income payments by the bond do not change and are predictable.
At each bond’s maturity, you can reinvest in another bond and create more “rungs” on the ladder, or receive a cash repayment of the principal amount. A similar strategy can also be implemented using Guaranteed Investment Certificates or GICs of varying maturities laddered to have a portion maturing and/or paying out interest each year.
3. Invest in Dividend-Paying Stocks
Investing in the stock market can also generate stable cash flow in retirement through dividend income. Dividend investing may offer inflation protection in cases where the earnings of the company themselves rise with inflation, such that the proportion of earnings paid out in dividends also rise. Unlike dividend paying stocks (with the exception of inflation-indexed investments), annuities, GICs, and bonds will generally not see their income streams rise with inflation but are fixed income streams, as the name of the asset class suggests. Furthermore, stocks may offer a potential for higher returns than purchasing immediate annuities or building bond ladders due to their capital appreciation component combined with their income for a meaningful total return.
One method is to buy ETFs comprised of dividend-paying stocks, which can take a lot of hassle and stress out of income investing. A dividend ETF is an exchange-traded fund designed for investment in a selection of dividend paying stocks which pays out the full dividends generated from its holdings. This method is best for those who have little interest or time in analyzing individual stocks, and are content with a less granular, more broad-based approach to managing their portfolio. Investing in dividend ETFs allows you to collect dividend income and provides the ability to sell units of the ETF fairly quickly and cheaply.
For investors seeking greater control and granularity, a portfolio invested directly in dividend-paying stocks is far superior to ETFs. Dividend income is generated by the individual holdings and paid out in accordance with each security’s schedule, while the shares themselves remain invested and continue to participate in the market for growth. While taking this more active approach requires more time and analysis in selecting the individual stocks that will each form part of the income stream, it allows the investor to select those securities that he/she feels possess superior attributes relative to their peers, whether due to robust cash flow and balance sheets, strong management teams, or other factors. By doing this, a portfolio can be constructed with greater conviction whereby portfolio weightings of individual holdings differ significantly from the benchmark index to minimize (if not exclude) the impact of stocks deemed to be suboptimal while amplifying the contribution of those believed to offer superior returns from a dividend sustainability and growth perspective. This approach also offers much greater control over portfolio yield when there are specific cash disbursement considerations, such as in the case of a trust making regular distributions or a charitable foundation required to meet a disbursement quota.
Dividend income streams may also present significant tax advantages over the aforementioned sources of income since interest income, as sourced from annuities, bonds, and GICs, is fully taxable while eligible Canadian dividend income is taxed much more preferentially.
4. Investing in Real Estate for Rental Income
Tenanted real estate, whether residential or commercial, is often looked to by investors as a source of income. Rental income from tenants is collected over the period of a lease, ranging from a single year in the case of residential real estate to more than 10 years in the case of some commercial properties. Capital appreciation may also contribute to the return, with both the capital appreciation and rental income relative to original capital invested often being significantly enhanced by the use of leverage via a mortgage. While the income itself is fully taxable, both expenses in maintaining the property along with the interest portion of the mortgage payments are deductible for tax purposes and can help offset the income inclusion from rents collected.
This type of income, however, may be subject to interruptions and present some unique risks. Local market dynamics may make finding a tenant more challenging during certain times and result in prolonged periods of the investor having to carry the property, or perhaps agreeing to a lease rate below the breakeven threshold to secure a tenant in a competitive market. In addition, real estate in general carries significant transaction costs, and valuations are highly subjective, such that adverse developments affecting a given property may not only make finding a tenant more challenging, but may make selling to pursue a better investment unfeasible in terms of price and time required.
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This content is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this content should consult with his or her financial partner or advisor.