Oran Hall | Income sources for retirees

Retirees need a steady, reliable flow of income. It can come from several different streams, but must be able to suit the needs of the retiree effectively because not all retirees have the same priorities.

Retirement is the spending phase of the life cycle when work generally stops and income comes from sources other than employment.

For people who are members of formal pension arrangements, employer-sponsored group plans or individual retirement schemes, such a pension can be the main source of retirement income. Investment income is another source, serving as a supplement to a pension, or as the primary source of income for individuals who do not have a formal pension.

Retirees need money to meet their day-to-day living expenses as well as to cover unplanned expenses and those required to live a full life. Thus, travel, leisure and hobbies cannot be ignored. Health-related expenses can be quite high in this stage of life, even for those fortunate to have health insurance. While income is important, so is liquidity. Having assets but not the ability to source cash readily when needed is hardly helpful.

The major objectives of retirees are steady, reliable and certain income, and safety of principal, which are best achieved from a conservative or low-risk portfolio. The main downside of this strategy is loss of purchasing power, which can, over time, severely impair living standards.

The law allows members of approved pension arrangements to take 25 per cent of their pension entitlement as a lump-sum taxed at the rate of zero per cent, the remaining 75 per cent being available to purchase an annuity, generally from a life insurance company.

An annuity is a contract whereby one party, the annuitant, agrees to pay a stipulated premium deposit and the other, the issuer, agrees to pay to the annuitant regular payments, fixed or variable, at regular intervals, beginning on a specified date and guaranteed for a fixed period, or for life, or both. There are several types of annuity contracts, but they generally provide for a lifetime guaranteed income paid monthly or annually, ensuring that income is available at a time when it is needed most.

Interest income is another important source of retirement income. It can come from bonds and their close relative – debentures. Both are debt instruments which pay interest at set intervals, such as quarterly or half-yearly – and at an agreed rate, with a commitment to repay the principal at the end of the loan period, also called the maturity date. The difference between them is that bonds are secured but debentures are not.

Quality matters. Instruments of high quality can be relied upon to meet the commitment to play interest and re-pay the principal in full and on time. Nevertheless, good borrowers are not exempt from falling on hard times, so there is some risk. Another type of risk is purchasing power risk due to inflation, meaning a dollar is not able to purchase the same amount tomorrow as today.

Bonds and debentures are issued for varying periods, so it is useful to match their maturities to the needs of the investor. It is useful, as retirement approaches, to build a portfolio with varying maturities, one benefit being that the staggering of maturities makes it more likely that funds will be available to meet various needs as they arise. Otherwise, it might become necessary to sell before maturity. Although this could be beneficial if declining interest rates cause bond prices to increase, the opposite could also be true.

It is also prudent to invest in bonds and debentures from more than one issuer. Governments issue debt instruments, but so do corporations – the former generally being considered safer. As part of their diversification programme, some individuals opt to invest in debt instruments issued in foreign countries.

But there are risks. For example, information on the issuer and other relevant matters can be limited, avenues for redress can be less accessible, there can be settlement issues, and changes in the prices of currencies can leave the investor exposed.

Bonds and debentures are useful because they tend to pay a fixed rate of interest over their lives, except in cases where they have a variable rate – which is good when interest rates are increasing. Not so when they are falling.

There are other sources of income.

Short-term instruments pay interest at maturity, but it is fixed only for the term of the instrument. They are, nonetheless, good for their liquidity, and useful to match maturity to when funds are required.

They are generally quite safe, especially those issued by the central bank, for example treasury bills, repurchase agreements, and certificates of deposit. It is often useful to engage the stockbrokers if their charges are reasonable enough to justify engaging them. Investors may, however, opt to buy the instruments they offer from their own inventory.

Dividends are a source of income for retirees who opt to invest in the shares of solid companies, but not all companies that make good profits pay good dividends.

Rent provides income for those who have property to rent.

Part-time or full-time employment, consulting, and the monetising of hobbies can help to generate additional income.

It is very important for retirees to outlive their income. How it is earned, how it accumulates, and how it is spent prior to retirement and during retirement matters.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.finviser.jm@gmail.com