How to Build Your Own Pension

Millions of Americans are barreling toward retirement with a small nest egg and a big question: Where will I find enough monthly income to sustain me when I stop working? This predicament has been three decades in the making. But only now is it coming into full view, as what may be the largest wave yet of pensionless workers gets ready to retire.

It’s no secret that since the 1980s, traditional pensions, which pay a guaranteed monthly income for life, have been swapped out for 401(k) plans, which are tax-advantaged savings that can run out in a blink. Now only 14% of workers have a traditional pension, down from 38% in 1979, the Employee Benefit Research Institute reports.

This switch has left millions to contemplate three decades of retirement with no guarantee that their money will last. People will have Social Security. But that will not be enough to live the way most expect to. Financial planners agree that the first thing prospective retirees must do is create an income plan–in effect, build their own pension. There are many choices, and you can’t expect to perfectly replicate a traditional pension. “Most people will have to accept an income stream that varies,” says B. Kelly Graves, a financial planner at Carroll Financial in Charlotte, N.C.

First, assess your fixed expenses–things like housing, utilities, taxes and insurance. Then add discretionary expenses–travel, entertainment, charitable giving, spending on grandkids. Ideally, you will have enough guaranteed income to cover all this. That’s a high bar. But you should have at least enough to cover fixed costs.

For most people, Social Security will be the primary source of guaranteed lifetime income–and it is likely to leave them with a shortfall. If possible, delay filing for benefits until age 70 in order to get the biggest monthly check. To fill the income gap, consider buying an immediate fixed annuity, which is an insurance product that for a single large premium may guarantee income for life. With interest rates low, fixed annuities do not offer a great return. A 65-year-old man would need $100,000 to buy $555 of monthly income. “But it’s not about the return,” says Jonathan Swanburg, a financial planner with Tri-Star Advisors in Houston. “What’s important is that you can’t outlive it.”

With your basic needs covered, you can take some risk with remaining assets and shoot for a higher return. Unless you are wealthy, you probably will have to draw down your savings over time–and you should plan for 30 years. A good strategy is withdrawing 4% of savings the first year and raising that for inflation each subsequent year. If your monthly income plus 4% of savings leaves you short of your needs, you may have to cut expenses or work part time.

To manage your savings, consider a simple bucket approach: keep three years’ worth of spending in a money-market account and the rest in a mix of 60% stocks and 40% bonds, using funds pegged to an index for low fees and diversification. Spend from the money-market bucket and refill it annually by selling from the bucket with stock and bond funds. If you own your home, consider opening a reverse-mortgage line of credit. By tapping home equity in this way, you can refill the spending bucket without selling assets if prices are down.

With traditional pensions all but gone, one thing is certain: you’ll have to make the most of every asset to get the income you need.