In the previous article, we discussed what a pension is and why you should have one.
Now that you’ve had some time to think about those reasons, I hope you can see the logic in creating your own pension. If you want to explore how to create your own pension, then this article is for you!
First, let’s dig into the criteria for creating a pension.
Criteria For Creating A Pension
As we discussed in the last article, a pension is basically an annuity and pays fixed monthly payments for life.
When developing your own pension, there is certain criteria that must be met. Following these criteria will drive you towards ideas for creating your pension and provide enough diversity so that it doesn’t overlap your 401K.
Consistent Income
First and foremost, the pension should create consistent, monthly income. Why? Because you’ll be depending on this income to support your living expenses. A consistent income stream will put you at ease knowing that you will always have enough to live on. This income should always occur despite the stock market suffering losses.
Having a consistent income stream will also allow growth investing with your 401K. Having a consistent base of money coming in not only gives you peace of mind, but it also allows you the ability to find other growth opportunities outside of your 401K too. These opportunities would otherwise not be available to you since you’d need to be more conservative with your 401K money to live off it.
Peace of mind is a beautiful thing isn’t it? 😊
Negative Correlation To Stock Market
What does this mean? Negative correlation was discussed in a previous article and basically means that whether the stock market goes up or down the investment is either unaffected or affected in the opposite way.
Why should you care about correlation? The reason we care is because finding assets with a negative correlation acts as a buffer, a hedge against uncertainty. This can be helpful when developing a retirement portfolio. To plan for uncertainty and still maintain a positive outcome, assets that negatively correlate against the stock market are needed to achieve that objective.
The traditional approach of only having a mix of stocks and bonds for portfolio diversification is not enough to prevent portfolio losses. In fact, having a portfolio of only stocks, bonds, and index funds leaves great exposure to potentially huge losses. Retirement funds need protection against the stock market ups and downs that naturally happen throughout the course of your life.
Easy To Manage
You time is valuable and precious. There are only 24 hours in a day and every minute counts. While some upfront work may be required for setting up, in the long run, the investment picked should also be easy to manage and maintain.
Let’s face it. You have a career to manage and a family to take care of on top of finding time to manage your financial future. It all takes time and prioritization. While educating yourself is a good idea, it shouldn’t absorb all your time.
That’s why it is so important that the investment is relatively easy to manage. While your financial future is important, your family is paramount.
Low Risk
When creating a pension, not only is it important for the investment to be a consistent income stream, not correlated to the stock market, and easy to manage, it should also be low risk. Why?
Because you are going to rely on this money always being there no matter what. You’re already investing a lot of your funds in the stock market through a 401K and/or IRA, why risk the rest of it too?
Contrary to popular belief, not all investments that offer a high return also offer high risk. There are several financial instruments that offer a return equal or higher than the stock market and at a low risk.
Let’s talk about those next.
5 Products That Can Be Used To Create A Pension
Annuity
This one may seem like a no brainer because a pension is essentially an annuity. However, did you know you can purchase an annuity from a life insurance company? Here’s an example of why an annuity might be right for you.
Let’s assume you did well and saved up $2.5M in your 401K and IRA accounts. Your minimum retirement income to live off is $5,000 per month but you want to travel a lot and start a few hobbies so ideally you would prefer to live off $7,000 per month.
Using the 4% Rule, your portfolio will generate about $8,300 per month…. Sweet! 😊
But wait, what if a recession occurs? You could easily lose 50% of your portfolio and that only generates about $4,200 per month. Not enough to live off of, and also doesn’t allow you the life you want to live.
What to do? One option is to create an annuity. Using this annuity calculator to generate $5,000 per month, you’ll need to use about $1.2M of your portfolio to create the annuity. This guarantees you have enough to live on. Then for playing, you’ll only need to withdraw about 2% of the remaining $1.25M to generate the remaining $2,000 per month needed.
If the stock market tanks and you lose half your remaining 401K / IRA… no problem! You’ll still have enough to play with and live on. You’re covered!
That’s the good news.
The bad news is that if planning to leave an inheritance for your kids, the odds of that become less likely. The reason is that the amount invested in the annuity is kept by the insurance company when you pass away. Your heirs do not receive it.
Another con for annuities is that you are counting on the company being around until after you pass. This is risky but not impossible to count on.
The keys when looking for an insurance company to invest in is look for a mutual insurance company because they have a lot of experience with these types of financial products and that they have been around for at least 100 years.
Companies that have been around this long have been through all the ups and downs of the economy including the Great Depression, the Inflation Crisis of the 70’s, and the Great Recession yet still thrived.
Finally, look for companies that are at least A+ rated or higher. These are the best quality insurance companies to invest in.
Lastly, if your family has a history of living into their 90’s and beyond, purchasing an annuity could be an option for you. The reason for this is the insurance company is betting that you will not outlive the amount invested and that in the end they will make a profit.
If your family has a shorter life expectancy, an annuity may not be the best choice for you. There are other ways to guarantee income for the short term and even provide an inheritance for your children and grandchildren.
Let’s look at one of those right now.
Life Insurance
Most people use life insurance to protect themselves and their family in case of their demise. Most of the time people use term insurance to achieve this goal.
Did you know that there are other types of life insurance that can not only benefit your family after your demise but also benefit you while living? In fact, if set up correctly, it can provide a consistent, monthly, tax-free payment!
Let’s explore 2 of those types of life insurance: indexed universal life (IUL) and whole life insurance.
Indexed Universal Life Insurance
Indexed universal life insurance (IUL) is a form of permanent life insurance (policy expires at demise) that has both a death benefit and a cash value. Unlike term life insurance, premiums paid goes toward both the death benefit AND a cash value.
In an IUL policy, a stock market index (i.e., S&P 500, Nasdaq 100, and Russell 2000) is used to set the cash value interest rate. The insurer does not directly invest in the market but uses the interest rate and performance of a specific index to set the interest rate for the policy.
A great benefit is that there is a built-in cap on both losses and earnings. The floor is typically 0 or 1% and the ceiling is typically 14-15%. So, the overall range on most policies can be 0% – 15%.
The good news is that a person cannot ever lose money on a policy. The bad news is that gains would be capped at 15%. While this is a good rate of return, if the market goes up to 20%, the policy only gains 15%. The flip side is if the market goes down 30% you lose zip, zero, nada, nothing! 😊
Remember, losses are what can kill a portfolio so capping at 0%, while not great, sure beats the alternative!
The protection from loss is a great way to achieve peace of mind while watching the assets grow. The protection from negative return years is a key benefit of purchasing an IUL policy.
Here is another great benefit on an IUL policy. A minimum premium is required to keep the policy in good standing. However, if a person overpays on the premium, this can significantly increase the cash value of the policy! If enough cash value is accumulated over time, it can be used to not only pay the premiums on its own, but also be accessed by the insured person while still alive.
The way the cash value is accessed is through loans on the policy. By taking out a loan against the policy, the money is borrowed tax-free from the policy. If designed correctly so that the cash value is maximized and death benefit minimized, a steady, monthly stream of tax-free income can be provided. Plus, a death benefit will be provided to the heirs of the insured upon demise.
Whole Life Insurance
Whole life insurance is like universal life insurance with some key differences. Both universal life and whole life are permanent life insurance that have a cash value component and a death benefit component.
A whole life policy provides a set amount of coverage for your entire life. As long as premiums are paid, the beneficiary will receive the benefit amount upon death.
Like universal life, whole life also has a cash value and can be accessed by the insured person while still alive. This cash value is built up over the life of the policy and people can access this money as the policy grows.
Like an IUL policy, overpaying on the premium can significantly increase the cash value of the policy. If enough cash value is accumulated over time, it can also be accessed by the insured person while still alive.
Like an IUL, the way the cash value is accessed is through loans on the policy. By taking out a loan against the policy, the money is borrowed tax-free from the policy. If designed correctly so that the cash value is maximized and death benefit minimized, a steady, monthly stream of tax-free income can be provided. Plus, a death benefit will be provided to the heirs of the insured upon demise.
The main difference between the 2 polices is how the interest rate accrued. In a whole life policy, the interest rate is fixed by the insurance company for the life of the policy. Typically, it falls in the 4-6% range. While not as good as an IUL policy, it still beats a bond by a long way.
In addition to the interest rate, whole life policies can also earn a dividend that can be added to the cash value component to increase growth. It usually adds up to 1% per year extra to the policy. The total interest rate then falls into the 5-7% range.
The good news is this interest rate is not dependent upon a stock market index, bond rate, etc. since the insurance company sets the interest rate. This provides steady, consistent, and predictable growth for the life of the policy. Year in and year out, it can be counted on because the whole life policy is actually a legal contract between you and the insurance company. On the other hand, an IUL has more potential for growth but can fluctuate between 0-15%.
Both good options for different reasons. Both can be used in different situations and potentially a way better option than an annuity.
Want to learn more about these policies? Read my article here.
Real Estate
Real estate has a negative correlation with the stock market. Plus depending on the type of real estate deal, it can provide both a consistent income stream and appreciation upon sale of a property.
Real estate consistently for decades (except 2008 – 2009) has appreciated in value and is also a great hedge against inflation.
There is a plethora of ways to invest in real estate. There are online platforms like Fundrise that allow a person to invest in eREITs for as little as $500 or Roofstock that allow the purchase of actual real estate.
From rental properties to wholesaling to crowdfunding, there are a ton of ways to add real estate to your portfolio. Some require a huge capital investment while others do not.
If just getting started and have little money to invest, Fundrise might be the way to go. Fundrise offers a variety of ways to create a portfolio that will appreciate, create dividends, or both. If enough is invested and in the right mix, a steady income stream could be generated relatively easily.
There is also good old fashioned rental property purchase. A property management company could be hired and funded through an LLC you create. This can also provide a steady income stream for your retirement.
If real estate doesn’t seem right for you, what else is there?
P2P Lending
A newer strategy is person to person (P2P) lending. Essentially P2P lending is one person lending another person or business money. Essentially you act as the “bank” when loaning out money.
P2P Lending can be setup like a traditional bank where the borrower makes monthly payments including interest. Depending on the number of loans outstanding, this could generate a nice income stream.
Own A Business
Something a person can do while working their current career that could potentially payoff huge in their journey to financial independence is starting a side business or being a silent investment partner in a business (i.e., “mom ‘n’ pop” business, online business, franchises, LLC’s etc.).
Not only are there huge potential passive income opportunities but also tax advantages with owning a business. The downside is that upfront costs can be high and active work may be needed depending on what business is chosen. The upside is a potentially consistent income stream that can not only speed up your journey to financial independence but also be used to open doors to other investment opportunities.
For example, I have a friend who is a silent partner in an automotive customization shop. He works his day job during the week and works at the shop on Saturdays. He helps to manage the books, provide a cash influx when needed, and in return he gets a share of the monthly profits plus a place to store his hot rod. 😊
I have another friend who is part of a group that owns a restaurant. He provides a cash influx, a managing partner does all the daily work, and he collects a monthly check.
Another friend has an online business. She only puts in 20 hours a week and makes a nice side income. Her upfront work was a lot, and it took her a couple of years to get it off the ground. Once she did, things just started rolling for her.
Yeah, it means you may need to work a few hours a week in retirement. However, for the peace of mind of having a consistent paycheck I think it’s worth it.
Want to learn more about these opportunities? Read my article here.
Choices, Choices, Choices
Feeling a little overwhelmed? It’s ok, it’s a lot to take in. The purpose was to show you ways to structure your retirement so that you are not a slave to the ups and downs of the stock market.
Knowing there are ways to create your own pension can be overwhelming yet empowering. Today, you’ve learned about 5 ways to create your own pension. These can be used individually or in some combination to achieve the desired results.
Take the opportunity to research these ideas further and see if any are a good fit for you.
Do you have any other ideas for how to create your own pension? I would love to hear from you here.
Live The Life You Love, Want, And Deserve!