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Social Security is only designed to replace about 40% of the average retiree's income, leaving two options -- either dramatically reduce your standard of living, or create additional income from other sources.
While annuities are certainly one way to create an income stream, there are some downsides to this popular approach. Specifically, annuities often have high fees, and better returns can often be achieved elsewhere.
With that in mind, here are five retirement income strategies that could be smart options for you to supplement your monthly Social Security checks.
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As the name implies, a reverse mortgage works in the opposite manner of a traditional mortgage. Instead of making monthly payments to a bank and building equity in your home, the bank makes payments to you in exchange for your equity.
Reverse mortgages are available to homeowners 62 and older who own enough equity in their home to justify the loan. Upon obtaining a reverse mortgage, the lender makes payments to you and interest begins to accumulate on the outstanding balance.
However, you'll never have to pay back the reverse mortgage unless you sell your home. Reverse mortgages are generally paid off through the sale of a home, either during the borrower's lifetime or after death.
To be clear, there are some downsides to reverse mortgages. Even so, in many cases, reverse mortgages can be a smart way to create an income stream without touching your retirement nest egg.
When it comes to creating retirement income, I'm a fan of maintaining a properly allocated investment portfolio of stocks and bonds.
We'll get to stock investing later, but there are some basic problems with bond investing, especially that bonds pay extremely low interest rates on a historical basis. Just look how low the 10-year Treasury note yield is now compared to its historical levels:
The concept of a bond ladder can help you still get current income, while also allowing yourself to boost your future income if rates rise.
Here's a simplified explanation of how a bond ladder might work. Let's say that you have $100,000 to invest, so instead of putting it all in 10-year bonds, you would put 20% in bonds that mature in two years, another 20% in four-year bonds, and so on. The result is that you'll get the higher income of some longer-dated bonds, but every two years, you'll have $20,000 to put to work at the then-current long-term rates.
Buy, start, or invest in a small business
This is the most "outside-the-box" way to create retirement income on the list, but it has become more popular recently. For example, a retired couple who plans to retire to a beach town might buy a bed and breakfast.
The "buy a business" route can be an especially good option because it can help cure another issue commonly encountered in retirement -- boredom. Operating a business can keep you active and engaged.
There are clearly some downsides of this option. For example, owning your business can be a risky way to make money, and not all retirees are physically capable of running a business. However, this is an interesting option for entrepreneurial-minded retirees.
Investing in real estate can produce excellent income, and can also increase your net worth over time. And thanks to the power of leverage (mortgage financing), retirees don't necessarily need a ton of money to get started.
There are several risks to be aware of. Vacancies, bad tenants, and unexpected maintenance issues are just a few of the uncertainties. However, for many people, the reward potential can definitely outweigh the risk. In fact, investing in rental properties is a big part of my own retirement planning strategy.
Dividend growth investing
Last, but certainly not least, stock investing can be an excellent way to generate a growing income stream in retirement.
A smart approach for retirees is to focus on dividend growth stocks -- in other words, stocks that not only pay dividends, but have a solid history of increasing their dividend payments. For example, Procter & Gamble has an above-average 3.7% dividend yield and has increased its payout for 62 consecutive years. Stocks like this pay more than you can get from many intermediate-term investment-grade bonds, with the added probability of rising income over time.
If you aren't comfortable with choosing individual stocks, you can invest in diverse assortments of these companies through mutual funds and ETFs. The Vanguard High Dividend Yield ETF (NYSEMKT: VYM) is one of my personal favorites.
Which is best for you?
The best choice for you depends on your risk tolerance, the level of involvement you want to have, and other factors. While it's likely that not all these suggestions are ideal for you, my point is to get you thinking about alternatives before putting your retirement nest egg into an annuity or other fixed-income strategy.
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