Inherited $500K? Or $1 million? Here’s how to make that money act like a monthly pension

A weighty inheritance can feel unnerving when you’re unsure what to do with it, especially considering one wrong decision could cost a pretty penny.

The good news: There are ways to structure that money — be it $250,000, $500,000 or $1 million or more — so it works overtime in and for retirement. With those assets, investors can have their own version of a monthly pension, something many Americans are without these days.

Having such a large sum of money can make even the most calm individual a little nervous. A well-considered plan, including how it’s invested and withdrawn, would not only dispel fears, but create a reliable stream of income well into old age.

Even still, novice investors may want to consider working with a financial planner for an undertaking like this. These professionals will take into account their goals and hesitations, as well as assumptions about inflation, the market and life expectancy. There are many types of financial professionals available, and plenty of questions investors should ask before working with one, including these.

“Retirement is not the time to play around with your nest egg and start gambling and speculating,” said Marianela Collado, chief executive officer and a senior financial adviser at Tobias Financial Advisors.

Although the private sector has moved away from pensions over the last three and a half decades, there are plenty of opportunities for Americans to create their own version, where they can receive a stream of income to live on every month from their own investments. This money may already be in a retirement account, such as a 401(k) or individual retirement account, or it may be in another vehicle. Investors can create a withdrawal plan, where money is distributed on a schedule they deem appropriate (such as every month or every quarter).

See: The truth about pensions: they aren’t dead, but some are barely holding on

First, it’s important to know there are myriad factors to consider to make this money work to its full potential, including: risk tolerance, which is how much risk an investor is comfortable taking, versus risk capacity, the amount of risk that person needs to accomplish her goals; life expectancy; investment allocations and diversification; what amount will be withdrawn every month; and of course having goals for the money.

“It’s like a giant formula,” Collado said. “When you move one variable up, the others would go down.”

There are many avenues one can take to generate income from these investments without eroding the principal amount invested, and no one “right” decision.

Have a question about retirement, including where to retire? Check out MarketWatch’s “Help Me Retire” column

Here are a few options investors have when deciding how to invest and later withdraw their funds:

The 4% rule

One common rule of thumb is the 4% rule. Essentially, this rule states that no matter how the markets are doing, you’re able to safely withdraw 4% of your portfolio every year. For example, if someone can expect to live on $60,000 per year in retirement (or $5,000 a month), that individual would need to have about $1.5 million invested by retirement, Collado said.

The 4% rule isn’t for everyone. Some people might feel they don’t need 4% or they may need more. Some experts even argue following this general guideline will leave “a huge amount of money left over,” because it doesn’t take account for other retirement income sources, such as Social Security.

Even the creator of the 4% rule says there’s room for improvement. He recently updated his calculation to 5% because of the current economic environment.

The ‘income bridge strategy’

Another option is the “income bridge strategy,” which uses stocks and bonds to their highest strengths, said Michael Peterson, a financial adviser and founder of Faithful Steward Wealth Advisors. Bonds are dependable for generating income, because investors will receive the principal of the bond at its maturity. In an income bridge strategy, bonds would be used to mature “just in time to fund each year’s spending needs,” Peterson said.

The next step in the income bridge strategy is to have a “growth bucket,” which would be for stock investments. “Over the long haul, they provide one of the greatest long-term returns available to investors.” When there are exceptionally good returns in the growth bucket, some of that money can extend into purchasing more bonds. “This strategy allows you to intelligently navigate the portfolio, as opposed to a systematic withdrawal plan,” Peterson said. “The income bridge strategy takes more work, but it could vastly increase the longevity of a retirement portfolio.”

Also see: Here’s a straightforward retirement income strategy for workers with no pension

Of course, as with all complex investing strategies, a financial adviser could help investors implement the structure, monitor the portfolio and field any questions that arise during the process. They might also suggest other options to generate a stream of income in retirement.

An annuity

Take a single premium immediate annuity, said Malcolm Ethridge, a financial planner and host of the Tech Money Podcast. This might be a viable choice for someone in good health who is concerned about outliving their savings, he said. “In essence, they are the equivalent of a pension provided by an employer,” he said. “You turn over to an insurance company a lump sum of money and in exchange, they promise to pay you a specified amount per month for the rest of your life.”

Not all financial professionals are proponents of annuities. Individuals can die before they’ve received the full amount they were owed from the annuity (in other cases, beneficiaries may receive the remaining amount), or there may be additional fees and stipulations to use them.

Annuities should be researched thoroughly, including the financial strength of the company issuing them. But after finding the right one to use (and perhaps consulting with a financial professional to make that decision), they could be a simpler way to receive a guaranteed stream of income. “Your job then becomes to make sure you live long enough to spend down your initial principal and get to spend some of the insurance company’s money too,” Ethridge said.

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