Real Income: Using Dividends and Interest to Avoid Running Out of Retirement Funds

2025 was the first year that the oldest of the Gen Xers reached 60 years of age, which allows them to retire using their retirement assets without penalty. It also marks the beginning of the Peak 65 Zone where approximately 4 million Americans will reach age 65 each year through 2030. By 2030, nearly all Baby Boomers, 73 million strong, will have reached retirement age.

For retirees, the number one concern is fear of running out of money or outliving their assets, according to the 2025 Annual Retirement Study from the Allianz Center for the Future of Retirement. This raises the question of how should retirees generate income from their assets?

Common Methods of Generating Income

There are generally three common methods of generating income from retirement assets. The first is the 4% Rule. The 4% rule states that retirees can withdraw 4% of their retirement savings in the first year of retirement and increase it each year based on inflation. The assumption of this rule is that retirement savings would last 30 years based on market returns.

The second is using annuities for income. With annuities, retirees would purchase an annuity and receive a guaranteed income stream for as long as they live or for a predetermined period of time.

The third most common method of generating income from retirement assets is share liquidation. In this method, retirees would sell shares of their investment positions, whether in mutual funds, ETFs, or individual stocks and bonds, as income. 

There are positives and negatives to each of these methods.

Sequence of Returns Matters

One of the risks associated with using both the 4% Rule and the liquidation of shares to generate income from retirement assets is the sequence of returns. When relying on market returns, it matters when the market is up and when it is down. If the market, as represented by the S&P 500, were to produce positive returns in the first several years of retirement, this would significantly increase the likelihood that your assets would last beyond your life expectancy. However, if the market were to enter into a downturn the first couple years into retirement, the likelihood of running out of money in the later years of retirement increases substantially. 

This can be seen in the sequence of returns from 1999 to 2024. In the chart below (Table 1), we have a retiree with $1 million of retirement assets. In the first year of retirement in 1999, the retiree withdraws 4% of their balance or $40,000 for the year. The $40,000 increases by 3% each year to account for inflation.

1999 happens to be the last year of the 1990’s bull market before the dot com bubble bursts and a three year bear market ensues. Yet, despite negative returns in the second, third and fourth years of retirement, the retiree manages to end their 25 years of retirement with an asset balance of $670,795. 

Table 1

YEAR	S&P 500 TOTAL RETURN	BEGINNING BALANCE	4% INCOME	GAIN/LOSS	ENDING BALANCE
1999	21.04%	$1,000,000	$40,000	$201,984	$1,161,984
2000	-9.10%	$1,161,984	$41,200	-$101,991	$1,018,793
2001	-11.89%	$1,018,793	$42,436	-$116,089	$860,268
2002	-22.10%	$860,268	$43,709	-$180,459	$636,099
2003	28.68%	$636,099	$45,020	$169,521	$760,600
2004	10.88%	$760,600	$46,371	$77,708	$791,938
2005	4.91%	$791,938	$47,762	$36,539	$780,714
2006	15.79%	$780,714	$49,195	$115,507	$847,026
2007	5.49%	$847,026	$50,671	$43,720	$840,076
2008	-37.00%	$840,076	$52,191	-$291,517	$496,367
2009	26.46%	$496,367	$53,757	$117,115	$559,725
2010	15.06%	$559,725	$55,369	$75,956	$580,312
2011	2.11%	$580,312	$57,030	$11,041	$534,323
2012	16.00%	$534,323	$58,741	$76,093	$551,675
2013	32.39%	$551,675	$60,504	$159,090	$650,261
2014	13.69%	$650,261	$62,319	$80,489	$668,432
2015	1.38%	$668,432	$64,188	$8,339	$612,582
2016	11.96%	$612,582	$66,114	$65,358	$611,826
2017	21.83%	$611,826	$68,097	$118,696	$662,425
2018	-4.38%	$662,425	$70,140	-$25,942	$566,342
2019	31.49%	$566,342	$72,244	$155,591	$649,689
2020	18.40%	$649,689	$74,412	$105,851	$681,129
2021	28.71%	$681,129	$76,644	$173,548	$778,032
2022	-18.11%	$778,032	$78,943	-$126,605	$572,484
2023	26.29%	$572,484	$81,312	$129,129	$620,301
2024	25.02%	$620,301	$83,751	$134,245	$670,795

On the other hand, if retirement were to begin one year later in 2000, the results are drastically different as illustrated in Table 2. 

Table 2

YEAR	S&P 500 TOTAL RETURN	BEGINNING BALANCE	4% INCOME	S&P 500 GAIN/LOSS	END BALANCE
2000	-9.10%	$1,000,000	$40,000	-$87,360	$872,640
2001	-11.89%	$872,640	$41,200	-$98,858	$732,582
2002	-22.10%	$732,582	$42,436	-$152,522	$537,624
2003	28.68%	$537,624	$43,709	$141,655	$635,569
2004	10.88%	$635,569	$45,020	$64,252	$654,801
2005	4.91%	$654,801	$46,371	$29,874	$638,303
2006	15.79%	$638,303	$47,762	$93,246	$683,788
2007	5.49%	$683,788	$49,195	$34,839	$669,432
2008	-37.00%	$669,432	$50,671	-$228,942	$389,820
2009	26.46%	$389,820	$52,191	$89,337	$426,965
2010	15.06%	$426,965	$53,757	$56,205	$429,414
2011	2.11%	$429,414	$55,369	$7,892	$381,937
2012	16.00%	$381,937	$57,030	$51,985	$376,891
2013	32.39%	$376,891	$58,741	$103,049	$421,199
2014	13.69%	$421,199	$60,504	$49,379	$410,074
2015	1.38%	$410,074	$62,319	$4,799	$352,555
2016	11.96%	$352,555	$64,188	$34,489	$322,855
2017	21.83%	$322,855	$66,114	$56,047	$312,788
2018	-4.38%	$312,788	$68,097	-$10,717	$233,973
2019	31.49%	$233,973	$70,140	$51,591	$215,424
2020	18.40%	$215,424	$72,244	$26,345	$169,524
2021	28.71%	$169,524	$74,412	$27,307	$122,419
2022	-18.11%	$122,419	$76,644	-$8,290	$37,485
2023	26.29%	$37,485	$78,943	-$10,899	-$52,358
2024	25.02%	-$52,358	$81,312	-$33,444	-$167,114

In this scenario, retiring during a bear market with three consecutive years of negative returns to begin the retirement years results in running out of money in 2023 - two years short of 25 years of retirement.

In other words, it matters if you happen to retire during a bull market or a bear market, and no one really knows the future. As a result, relying on a favorable sequence of returns is a major risk for retirees who use the 4% Rule or the share liquidation method.

Annuities: Forfeiting Assets for A Guaranteed Income Stream

One of the benefits of using annuities for income is that it can provide a guaranteed stream of income during retirement years. The main drawback to annuities is that once you purchase the annuity and annuitize it, you no longer have an asset with a market value. Instead, you have a promise of future payments. This directly impacts the value of one’s estate. In addition, it could result in receiving less than the principal amount purchased if you die prematurely (this can be hedged with a policy rider that reimburses the undistributed principal).

Another drawback is that, once annuitized, the income stream is generally fixed and cannot be changed if one’s needs change. This becomes even more relevant with the prospect that social security benefits could be reduced in the future, as a result of its potential insolvency. This creates a need for retirees to increase their income from other sources such as retirement accounts. However, with annuities that have been annuitized, this is not possible, resulting in no flexibility in adjusting the income stream from annuities. 

Share Liquidation: An Inefficient Method of Generating Income

Another way to generate income from retirement investments is to sell shares of your investment positions, also known as share liquidation. For most people, this seems to be the most intuitive way to generate income, especially if one does not have a specific strategy for generating income - it’s simply easier to sell shares. 

One benefit of selling shares is the tax treatment. If you were to sell shares of an investment that you have owned or held for more than 12 months, at a gain, it would be treated as capital gains, which could be at a lower tax rate than the tax rate of ordinary income from dividends and interest. 

The biggest drawback of the share liquidation method is that it is the most inefficient method of generating income. When it comes to selling shares for income, the number of shares you own is important. So, holding on to as many shares as you can over the long term is paramount to longevity. By continuing to sell shares, you are literally depleting your assets.

In addition, the share liquidation method is dependent on the price per share rising over time. Thus, the risk of the sequence of returns comes into play. As we’ve seen in Table 2, the sequence of returns matters and if you retire during a bear market and sell shares while the price per share is depressed, you end up selling more shares of your assets.

Real Income: Dividends and Interest

The most effective and efficient method of generating income from retirement assets is through dividends and interest - dividends from stocks and interest from bonds (and cash). With this method, you are not having to sell shares to generate income. Instead, you are generating income from the number of shares you own of your investment positions, whether it’s stocks or bonds.

By using dividends and interest for income, it provides a more stable and reliable source of income. For a stock to distribute dividends, there is generally a profitable business behind the company that declares the dividend. Dividends cannot be faked. Dividends are paid as actual cash, so they are real. When it comes to bonds, the interest paid is also real, so the investor can see it deposited into their account in cash. 

Another advantage of dividend paying stocks is that they are generally less volatile in the price swing of their stock than non-dividend paying stocks. According to Perkins Coi Trust Company, “dividend payers have up to 30%-33% lower volatility than non-dividend-paying stocks.” This is because companies with a history of paying dividends tend to be more established and financially stable, with consistent earnings and cash flow. In down markets, this is especially beneficial as they experience less downside capture.

The long term advantage of using dividends and interest for income is that it preserves your principal investment because you are not having to sell shares. This ensures that you have a high probability of maintaining your principal investment over the course of retirement, which ultimately leads to preserving the value of your estate and having something to leave to your heirs.

By preserving the number of shares you own, you are also not subject to the risk of the sequence of returns, and you have the ability for those shares to rise in value, particularly for the stock holdings. This can be seen in the long term returns of stocks through capital appreciation beyond their dividend yield. As a result, there is the opportunity for your principal investment to still grow and keep up with inflation during retirement years.

Target Income Portfolios

In providing income to retirees from dividends and interest, it is important to design portfolios based on the income need. For example, if a retiree needs $30,000 a year from a $1 million portfolio, the target income (distribution rate) is 3%. As a result, it is important to label these portfolios as Target Income Portfolios, where the choice of portfolios by the investor or their financial advisor is based on the target income generated by the portfolio, such as 1%, 2%, 3%, etc. This concept is consistent with Target Date Funds that specify the year in which one is planning on retiring and allocating the portfolio based on that date or year. 

Below is a sample 4% Target Income Portfolio that shows the annual income each investment position would generate based on their respective yields. By designing a portfolio based on asset allocation and yield of each fund, it is possible to generate the desired annual income needed by the retiree.

Sample Target Income Portfolio

Fund	Asset Class	Percent of Portfolio	Amount	Yield	Annual Income
Income Fund of America	Equity Income Fund	30%	$300,000	3.8%	$11,400
Capital Income Builder	Global Equity Income	30%	$300,000	3.1%	$9,300
Bond Fund of America	Long Bond Fund	15%	$150,000	4.3%	$6,450
U.S. Government Securities Fund	Treasury Bond	5%	$50,000	4.1%	$2,050
American High Income Trust	High Yield Bond	15%	$150,000	6.4%	$9,600
Capital World Bond	Global Bond	5%	$50,000	3.1%	$1,550
	TOTAL	100%	$1,000,000	4.04%	$40,350

In this sample Target Income Portfolio above, using American Funds mutual funds as an example, the portfolio is allocated with 60% equities (stocks) and 40% bonds. Based on each fund's yield, the average yield of the portfolio is 4.04% generating approximately $40,350 in annual income from a $1 million portfolio.

If we were to backtest this portfolio 25 years from 2000-2024 with a $1 million investment and take income from the dividends and capital gains (not reinvested) generated by the portfolio each year, we can see in the table below (Table 3) that the portfolio would generate a total income of $1,551,788 over 25 years.

Table 3

Year	Dividends & Interest	Capital Gains	Total
2000	$59,217	$15,758	$74,975
2001	$57,601	$11,480	$69,081
2002	$54,873	$4,241	$59,114
2003	$50,729	$1,293	$52,022
2004	$47,809	$9,731	$57,540
2005	$52,902	$13,256	$66,158
2006	$57,402	$18,525	$75,927
2007	$63,173	$37,098	$100,271
2008	$62,522	$0	$62,522
2009	$50,344	$165	$50,509
2010	$51,779	$1,968	$53,747
2011	$49,901	$1,304	$51,205
2012	$47,716	$2,453	$50,169
2013	$43,787	$532	$44,319
2014	$52,254	$967	$53,221
2015	$42,052	$9,006	$51,058
2016	$41,888	$1,011	$42,899
2017	$42,375	$17,613	$59,988
2018	$45,992	$20,015	$66,007
2019	$47,691	$19,831	$67,522
2020	$47,415	$8,697	$56,112
2021	$45,580	$25,132	$70,712
2022	$48,586	$21,278	$69,864
2023	$54,624	$2,060	$56,684
2024	$61,747	$28,415	$90,162
Total	$1,279,959	$271,829	$1,551,788

The same portfolio would also have an ending balance of $1,596,835 at the end of 25 years after income distribution. In addition, with dividends and capital gains being deposited into the cash account of the portfolio, and taking $40,000 (4% of the original $1 million invested) in the first year and increasing the income distributed by 3% each year for inflation, there would still be an excess of $93,417 in cash after 25 years.

With this back testing example, it assumes no reallocation or rebalancing, which would not have taken advantage of any improvements in pricing and yields as markets changed.

Comparing this sample portfolio to our original scenario with the 4% rule (Table 1), the Target Income Portfolio would have generated more income (additional $93,417) and grown the portfolio value by an additional $926,040. This clearly proves that using income from dividends and interest is a better method.

One final thought regarding using Target Income Portfolios is that the investment industry primarily compensates investment managers based on total return. As more people retire and a larger percentage of investment assets convert from the accumulation phase to the decumulation phase, it would be appropriate for investment managers to also be compensated based on generating reliable income over the long term.

Conclusion

Running out of money during retirement is a very real fear - even more than death. Retirees should enjoy their golden years with confidence that they will not outlive their money regardless of what age they live to.

We have seen that the three most common methods used today to generate income from retirement assets have significant disadvantages. They are either inflexible, subject to the sequence of returns risk or require the retiree to forfeit their assets.

On the other hand, generating income from dividends and interest has all the advantages that retirees need. It is flexible in their withdrawal rates, maintains the principal, has potential for growth, is not subject to the risk of the sequence of returns, and is a less volatile way of investing.