Paying the Bills: Potential Sources of Retirement Income
Planning your retirement income is like putting together a puzzle
with many different pieces. One of the first steps in the
process is to identify all potential income sources and estimate
how much you can expect each one to provide.
The vast majority of people
aged 65 or older receive Social Security benefits. However, most retirees also
rely on other sources of income.
For a rough
estimate of the annual benefit to which you would be entitled at various retirement ages, you can use the calculator on the Social Security website, www.ssa.gov. Your Social Security retirement benefit is calculated using a formula that takes
into account your 35 highest earnings years. How much you receive ultimately
depends on a number of factors, including when you start taking benefits. You
can begin doing so as early as age 62. However, your benefit may be approximately 25% to 30%
less than if you waited until full retirement age (66 to 67, depending on the
year you were born). Benefits increase each year that you delay taking benefits until you reach age 70.
As you're planning, remember that the question of how Social Security will meet
its long-term obligations to both baby boomers and later generations has become
a hot topic of discussion.
Concerns about the system's solvency indicate that there's
likely to be a change in how those benefits are funded, administered, and/or taxed
over the next 20 or 30 years. That may introduce additional uncertainty about
Social Security's role as part of your overall long-term retirement income
picture, and put additional emphasis on other potential income sources.
If you are entitled to receive a traditional pension, you're lucky; fewer
Americans are covered by them every year. Be aware that even if you expect
pension payments, many companies are changing their plan provisions. Ask your
employer if your pension will increase with inflation, and if so, how that
increase is calculated.
Your pension will most likely be offered as either a single or a joint and
survivor annuity. A single annuity provides benefits until the worker's death; a
joint and survivor annuity provides reduced benefits that last until the
survivor's death. The law requires married couples to take a joint and survivor
annuity unless the spouse signs away those rights. Consider rejecting it only if
the surviving spouse will have income that equals at least 75% of the current
joint income. Be sure to fully plan your retirement budget before you make this
Work or other income-producing activities
Many retirees plan to work for at least a while in their retirement years at
part-time work, a fulfilling second career, or consulting or freelance
assignments. Obviously, while you're continuing to earn, you'll rely less on
your savings, leaving more to accumulate for the future. Work also may provide
access to affordable health care.
Be aware that if you're receiving Social Security benefits before you reach your
full retirement age, earned income may affect the amount of your benefit
payments until you do reach full retirement age.
If you're covered by a pension plan, you may be able to retire, then seek work
elsewhere. This way, you might be able to receive both your new salary and your
pension benefit from your previous employer at the same time. Also, some
employers have begun to offer phased retirement programs, which allow you to
receive all or part of your pension benefit once you've reached retirement age,
while you continue to work part-time for the same employer.
Other possible resources include rental property income and royalties from
existing assets, such as intellectual property.
Until now, you may have been saving through retirement accounts such as IRAs,
401(k)s, or other tax-advantaged plans, as well as in taxable accounts. Your
challenge now is to convert your savings into ongoing income. There are many
ways to do that, including periodic withdrawals, choosing an annuity if
available, increasing your allocation to income-generating investments, or using
some combination. Make sure you understand the tax consequences before you act.
Some of the factors you'll need to consider when planning how to tap your
retirement savings include:
- How much you can afford to withdraw each year without exhausting your nest egg.
You'll need to take into account not only your projected expenses and other
income sources, but also your asset allocation, your life expectancy, and
whether you expect to use both principal and income, or income alone.
- The order in which you will tap various accounts. Tax considerations can affect
which account you should use first, and which you should defer using.
- How you'll deal with required minimum distributions (RMDs) from certain tax-advantaged
accounts. After age 72, if you withdraw less than your RMD, you'll pay a
penalty tax equal to 50% of the amount you failed to withdraw.
Some investments, such as certain types of annuities, are designed to provide a
guaranteed monthly income (subject to the claims-paying ability of the issuer).
Others may pay an amount that varies periodically, depending on how your
investments perform. You also can choose to balance your investment choices to
provide some of both types of income.
An inheritance, whether
anticipated or in hand, brings special challenges. If a potential inheritance
has an impact on your anticipated retirement income, you might be able to help
your parents investigate estate planning tools that can minimize the impact of
taxes on their estate. Your retirement income also may be affected by whether
you hope to leave an inheritance for your loved ones. If you do, you may
benefit from specialized financial planning advice that can integrate your
income needs with a future bequest.
Equity in your home or business
If you have built up substantial home equity, you may be able to tap it as a
source of retirement income. Selling your home, then downsizing or buying in a
lower-cost region, and investing that freed-up cash to produce income or to be
used as needed is one possibility. Another is a reverse mortgage, which allows
you to continue to live in your home while borrowing against its value. That
loan and any accumulated interest is eventually repaid by the last surviving
borrower when he or she eventually sells the home, permanently vacates the
property, or dies. (However, you need to carefully consider the risks and costs
before borrowing. A useful publication titled "Reverse Mortgages: Avoiding a
Reversal of Fortune" is available online from the Financial Industry Regulatory
If you're hoping to convert an existing business into retirement income, you may
benefit from careful financial planning to minimize the tax impact of a sale.
Also, if you have partners, you'll likely need to make sure you have a buy-sell
agreement that specifies what will happen to the business when you retire and
how you'll be compensated for your interest.
With an expert to help you identify and analyze all your potential sources of
retirement income, you may discover you have more options than you realize.