According to the
approximately 67% of
Americans elected to
receive their Social
early in 2019. (Source: SSA
Your pension plan
must provide you with
an explanation of
your options prior to
an explanation of
your right to waive
the QJSA, and the
relative values of any
optional forms of
benefit available to
Retirement Income: The "Three-Legged Stool"
Traditionally, retirement income has been described as a "three-legged stool"
comprised of Social Security, traditional employer pension income, and individual
savings and investments. With fewer and fewer individuals covered by traditional
employer pensions, though, the analogy doesn't really hold up well today.
Social Security retirement income
The amount of Social Security retirement benefit that
you're entitled to is based on the number of years you've been working and the amount
you've earned. Your benefit is calculated using a formula that takes into account
your 35 highest earning years.
Social Security Full Retirement Age
|Birth Year||Full Retirement Age|
|1955||66 and 2 months|
|1956||66 and 4 months
66 and 6 months
66 and 8 months
66 and 10 months
|1960 and later||67
Source: Social Security Administration
The earliest that you can begin receiving Social Security retirement benefits is
age 62. If you decide to start collecting benefits before your full retirement age
(which ranges from 66 to 67, depending on the year you were born), there's a major
drawback to consider: Your monthly retirement benefit will be permanently reduced.
In fact, if you begin collecting retirement benefits at age 62, each monthly benefit
check will be 25% to 30% less than it would be at full retirement age. The exact
amount of the reduction will depend on the year you were born. (Conversely, you
can get a higher payout by delaying retirement past your full retirement age — the
government increases your payout every month that you delay retirement, up to age
If you begin receiving retirement benefits at age 62, however, even though your
monthly benefit is less than it would be if you waited until full retirement age,
you'll end up receiving more benefit checks. For example, if your normal retirement
age is 67, if you opt to receive Social Security retirement benefits at age 62, you'll receive 60 additional monthly benefit payments.
The good news is that, for many people, Social Security will provide a monthly benefit
each and every month of retirement, and the benefit will be periodically adjusted
for inflation. The bad news is that, for many people, Social Security alone isn't
going to provide enough income in retirement. For example, according to the Quick
Calculator on Social Security's website, an individual born on January 2, 1960, who currently
earns $100,000 a year can expect to receive approximately $30,984 annually at full
retirement age (67). Of course, your actual benefits
will depend on your work history, earnings, and retirement age. The point is that
Social Security will probably make up only a portion of your total retirement income
Traditional employer pensions
If you're entitled to receive a traditional pension, you're lucky; fewer Americans
are covered by them every year. If you haven't already selected a payout option,
you'll want to carefully consider your choices. And, whether or not you've already
chosen a payout option, you'll want to make sure you know exactly how much income
your pension will provide, and whether or not it will adjust for inflation.
In a traditional pension plan (also known as a defined benefit plan), your retirement
benefit is generally an annuity, payable over your lifetime, beginning at the plan's
normal retirement age (typically age 65). Many plans allow you to retire early (for
example, at age 55 or earlier). However, if you choose early retirement, your pension
benefit is actuarially reduced to account for the fact that payments are beginning
earlier, and are payable for a longer period of time.
If you're married, the plan generally must pay your benefit as a qualified joint
and survivor annuity (QJSA). A QJSA provides a monthly payment for as long as either
you or your spouse is alive. The payments under a QJSA are generally smaller than
under a single-life annuity because they continue until both you and your spouse
Your spouse's QJSA survivor benefit is typically 50% of the amount you receive during
your joint lives. However, depending on the terms of your employer's plan, you may
be able to elect a spousal survivor benefit of up to 100% of the amount you receive
during your joint lives. Generally, the greater the survivor benefit you choose,
the smaller the amount you will receive during your joint lives. If your spouse
consents in writing, you can decline the QJSA and elect a single-life annuity or
another option offered by the plan.
The best option for you depends on your individual situation, including your (and
your spouse's) age, health, and other financial resources. If you're at all unsure
about your pension, including which options are available to you, talk to your employer
or to a financial professional.
Most people are not going to be able to rely on Social Security retirement benefits
to provide for all of their needs. And traditional pensions are becoming more and
more rare. That leaves the last leg of the three-legged stool, or personal savings,
to carry most of the burden when it comes to your retirement income plan.
Your personal savings are funds that you've accumulated in tax-advantaged retirement
accounts like 401(k) plans, 403(b) plans, 457(b) plans, and IRAs, as well as any
investments you hold outside of tax-advantaged accounts.
Until now, when it came to personal savings, your focus was probably on accumulation — building
as large a nest egg as possible. As you transition into retirement, however, that
focus changes. Rather than accumulation, you're going to need to look at your personal
savings in terms of distribution and income potential. The bottom line: You want
to maximize the ability of your personal savings to provide annual income during
your retirement years, closing the gap between your projected annual income need
and the funds you'll be receiving from Social Security and from any pension payout.
Some of the factors you'll need to consider, in the context of your overall plan,
- Your general asset allocation: The challenge is to provide, with reasonable certainty,
for the annual income you will need, while balancing that need with other considerations,
such as liquidity, how long you need your funds to last, your risk tolerance, and
anticipated rates of return.
- Specific investments and products: Should you consider an annuity? Bonds?
What about a mutual fund that's managed to provide predictable retirement income
(sometimes called a "distribution" mutual fund)?
- Your withdrawal rate: How much can you afford to withdraw each year without exhausting
your portfolio? You'll need to take into account your asset allocation, projected
returns, your distribution period, and whether you expect to use both principal
and income, or income alone. You'll also need to consider how much fluctuation in
income you can tolerate from month to month, and year to year.
- The order in which you tap various accounts: Tax considerations can affect which
accounts you should use first, and which you should defer using until later.
- Required minimum distributions (RMDs): You'll want to consider up front how you'll
deal with required withdrawals from tax-advantaged accounts like 401(k)s and traditional
IRAs, or whether they'll be a factor at all. After age 72, if you withdraw
less than your RMD, you'll pay a penalty tax equal to 50% of the amount you failed
Other sources of retirement income
If you've determined that you're not going to have sufficient annual income in retirement,
consider possible additional sources of income, including:
- Working in retirement: Part-time work, regular consulting, or a full second career
could all provide you with valuable income.
- Your home: If you have built up substantial home equity, you may be able to tap
it as a source of retirement income. You could sell your home, then downsize or
buy in a lower-cost region, investing that freed-up cash to produce income or to
be used as needed. Another possibility is borrowing against the value of your home
(a course that should be explored with caution).
- Permanent life insurance: Although not the primary function of life insurance, an
existing permanent life insurance policy that has cash value can sometimes be a
potential source of retirement income. (Policy loans and withdrawals can reduce
the cash value, reduce or eliminate the death benefit, and can have negative tax
What if you still don't have enough?
If there's no possibility that you're going to be able to afford the retirement you want, your options are limited:
- Postpone retirement: You'll be able to continue to add to your retirement savings. More importantly, delaying retirement postpones the date that you'll need to start withdrawing from your personal savings. Depending on your individual circumstances, this can make an enormous difference in your overall retirement income plan.
- Reevaluate retirement expectations: You might consider ratcheting down your goals and expectations in retirement to a level that better aligns with your financial means. That doesn't necessarily mean a dramatic lifestyle change — even small adjustments can make a difference.
1The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in late 2019 raised the RMD age from 70½ to 72, effective January 1, 2020. Anyone who turns 72 before July 1, 2021, (and therefore reached age 70½ before 2020), will need to take an RMD by December 31, 2021.