Where will my income come from in retirement? How will I know which account or source to tap when? Learn more to better understand how your retirement paycheck is created!
Last month we looked at managing expenses before and/or during retirement. Why? Well, it is an important question that must be answered in order to determine how much you need to save for retirement. If you are just a few years away from retirement it is a consideration that needs to be thought through in order to understand what lifestyle you can afford in retirement. In other words, what you save or spend now will affect your retirement tomorrow.
This article explores the different sources of income that can be tapped for retirement.
Sources of Income
Generally, there are six major sources of income in retirement.
We (financial planners) think about sources of income in two categories: fixed and variable. Fixed sources, once initiated, will usually last your lifetime (and possibly your spouse’s). Common sources of variable income include rental income, portfolio income, employment, inheritances, etc. They may not last your lifetime and the amount may vary over time.
Each of these sources, in addition to generating varying amounts of income, has a unique tax profile. They may also start and stop in different years. Creating income is a unique blend of income, taxes, and timing for each person. Some of retirement’s BIG DECISIONS come into play when determining which source to use and when. The important question to ask is what is my standard of living during my life expectancy.
Social Security (fixed)
The most common source of a “fixed” income is social security. You may recall our article on Social Security last fall reporting that this is the largest source of retirement income for more than 40% of Americans. Even better, it is guaranteed by the US government. And as a bonus, you can earn substantially more the longer you wait to claim your benefit. Claiming Social Security is one of the BIG RETIREMENT DECISIONS (there are many!)
There are many strategies for claiming social security. It pays to do your homework to make sure you claim the right one for you and your spouse. Make sure your financial advisor has the appropriate software to help make the decision. If you are a DIY-er, there are several software programs that can help. We list them in this blog. At Mosaic Fi we invested in special software to make sure it is done correctly. You should know that the Social Security office will call you 6 months prior to turning age 70 (the latest age you would want to wait to begin collecting) and offer to enroll you. Decline the offer. They will actually penalize you for enrolling 6 months before age 70.
Another source of a “fixed” income is a pension. Corporate pension plan offerings continue to diminish. However, if you are fortunate to have a pension, the fine print is important. Typically, one must decide whether to convert the pension into an annuity or transfer it into an IRA.
Annuities are great sources of fixed income if you need them. Generally, they are most appropriate for those whose retirement savings are constrained or those who are uncomfortable taking any financial risk. However, there can be embedded risk depending on the financial worthiness of the provider. Fees can also be high. They should be shopped carefully.
Retirement accounts including traditional and Roth IRAs, 401ks, 403(b)s, 457(bs) are more popular retirement accounts. With the exception of Roth IRAs, withdrawals from the other plans are subject to ordinary income tax. In addition, the law may require you to start withdrawals at age 72 if you haven’t already started withdrawing. Roth withdrawls are tax free and there is no minimum age distribution requirement.
Taxable investment accounts are funded with post tax income and are subject to short- or long-term capital gains or losses.
Creating income from savings is generally fine-tuned using various asset allocations and withdrawal strategies. Depending on your situation, your financial advisor will make recommendations that can and will vary as you age and your spending changes.
According to the WSJ, the share of workers 65 and over in the US is expected to increase faster than any other age group between now and 2030. Yes, many people work in retirement both part-time and full-time for several reasons:
Other Sources of Income
Other sources can include rental income, inheritance, royalties, business sale, as well as proceeds from divorce.
Gathering this information before retirement is helpful to understanding:
In addition, tax planning before and during retirement is critical to maximize cash flow.
Please contact us if you have questions.