Retirement Income Strategies – 4 Typical Sources of Income
Retirement income strategies are plentiful. Littered with different products, approaches, and techniques, it can be confusing to identify which route to take. The focus of this article is to take a step back and identify the typical sources of that income.
Figuring out how to generate income in retirement is the art and science of recreating the dollar – and then stretching it for 30 years. While it can be a scary thought to turn off the spigot of a steady paycheck – assessing where the funds will come from can help alleviate those concerns.
1. Social Security
The first source of funds in retirement is typically Social Security. While there’s been much ado about whether Social Security will still be around for retirees, recent research paints a rosier picture along with potential fixes that could extend benefits for quite a while. Start by obtaining your Social Security estimate at www.ssa.gov. Typically you’ll get an estimate for different ages – 65, 67, and 70.
How and when to file is beyond the scope of this article, but having a rough estimate of the income you can expect is helpful. It is also helpful to know that your benefit amount typically increases year over year by a factor of inflation, currently about 1.3%.
2. Retirement Accounts
Retirement accounts are the next common source of funds for pre-retirees and retirees. Over the course of your career, you’ve likely accumulated funds in a 401k from various employers. With luck, you took advantage of the company match (if any) and have accumulated a modest nest egg. Drawing down from your accounts depends on several factors and it’s not always so obvious.
Traditional 401ks are your most common workplace plan. Money goes in before tax, it grows tax deferred, and it eventually is taxed on the way out (hopefully at a lower tax bracket since you’re no longer working). It might be tempting to accumulate as much as you can in a pre tax plan, but beware – at age 72 Uncle Sam comes knocking on the door for his share.
Required distributions are real and they can be hefty. As such, it could make sense to draw down part of your workplace plan while you’re in a lower tax bracket and simultaneously reduce the amount you are required to withdraw.
With luck, you may have also built up a good amount in an after tax plan such as a Roth 401k. While this type of plan has just recently gained traction and popularity, it can be a useful tool.
Unlike the traditional plan, money goes in after tax, grows tax deferred, and on the way out – Uncle Sam has no right to it. Better yet, qualifying for the plan is much easier than a Roth IRA. There are no income limits, and as long as your employer provides it you’re in!
Depending on your tax situation it could make sense to mix and match distributions from each account – diluting the amount that’s taxable to you at the end of the year.
Savings are often the next source of income for executives. As your peak earnings years ramp up and excess savings become a thing – you may have accumulated funds in a regular (after tax) account. A rule of thumb is to have cash-like assets on hand to cover about a year’s worth of expenses in case of an emergency.
Aside from that, if you’ve built up investments in an after tax account this could also be a source of draw-downs. From a tactical perspective, you may draw down from these accounts via the sale of appreciated stock while taking advantage of the lower capital gains rates.
If your asset allocation and tax situation warrants it – you may even hold your tax free bond allocation in these accounts to avoid paying ordinary income on the bond interest.
4. Pensions and Others
Pensions are mostly a thing of the past and fewer than 4% of companies offer these as their only type of retirement plan. Pensions provide a sense of security and the routine of a steady paycheck – you always know it’s coming in.
Depending on your appetite for risk and comfort level, turning some of your retirement or savings account into “pension-like” products can be appealing to some investors.
Rental income is another source of liquidity that many investors have to look forward to. While not without its drawbacks, rental income can be very attractive given today’s interest rate environment (a.k.a money sitting in a bank won’t do much for you).
While the above is not all encompassing and there are many more things to consider, knowing where the money is coming from to recreate that paycheck can calm some of the panic.
You’ll want to consider the fact that things cost more over time, your health history (may impact how long you’ll have to draw down on your funds) and how to stop tipping Uncle Sam. Have questions? Let’s discuss.