If you're not thinking about how you'll support yourself in retirement, you should. The typical retirement income plan used to be referred to as a "three-legged stool," with Social Security, a pension, and personal savings as the legs. It's a rather wobbly stool these days, though, as few people have pensions, most Americans have far too little in retirement savings, and Social Security is insufficient to fully support most folks.
For many people, retirement income may come from a variety of sources. Here’s a quick review of some of the main sources:
Many people assume Social Security will cover all of their retirement income needs. Yet, it is usually a very slim budget to try to live on by itself. As the government-administered retirement income program workers become eligible after paying Social Security taxes for 10 years. Benefits are based on each worker’s 35 highest earning years. If there are fewer than 35 years of earnings, non-earning years are averaged in as zero.
Personal Savings and Investments
Personal savings and investments outside of retirement plans can provide income during retirement. There are a wide variety of investment options for these types of savings. You can customize a mix of diversified funds that match the amount of risk you are comfortable holding in your investments. While savings accounts may seem safe and secure, investments in mutual funds are usually better able to help you keep up with inflation over the long term. Also, once you pass away, those assets can be left to your loved ones.
Health Savings Accounts (HSA)
If you have a high-deductible health insurance plan, you may be able to set up a Health Savings Account (HSA) through your employer. It's meant to cover healthcare costs, but it has a good retirement-savings element to it, as well. You park pre-tax money in your HSA and get an upfront tax break that year. Then you can use the money in the account, tax-free, for qualifying healthcare expenses, such as prescriptions, physician visits, lab work, and eye exams, and any money that remains in the account at the end of the year stays there. Once you turn 65, you can take money out of the account for any reason, paying taxes on it at your ordinary income tax rate. In addition, while the money is in the account, it can be invested. The contribution limit for HSAs in 2020 is $3,550 for individuals and $7,100 for families. Those 55 or older may contribute an additional $1,000.
Your Life Insurance Policy
If you have a whole or universal life insurance policy (as opposed to a term policy), you may be able to borrow against it or even cash it out. Borrowing against a policy – and getting money that is typically tax-free – will reduce the death benefit, which can be restored when you repay the loan. Surrendering a policy, or cashing it out, will generally result in your paying a penalty and receiving taxable funds.
Individual Retirement Accounts
Contributions you make to a traditional Individual Retirement Account (IRA) may be fully or partially deductible, depending on your individual circumstances. You can contribute pre-tax dollars to a traditional IRA enabling you to reduce your taxable income for the year. Roth IRAs are an option for some investors where you can contribute after taxes which means when you take the money out in retirement you will not pay taxes on it. Keep in mind Roth IRA contributions cannot be made by taxpayers with high incomes. To qualify for the tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½.
Under the SECURE Act, in most circumstances, once you reach age 72, you must begin taking required minimum distributions from an IRA.
A Fixed Annuity
Many businesses don’t offer pension plans anymore, but you can set up dependable pension-like income for yourself via a fixed annuity. You pay an insurance company a certain sum and in exchange, you can collect monthly checks for a specified period or for the rest of your (and/or your spouse's) life.
Defined Contribution and Benefit Plans
Many workers are eligible to participate in a defined-contribution plan such as a 401(k), 403(b), or 457 plan. Eligible workers can set aside a portion of their pre-tax income into an account, which then accumulates, tax deferred. Under the SECURE Act, in most circumstances, you must begin taking required minimum distributions from your 401(k) or other defined contribution plan in the year you turn 72.
Defined benefit plans are traditional pensions – employer-sponsored plans under which benefits, rather than contributions, are defined. Benefits are normally based on factors such as salary history and duration of employment. The number of traditional pension plans has dropped dramatically during the past 30 years.
This is a more obvious source of additional retirement income that will be more possible in your early retirement years than your later ones. In a recent survey, 68% of workers stated that they planned to keep working in retirement. In contrast, only 26% of retirees reported that continued employment was a major or minor source of retirement income.
Your home is another possible source of retirement income if you get a reverse mortgage. That's essentially a loan from a financial company with your home as the collateral. You get a lump sum from the company or monthly payments, and you don't have to pay the loan back until you're no longer living in the home.
Another source of retirement assets can come from your home – if you downsize into a less costly one. For example, you might sell your home and buy a smaller, less costly one in the same general area, or you might move to a region with a significantly lower cost of living. Either way, you can set yourself up to pay a lot less in mortgage payments, insurance, taxes, maintenance, and so on.
Expected Vs. Actual Sources of Income in Retirement
What workers anticipate in terms of retirement income sources may differ considerably from what retirees actually experience.
Employee Benefit Research Institute, 2019 Retirement Confidence Survey
Americans are strikingly lacking in their financial planning for their golden years. In a GALLUP survey, just 25% overall saying they are saving enough for retirement, while 18% do not have any retirement savings, and 5% do but are not adding to it. In all, this means 46% of these adults could be classified as largely unprepared for retirement.
You shouldn’t assume that Social Security will be enough to support you in retirement because it probably won't. It’s important to seriously consider how you're going to live in retirement and come up with a good plan.
As your financial advisor, I will review about all aspects of your life in detail and conduct a thorough process of creating and implementing an ongoing retirement plan that will get your savings on the right track. CONTACT ME today for a retirement review.
- Social Security Administration, 2019
- Insured Retirement Institute, April 2018
- Employee Benefits Research Institute, 2018