Retirement is a period of our lives that many of us look forward to. However, it’s also a time when you’ll most likely no longer work. For that reason, you may have no income except for what you’ve set aside in your retirement fund. Planning for the future is vital. Most global retirement funds come through a defined contribution plan, such as a 401k plan. For that to work, you must take an amount from your pre-retirement income that you receive and set it aside, slowly building a nest egg to rely on in the future.
That same nest egg needs to last you for the rest of your days. The bills don’t stop just because you retire, and when your limited funds run out, you’ll find yourself in trouble.
It’s not only continuous living expenses that you should consider. You’ve spent your life working five days a week or more, and retirement is the perfect opportunity to take some time for yourself. Perhaps you want to spend more time with your family or take up some hobbies. To make the most of your time, some extra funds won’t hurt.
To secure those extra funds, you need a steady flow of income in retirement. Luckily, there are multiple ways for you to acquire this income, though you need to consider your needs first. The best way to do this is by planning out your retirement income strategy.
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Setting out Your Retirement Income Strategy
With your retirement strategy, you need to ensure your chosen source of income works for you. Consider the amount of time you’ll have available to put into your desired income method versus other activities. You’ll need to balance your priorities. You must also consider the economic factors involved. Interest rates and inflation can all impact how long your chosen income method is viable.
Calculating Your Expenses
Before deciding on your chosen income source, you need to consider how much money you’ll need. There are numerous ways of calculating your required retirement income, but you’ll only ever obtain an estimate. A good rule to follow is to aim for 80% of the amount you’re spending before your retirement. You’ll find that a lot of expenses you had while working are no longer valid, such as commuting costs and your retirement fund contributions. However, you may also find yourself spending more on vacations or shopping trips because you have more time.
The amount of your original take-home pay may not cover these additional expenses, though retirement is the perfect time to take a vacation. You may witness a cost-of-living increase due to you being at home more than you were before. Your healthcare and other forms of long-term care expenses may also increase. It’ll be difficult to ascertain an exact figure, but a ballpark amount will at least give you an idea.
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Adding up Your Current Retirement Income
Once you have a rough idea of your expected expenses, you need to calculate your current income. Knowing whether you’ll have enough will determine if you need to find an alternate source, with some possible options detailed below.
The first aspect of your retirement income that you should consider is your social security benefits. If you’ve been working and paying into your social security for at least ten years, you can use a social security estimator. The closer you are to your retirement, the more accurate the projected amount will be. The earlier you claim your social security benefits, the less you’ll receive. You can take out your benefits as early as 62 years old, with 70 being the maximum age to claim your owed amount. It’s still possible to claim after 70, but you won’t see any further increase to the amount owed to you.
If you’re owed a pension from a current or previous employer, it’s essential to know how much you should expect from your employer-sponsored retirement plans. The company’s pension plan manager can provide you with an estimate, no matter if the program is a single-employer or multiple-employer plan.
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The last source of income you need to consider is your actual savings. How much will you receive from your 401(k), IRA, and any other form of retirement account that you hold? Generally, you should not count on more than 4% per year from your gathered savings. With that withdrawal amount, you can expect to get about 30 years’ worth of income from your savings while still maintaining an investment portfolio. Your 401(k) will tend to be your most significant source of savings, with most participants claiming to need $1.7 million for a secure nest egg.
The Final Figure
Adding up all of the above will give you the final figure. A retirement calculator can also help if you aren’t up to doing the math yourself. If this figure doesn’t match your expected expenses, it’s time to consider an alternative. You can aim to lower your costs or increase your income. You can continue working with your current employer, source a part-time job, or pay more into your retirement savings. The sooner you do the math, the more time you’ll have to find a solution.
Sourcing Your Income
Each person will come out with a different amount when calculating how much income they need to see them through retirement. Your current income may fully cover your expected expenses, or you may fall short. Even if you’re fully covered, you may want some extra spending money. For this reason, there will be no one right option for your retirement income source. However, the options below are sure to set you on the right path:
For simplicity, an immediate annuity copies the behavior of a standard retirement plan. Like a retirement fund, an immediate annuity will allow you to convert your nest egg into an income stream that’ll help you meet your monthly expenses. The certainty of a monthly income gets achieved by sending all of your retirement savings to an insurance company, or similar financial entity, in one lump sum. The company then pays out your savings back to you in increments on a scheduled date. In this case, you’re giving up control of your funds and can’t withdraw them yourself. In return for the lack of control, you’ll have a guaranteed retirement income.
Immediate annuities are a type of insurance and not an investment for your portfolio. You’re purchasing the assurance of a lifetime income and not looking to make a further profit. However, you can opt for variable annuities that will provide a minimum payout amount, with the rest tied to a stock index. If you want to see a higher amount of income, you have to first work with a minimal amount.
Laddered bonds work similarly to immediate annuities. You can secure regular payments to provide a stream of income. However, that’s where the similarities end. Laddered bonds are an investment. Laddering is the process of investing in multiple bonds, all of which have different levels of maturity. The principal payments and interest on your purchased bonds are how you secure an income. You have the added benefit of accessing your savings if you need to, unlike with annuities.
As an investment vehicle, bonds are almost risk-free. For example, the Treasury Inflation-Protected Securities are Treasury Bonds that protect against increased inflation. The flexibility is an excellent addition to your portfolio; however, collecting a payout is not guaranteed. Even if it’s received, it may be lower than what you receive with an annuity. It’s possible to make a higher profit, and thus generate more income with other stock market assets, but that territory comes with more risk.
Target Date Funds
Target date funds take advantage of a mix of stocks, bonds, and other assets. Initial investments come with a high risk, and as you close in on your retirement date, you can invest in less risky securities. This process allows you to secure a retirement income while also giving your investment a chance to provide higher returns. A target-date fund may even be part of your 401(k) plan.
Unfortunately, market volatility cannot guarantee a return. You’ll have to manage your monthly withdrawals as needed, to avoid losing your savings. If that concerns you, you can set up a managed payout fund. Instead of taking out monthly withdrawals at your leisure, you take withdrawals based on a fixed percentage of your account balance. Keep in mind that you’ll still have uncertainty regarding how much income you’ll have to work with each month.
Mutual funds come in many shapes and sizes, including the above target-date funds. Another great option is an equity mutual fund. A mutual fund is a collection of stocks, bonds, and other financial assets that are all managed by a mutual fund manager. They’re mutual because you aren’t the sole investor. Instead, multiple investors invest as little or as much as they like into a fund. You earn money by buying and selling your shares, by receiving dividend payouts, or by making long-term capital gains. Mutual funds are categorized by their investment strategy, the type of companies they invest in, and more. There are even specific mutual funds for retirees.
You can use dollar-cost averaging to assist with making a mutual fund viable. Specifically, no-load mutual funds that are bought and sold with no commission fees can allow you to secure a return with minimal risk. Putting the same dollar amount into the fund each month achieves the best result.
A Roth IRA is a type of tax-advantaged savings account. You pay tax on the payments put into your account, then withdraw money with no tax necessary. The money you put into your Roth IRA contributes to investments, and the return you receive is tax-free. The money you initially put into the fund, as well as profit, are both counted as tax-free distributions.
As of 2019, you’re only able to put in $6,000 a year. If you’re over 50, you can contribute up to $7,000 per year. You can only put in income that you’ve earned. If you make over a certain amount, specifically $137,000 in annual income, you’re not able to apply for a Roth IRA. A Roth IRA can be taken out with multiple brokerage firms, as well as banks and investment companies. After the age of 70, you can still contribute to your IRA as long as the cash you deposit is generated income. There are also no required minimum distributions for you to plan around. You can withdraw the money when you need it, at an amount of your choosing. However, if you leave a Roth IRA to beneficiaries, they’ll have to abide by the required minimum distributions.
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Taxes on Retirement Income
Even during retirement, the IRS requires you to pay income tax. How your retirement income is taxed depends on the source:
- Social Security: Your social security can see tax applied at a rate of anywhere between 0% and 85%. The actual amount depends on your income. As an example, for the tax year of 2019, if you had a combined income of between $25,000 and $34,000, you would have a required income tax of 50% on your social security benefits.
- Tax-deferred accounts: Whether you have an IRA, 401(k), or another retirement saving scheme, income tax applies at the standard taxable income rate of between 10% and 35%.
- Investment Schemes: How you handle your investment gains will decide how much you have to pay back in taxes. Any short-term capital gains, which are gains made from investments held for less than a year, are taxed as ordinary income. Long-term capital gains get tax applied at an improved rate of either 0% or 15%.
- Roth retirement accounts: Funding of a Roth retirement account, no matter an IRA, a 401(k), or other, is done with after-tax dollars. This means you don’t have to pay further income tax.
Don’t Wait for Tomorrow
The sooner you make plans on securing some form of retirement income, the better. If you use some form of investment to obtain your retirement benefits, the earlier you start investing in financial assets, the higher your returns will be. No matter how you fund your retirement, the key is to enjoy it. The average retirement age in the U.S. is now 60 years old. That can amount to around 40 years of hard work, if not more. It’s fair to say that you’ve done your time. You deserve to spend your final years however you want. A secure retirement income plan can help you achieve this.
Do you have a retirement income strategy? Have you taken advantage of one of the above methods to secure a retirement income? Let us know in the comments below!