One of the biggest worries individuals and couples face when preparing for retirement is if their savings will be enough to last their lifetime. But to enjoy retirement to the fullest, it’s important to feel confident, comfortable, and excited about the journey ahead — and not anxious about where your money will come from in retirement.
While you’re used to living on a paycheck now, your “paychecks” in retirement will look much different. You’ll have a variety of sources to pull your income from, which your financial advisor can help you navigate. Each source has its own benefits or considerations, as well as tax treatment.
Let’s review some of the most common retirement income sources together as you start to think about your own retirement income strategy.
Social Security is important because it’s a fixed income and may adjust for inflation each year (called a cost-of-living adjustment, or COLA).
The biggest decision regarding Social Security is when you’ll choose to start receiving benefits. While you become eligible at age 62, you’ll actually be taking a lesser amount than if you waited until full retirement age (around age 67). In fact, if you opt to start receiving benefits at age 62, you could be receiving up to 30% less in benefits each month than if you waited until age 67.1
On the other hand, putting off payments (up until age 70) will earn you delayed retirement credits, which add up to an additional 8% each year.2
While waiting to receive Social Security will earn you more per month, it’s important to consider other factors before making a decision, such as family history of longevity, or if you may be eligible for spousal or survivor benefits. If delaying payments means you’ll have to draw down your investments early or take on debt, it may not be worth waiting to collect. These are all things your financial advisor will review with you when creating a retirement income plan.
401(k) and IRAs
If you or your spouse have been contributing to a defined contribution plan, such as a 401(k) or 403(b), or an individual retirement account (IRA), these will serve as essential income sources in your retirement.
There are two important considerations regarding 401(k)s and IRAs: tax treatment and required minimum distributions (RMDs).
Traditional 401(k)s and IRAs are funded with pre-tax contributions, meaning anything you contribute will reduce your taxable income for the year. The account grows tax-deferred, so you are not responsible for paying taxes until you make withdrawals from the account. At that point, you must pay income tax on any amount withdrawn, including contributions and growth. These types of accounts are ideal for women who believe they’ll be in a lower tax bracket in retirement than in the year(s) the contributions are made.
You may also contribute to a Roth IRA or Roth 401(k), which is funded using after-tax dollars. While you won’t be able to deduct contributions from your taxable income, the account grows tax-deferred. Once you reach retirement, withdrawals of your initial contributions are tax-free. Withdrawals of any growth or earnings in the account may be tax-free as well, as long as you’ve had the account for at least five years and meet the following criteria:3
- You’re 59 ½ or older
- You have a qualifying disability
- You’re the beneficiary of an estate
- You’re buying your first home (up to $10,000)
Traditional 401(k)s and IRAs are subject to RMDs. RMDs are mandatory withdrawals, which you must begin taking at age 72 to 73, or face penalties from the IRS. Everyone’s RMDs are different since they’re based on how much money is in the account (here’s a worksheet the IRS provides to determine RMDs). The tricky thing about RMDs is that they count toward your taxable income for the year (unless they’re otherwise determined to be tax-free). For that reason, it’s important to plan ahead for RMDs when establishing your retirement income strategy. Roth 401(k)s and Roth IRAs do not have RMDs.
Stocks and Bonds
Stocks and bonds are like the bread and butter of your financial life. As you near retirement, you and your advisor will regularly reassess your risk tolerance and likely reallocate a greater portion of your assets into more conservative investments. Because you’ll need to rely on these investments to help fund your future retirement, taking on less risk is critical. In fact, it can impact the longevity of your portfolio in retirement.
Other Possible Income Sources
While the sources mentioned above are the most commonly used to fund retirement, it’s possible (likely even) that you’ll acquire income from other places as well. These might include:
- Health savings account (HSA): After age 65, you can take penalty-free distributions for any reason, though non-medical withdrawals will be taxed as ordinary income.
- Pension plan: They’re rare, but some workers still have pension plans to rely on in retirement, which provide guaranteed retirement income from a previous employer.
- Part-time job or contract work: Some people like to enjoy an encore career in retirement. Perhaps you’d like to work part-time at a flower shop or offer your expertise on a contract basis. Many retirees enjoy staying active and involved in the community this way.
- Your home’s equity: Chances are, your family home has generated a sizable amount of equity over the years. You could either use that equity to take out a line of credit, or sell the home, downsize, and use the difference to cover your expenses in retirement.
Funding Your Dream Retirement
At Northstar Financial Planning, we help our clients design and enjoy the retirement of their dreams. By providing a holistic review of their available resources, we’re able to provide coordinated advice that accounts for all aspects of their wealth and considers their unique needs. If you’d like to learn more about working with our women-led team of passionate financial professionals, reach out today.