A secure, successful retirement is predicated on two pillars.
1) Understanading how much you need/desire to spend in retirement
2) Understanding your income sources and how each function and supports the other sources.
This article seeks to explore the common income sources retirees will rely on in retirement. We will attempt to provide a framework that will help you TRULY quantify how much money you will need saved in order to retire, AS WELL AS how much income you will need to generate from retirement savings.
We have helped dozens of pre-retiree and retiree's navigate their retirement planning with confidence (see results here). This article will shed light on one of the primary frameworks through which our retirement planning is done.
Income diversification is essential because it reduces the likelihood that a retiree's entire financial well-being will be affected by fluctuations in one particular asset or investment. Having income from various sources such as Social Security, Pension, Annuity, Retirement Accounts, etc. spreads your risk and increases the probability that your retirement will succeed.
Retirees need to understand their income options as a part of a framework through which they can make wise decisions. The framework we use at Peak Financial Planning is:
By diversifying your income sources, you create a more stable financial foundation. Speak with a financial advisor to determine the best strategy for your unique situation - click here to schedule a free no obligation consultation.
A guaranteed, income payment stream is one where you - the retiree - bear none of the responsibility for producing the income. That means you don't trade hours for dollars, you aren't responsible for the portfolio construction - nothing. You simply receive a check for a guaranteed dollar amount over a guaranteed time frame.
At this point, there are really only three sources that really fit this description.
Social Security, Pension, or Annuity income.
All three of these function as an "annuity".
An "annuity" is "A fixed sum of money paid to someone each year (or month), typically for the rest of their life".
One of the most important sources of retirement income is Social Security benefits.
Social Security is an annuity that we all pay into over our working lives so that it can pay out to us during our retirement.
Forgetting whether we think the social security trust fund is sustainable or not, the truth is that social security will often be the largest guaranteed income source that most American's will have in retirement.
Social security income is guaranteed by the US government, it's adjusted for inflation annually, and you as the retiree bear no responsibility or risk in exchange for receiving a steady income from the monthly cash flow.
As such, it is critical to have some understanding of how to maximize social security income well in advance of retirement.
You can learn more about how these adjustments work on the Social Security Administration website.
When planning for retirement, one key decision involves determining when to begin receiving Social Security benefits. While you can start collecting them as early as age 62, doing so will result in permanently reduced monthly payments compared to waiting until your full retirement age (FRA), which ranges from 66 to 67 depending on your birth year. Moreover, delaying beyond FRA can further increase benefit amounts up until age 70 due to delayed retirement credits earned each month past FRA.
Think about health, life expectancy, and money needs when deciding when to begin taking Social Security. Consult with a fee only fiduciary financial advisor who specializes in retirement planning for personalized guidance regarding your optimal SS claiming strategy.
Key Takeaway:
Social Security benefits are an essential source of retirement income that is adjusted for inflation annually. The timing of when to start collecting these payouts is crucial, as earlier withdrawals result in smaller amounts received over time, while delaying beyond full retirement age can increase benefit amounts up until age 70.
Schedule a FREE no obligation consultation with us if you'd like to learn more about how social security claiming will effect your retirement success.
Two other less common guaranteed income source are compnaypensions, or purchased annuity products (usually purchased from a life insurance company).
Defined benefit pension plans, often provided by companies or government entities, offer retirees a steady stream of income throughout their retired life. These payments are usually based on factors like years of service and salary history. The main advantage is that the retiree receives these benefits regardless of market conditions, providing peace of mind and stability in retirement.
Just as with Social Security, you are not retired to trade dollars for hours in order to receive your pension payment (once retired of course!). Pensions are not as common these days, as most companies have drifted away from offering these guaranteed retirement benefits in favor of offering 401k type retirement savings plans to shift the risk away from the company and onto the retiree.
The risk you bear when receiving pension income is that this income sources is supported by a company that may or may not go out of business. If your previous employer (that provides you the pension) encounters financial hardship or files for bankruptcy, it is possible that you may lose your pension benefits. This is another reason to make sure you diversify your income sources so that you are not overly reliant on any one source.
An annuity is another option for generating a consistent income stream and cash flows in retirement. It is an insurance product that pays out regular income over time after an initial investment (lump sum or series of payments). There are various types of annuities available, including fixed-rate, variable-rate, immediate-income, and deferred-income.
Before purchasing an annuity, it is essential to understand its pricing structure and fees involved. Annuities are typically expensive - you pay a premium in order to obtain a "guaranteed" source of income. Professionals that sell annuities are often compensated via commission - which can lead to predatory practices when being presented with an annuity purchase. You should ALWAYS consult with a Fee Only Fiduciary financial advisor (one who is not compensated via commissions) when considering how an annuity might fit into your retirement income plan.
In addition, it is important to consider the financial stability and security of the insurance company before purchasing the annuity product. It would be a tragedy to fork over a significant sum of money for a deferred annuity just to have the company file for bankruptcy before you ever receive any of the income stream.
If you are being presented with or considering how an annuity may fit into your retirement income plan, we encourage you to schedule a free consultation with us. We are fiduciary, fee only, certified financial planner professionals and would be privileged to advise you.
A non-guaranteed income stream is one where you - the retiree - bear ALL of the responsibility for producing the income.
That means you trade hours for dollars and/or you are responsible for the portfolio construction that will produce the income.
You run the risk of mismanaging the investments, taking inappropriate distributions, understanding the income tax implications of those distributions, and are responsible for piecing that puzzle together so that you do not run out of that bucket of retirement savings while still alive.
This quadrant of your retirement income will be responsible for filling the gap between your desired amount of spending and your income from GUARANTEED sources.
If you want to spend $60,000 a year in retirement and receive $30,000 a year in guaranteed income sources, this quadrant (non-guaranteed income) will be responsible for filling that $30,000 gap.
If your retirement savings can support that gap for the entirety of your life, then you never need to consider quadrants 3 or 4 of the retirement income framework.
However, if your retirement savings are not sufficient to fill that gap in a reliable way for the rest of your life, you will need to consider other income options in order to improve the reliability of your retirement income strategy.
You bear all the risk with this quadrant of your retirement income. It is therefore crucial that you understand how to navigate that risk.
In our opinion, navigating that risk means thinking about your retirement accounts in the following framework:
The decision that will lead to the highest rate of retirement success is to save as much as possible over many years prior to retirement. More savings means more investable dollars. But if you are already past your prime saving years, focusing on asset location first, asset allocation second, and on investment selection third will allow you to cover the bases over which you have the most control.
If you'd like to discuss how to optimize your investment portfolio through good decision making, schedule a free consultation with us here.
An effective risk management strategy is crucial. Consider these factors when determining an appropriate risk management strategy for your non-guaranteed sources of income:
Diversification is essential for managing risk within an investment portfolio effectively. By including non-correlated investments such as real estate or private equity investments alongside conventional stocks, bonds, and mutual funds holdings in diversified portfolio, retirees can achieve several advantages:
It is essential to consult with a fee only fiduciary financial advisor before venturing into alternative investments. They can carry unique risks and complexities when compared to traditional investment options.
Click here to learn more about how we can help.
When changes to asset location, asset allocation, and investment selection simply aren't sufficient, it's time to consider active sources of retirement income.
Active sources of retirement income are things like business income or part time employment.
These are all activities that require a direct dollar for hour trade off. They are not reliable, they are not guaranteed, and they are not activities traditionally considered consistent with "retirement".
However, oftentimes 2-5 years of part time (or other active income) is enough to take a retirement plan with a very low probability of success to one that has a much more comfortable probability of success.
Despite oftentimes being an undesirable option to consider, this "phased retirement" option will help improve your level of confidence and is a rather reasonable trade off to make to increase your odds of retirement success.
Click here to schedule a free consultation with our fee only fiduciary financial planning team.
When all else fails, here are some backup retirement income options to consider.
One often overlooked aspect of retirement income planning is the potential benefits offered by owning property outright in retirement. A paid-off house can serve as an additional source of retirement funds while maintaining financial security, especially when other income sources might be insufficient or unpredictable.
In certain situations, using home equity might be an appropriate option. Some common scenarios include:
Options like a reverse mortgage or home equity line of credit (HELOC) allow homeowners to access cash based on the value of their homes while still retaining ownership.
It's essential to carefully weigh the pros and cons before making any decisions involving your home equity - consult with a fee only fiduciary financial advisor to better understand the implications of these options.
Click here to schedule a free consultation with our fee only fiduciary financial planning team.
Diversifying your retirement income sources is crucial for financial security in retirement. Overdependence on one source can be risky, and it's important to consider a range of options.
Improving your knowledge of these various income streams can help you make informed choices regarding the sum required to live comfortably in retirement and how to manage your savings once retired.
Click here if you'd like to watch our comprehensive retirement income planning masterclass.
Guaranteed Income, Non Guaranteed Income, Active Participation Income, and Backup Income. Having an understanding of how to influence and when to consider each option will help increase financial security during retirement.
The best way to generate income in retirement is by diversifying your portfolio across various assets like Social Security benefits, pension plans or annuities, tax-deferred accounts (401(k), IRA), stocks and bonds investments. Balancing risk with potential returns while considering alternative asset classes can optimize growth potential and minimize risks.
Average retirement incomes vary based on factors like location and lifestyle choices. According to a 2023 report, the average monthly Social Security benefit was $1,503 per month. Combined with other sources like pensions or personal savings/investments; an estimated total annual household income of around $50k-$60k could be expected for many retirees.
Social Security remains one of the most significant contributors towards financing retirements in America today. For approximately 64% of beneficiaries, it provides at least half their total monthly incomes; making it crucial that individuals maximize their benefits through informed decisions regarding withdrawal timing.
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