Most of us have only one source of steady income while we are working- our job. The coming paychecks create a level of comfort and confidence in our future. We keep spending this money ignoring that one day it will stop coming. Once we retire, our work paychecks will need to be replaced with other sources of income.
Do you know how much is your income during retirement? Do you know where your retirement income will come from?
There are several potential sources of retirement income. Let’s discuss all of them.
1. Social Security
Many of us are concerned with the prospect of not having enough money for retirement. We need some level of income to last during our retirement years. The great thing about Social Security is that the checks will keep coming as long as we live. I know there is a lot of buzz about whether the Social Security bucket will run dry, but I want to stay positive about how long it lasts.
When it comes to the question of when to take Social Security, there is no “one size fits all” answer. If you want to retire early and take payments at 62, your payment will be reduced by up to 25% of the amount you would have received if you waited until full retirement age.
But if you delay claiming benefits after your full retirement age, your monthly payment will be bumped up by 8% for each year (up to age 70).
Do you know how much is YOUR Social Security benefits?
If you don’t, it’s a good idea to look at your Social Security Statement from SSA
When you open the link, your Social Security Statement will show how much you could expect to receive at different ages. Depending on your birth date, you’ll see various numbers of expected income. You need to plug in early retirement age at 62, your normal retirement age (between 65 and 67) or 70.
If you’re approaching your 60s, you might be facing a big decision to make based on these numbers. This decision will impact your lifestyle in retirement if Social Security will be a main source of your income.
You have to ask yourself two questions:
- Do you want to retire early and receive a permanently reduced Social Security benefit?
- Do you want to delay taking it and get bigger check for the rest of your life?
If you believe you’ll live late into retirement and you can afford to wait, probably it is a good idea to delay claiming Social Security up to age 70. But if you need the income as soon as possible and/or based on your family history don’t expect to live well into old age, it’s a good idea to take the money earlier.
Consider yourself lucky if you expect to receive a pension in retirement. Fewer and fewer companies offer pension plans these days. It has been replaced with do-it-yourself plans like 401(k). Income from a pension usually lasts for life, like Social Security. Many companies have websites that will help you estimate the amount of your pension at various ages.
So, what you need to do is to get your recent pension benefit statement from the website or by calling your plan administrator. Then add the amount of your pension to your retirement income. Don’t forget to update that number every year.
3. Income from work
One of the best ways to stretch your retirement money is to delay retirement or even work past the traditional retirement age. It could be either part-time or full-time job.
When people think about retirement, they think “no more work”, “no boss”, “no deadlines.” But the reality is that many of us don’t have enough money saved for retirement. Many of us still worry if we have enough funds to support ourselves for the rest of our lives.
There are many benefits from continuing to work in retirement:
- You earn income
- You save more money
- You have access to health insurance through the employer
- You delay using your existing savings
- You keep being engaged socially with co-workers
The more income you get in retirement, the less money you’ll need to withdraw from your retirement savings.
What is an annuity and why we consider it as retirement income?
Annuities is an insurance product and considered as a guaranteed income. Many of us would love to be part of a traditional employer-sponsored pension plan and get a monthly check for the rest of our lives. But the reality is that not so many companies offer a pension plan to their employees.
But there is good news for all of us. We can create “DIY” pensions by buying an annuity from an insurance company.
How it works?
You hand over a portion of your retirement savings to an insurance company in exchange for a limited monthly income. So in exchange for cash, you buy an income stream that will last as long as you live.
- For most people annuities are a last resort investment. They are too expensive and might come with high fees and withdrawal penalties. But on the other hand, annuities can give you peace of mind and reduce the fear of running out of money in retirement.
Annuities come in different shapes and forms. Find out if it’s a right choice of income for you, by exploring the pros and cons of annuities.
5. Retirement accounts: 401(k), IRA, Roth IRA
When we put our savings in retirement accounts: 401(k), IRA and Roth IRA, our money grows tax-free for years.
By the time we reached age 59 ½ we can start taking withdrawals from these retirement accounts.
I hope that you already have several or at least one of these retirement accounts and been contributing money on a regular basis. These accumulated savings will be part of your retirement income.
One of the most popular is to withdraw no more than 4% out of the account. This 4% withdrawal hopefully protects you from running out of money too early.
Just remember that 401(k) and traditional IRA accounts are tax-deferred retirement accounts. It means that you are not taxed when you put money in, but you have to pay taxes when you take money out.
Then there is the Roth IRA. It doesn’t offer an immediate tax deduction, and money is contributed on an after-tax basis. But as long as you follow some simple rules, your Roth contributions and their investment gains will never be taxed again.
There is a popular saying “Cash is King.” It’s true. When you stop working and start living on fixed income you will need some cash to cover living expenses, repairs, medical bills, and so on.
If you were stashing away some of your savings into brokerage investment account, once you retire, it will become one of your income sources.
Another way to cover your expenses is to have an emergency fund. I think everyone needs one. The money set aside for the unexpected things or financial emergencies has a psychological effect that makes you feel safe and protected.
If you don’t have an emergency fund, open the savings account with your local bank and start by stashing away a small amount of money regularly. The basic rule is to have enough money to cover 3 to 6 months’ worth of living expenses.
If you feel comfortable investing money on your own, and have a brokerage account, you can put money into a separate “emergency fund” money market account.
Money market accounts usually pay more interest than a checking or savings account. When you’re thinking about where to put your money, make sure you’ll be able to get access to your savings fast, easily and without any penalty when you need it.
7. Home equity
According to statistics, for many Americans their home is their largest financial asset. More Americans own a home than have any kind of retirement or investment accounts.
If you own your home, tapping into home equity is one of best ways to reach your retirement goals. There are several strategies about how to use your home equity as part of the retirement income.
- Downsize to a smaller home or condo to reduce overhead expenses and mortgage payments.
- Sell your home, cash out equity to use for retirement expenses.
- Rent out a room in your home to increase retirement income.
- Keep your home equity and then tap into it in the future to pay for medical expenses or long term care.
8. Rental property
Rental property can be a great source of retirement income. It brings the potential for future growth in price and the chance to increase rents to keep up with inflation, taxes and maintenance costs.
The main drawback is that it requires a lot of work and expertise. When you own real estate, you own a hands-on business.
I know many people who own multi-family houses and don’t mind managing properties and dealing with tenants on their own. That’s fine. But if you are like me who tried to be a landlord for 7 years and didn’t like it, it can turn your retirement into a full-time nightmare.
You can always hire a property manager. And if you are lucky, you can find a good and trusted one. However, it was my experience, having a property manager is rarely a full solution. It’s just not the same as you are managing your own investment.
A rental property will offer you an additional income, but you cannot call it a passive income investment. You need to work hard to make it work. And if you need to sell it fast, it might take months or even years before you sell that property.
If you plan to buy real estate for the purpose of income in retirement, you need to understand the pros and cons of that decision and how it will affect your lifestyle.
9. Own a business
If you own a business right now and are planning to continue working in your retirement years, you might be better off financially than many other retirees.
You may also be thinking about starting a new business in retirement. A new business comes with a lot of responsibilities, hard work and expertise. And it certainly won’t be considered as passive retirement income.
However, retirement might be a great time to take a leap and start a new business. Here’s why:
- You can make money and not be limited to only Social Security benefits.
- You will occupy your free time with something you’re passionate about.
- It will be good for your health, by staying busy and mentally engaged in running the business.
- The extra money can be used for travel, hobbies and extra gifts for the grandkids.
Stocks as an investment generate income in the form of capital gains, dividends, and interests. Unfortunately investing in stocks involves market risk, because stocks are volatile. The stock market goes up and down over time, and so does the value of your investments.
When people get closer to retirement, they become more and more reluctant to take a risk with their savings. This makes sense to me. You have fewer years to make up for big losses as you get older.
When we retire we live off our savings and investment portfolios. So, it’s obvious that we want to protect our nest egg from market downturns.
11. Bonds and CDs
Once we see the risks with stock market investing, we want to put all our assets in safe investments, like bonds. The only problem with this strategy is that inflation can eat away the value of our investments. Many people who come close to retirement like to put their money into bonds and bank CDs. The reason is the principal is guaranteed and you make some money on the accumulated interest.
The interest paid on your principal is fixed, which means it won’t drop, but it will never go higher either.
Usually, bonds pay more interest than CDs, but because they are not insured, they carry more risk.
Bonds, CDs, bank savings are all considered fixed income investments. These income sources protect your nest egg from market volatility. They are relatively “safe” investments, but they are not safe from inflation. Social Security and annuities are still considered a much safer source of retirement income.
Putting it all together
We all need a little help when it comes to personal finance. Most of us have some ideas about how much retirement income we need and where it will come from. And many of us have that magical number in mind. There is always something we can improve in our finances and investments and hopefully it will protect us from all bad luck, and we will never need to worry about money again. It would be lovely, if it was the truth. But unfortunately, it is not.
We’re living longer than ever after we retire. We need to have more money saved, stashed away and invested. We need to have multiple sources of income just to make ends meet. We have to work harder for our money, so when we retire, the money starts working for us.
So what are you waiting for? You have all the information you need to start building the list of your sources of income in retirement.
Do you have a list or ideas about your source of income in retirement?