Managing retirement income begins with understanding your income sources, which can range from Social Security to an employer-sponsored retirement savings account such as a 401(k), as well as the rules that govern each income source.
Social Security benefits
For many people, Social Security will be an important source of retirement income. Unlike most other sources of retirement income, Social Security benefits are adjusted for inflation on a regular basis.
The most important decision you’ll make about Social Security is when to apply for benefits. You can start receiving reduced payments at 62, wait until you’re eligible for full benefits (which will vary depending on the year you were born), or delay your initial payment to qualify for a higher amount. Many financial advisors advise waiting until you are eligible for full benefits, or even longer if you can.
The Social Security Administration (SSA) provides many tools and resources to help you understand your Social Security benefits and how to effectively plan for the day when you will use those benefits to help fund your retirement. Here are a few to look into:
- Determine Your Full Retirement age.
- Planner for Social Security Retirement
- When Should You Begin Receiving Retirement Benefits?
- Calculate Life expectancy.
If both you and your spouse are eligible for Social Security payments based on your employment histories, you must make a critical decision. You must select whether to draw from your individual accounts or have one of you draw spousal benefits.
Drawing on your individual accounts will bring the biggest rewards if you and your spouse earn roughly similar amounts during your working years. However, if one of you earns significantly more than the other, you should weigh your options. If you are qualified for both your individual retirement benefit and benefits as a spouse, the Social Security Administration will always give you payments based on your record first. If your spouse’s benefit exceeds your retirement benefit, you will get a combination of benefits equal to the greater spouse’s benefit.
You may be eligible for additional Social Security benefits if you have a minor child.
Plans with Predefined Benefits
If you have a defined benefit pension, you should know how much pension income you will receive before you retire. This income is normally determined by how long you worked for your employer, how much you earned, and your age when you retired. As you near retirement, you should consult with your employer’s human resources office about a variety of pension eligibility issues. And even after you retire, the workplace should remain a useful resource.
First, ensure that you are fully vested, or qualified, to get the full pension. Many employees in private companies gain vested rights after five years of service, or gradually between years three and seven.
You should also inquire with your employer about what happens to your pension plan benefits if you retire before the age of 65 or work past that age. Some employers may reduce the amount of pension you would normally receive if you retire before or after the age of 65.
If you are married and have a defined benefit plan, your employer is legally required to pay a portion of your pension to your surviving spouse when you die. The percentage may be fixed at 50%, but you may be able to increase it. If you do not want your spouse to receive any of your pension, he or she must sign a written waiver of rights to this income.
Pensions can be a significant draw for people working in the public sector and the armed forces. In various ways, government pensions and military retiree pay differ from corporate pensions:
Employees of the government may be obliged to contribute a percentage of their post-tax wages to their pensions.
Government employees and military service members may be allowed to receive their pensions after a defined period of time, such as 20 or 30 years, regardless of their age or proximity to the more standard retirement age of 65.
Government pensions and military retiree pay are typically updated for inflation automatically using a cost of living index adjustment, or COLA.
If you have questions or concerns about your pension, the Employee Benefits Security Administration (EBSA), which supervises retirement plans, is an excellent place to start. The toll-free number for EBSA is 866-444-EBSA (3272).
The Pension Benefit Guaranty Corporation (PBGC) insures many corporate pensions. This federally funded agency was established to safeguard defined benefit pensions, including those that cease when an employer cancels a plan. If you lose track of your pension or your employer mismanages it, you can seek assistance from the PBGC. You can also check the PBGC website for a pension you believe you are entitled to. You only need your name and the name of your previous employer.
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Defined Contribution Plans (DCPs)
If you have a defined contribution plan, your company may contribute to it, enable you to contribute, or occasionally contribute if you do. However, unlike a defined-benefit pension, your employer makes no guarantees about the income you’ll receive when you retire. Instead, the amount is determined by how much money was invested, where it was put, and how long you have been a member of the plan.
The most well-known defined contribution plans are those offered by employers, such as 401(k)s, 403(b)s, and 457s. SIMPLE IRAs, SIMPLE 401(k)s, and Simplified Employee Pension (SEP) IRAs are other schemes that mainly cater to small enterprises. These programs let you save a portion of your current income for retirement. In most situations, you also choose how your money is invested by selecting from among the options provided by the plan.
In various ways, defined contribution plans differ from defined benefit plans. For starters, most defined contribution plans provide faster, if not instant, vesting rights on any contributions made by your employer—and you are always automatically 100 percent vested in your own contributions and any returns on those contributions.
Another essential aspect of defined contribution plans is that when you change jobs, you may usually transfer or roll over your accrued assets to your new employer’s plan or an IRA. This way, when you start a new job, you’ll have a foundation to build on. If you are unable to relocate it, you can frequently leave your account with your former employer so that it continues to grow until you retire.
Residence Equity
Your home might potentially provide you with retirement income. If you own your home outright or have large home equity, the two most typical ways to use it to produce retirement income are to sell it or take out a reverse mortgage.
If you decide to sell your property, your goal should be to use some of the earnings to fund your retirement. This, of course, presupposes that the value of your home has increased since you purchased it. The Taxpayer Relief Act of 1997 permits you to sell your house and obtain tax-free gains of up to $250,000 for single people and $500,000 for married people.
Because you must live someplace, you must decide whether to utilize the proceeds of the sale to downsize and acquire a less expensive home or to rent. If you decide to downsize and purchase a less expensive home, you will have to choose between buying another home outright or receiving a mortgage on the new home. The first choice provides piece of mind (your residence is paid for), but it ties up more of your money, leaving less available for income generation.
Taking out a new mortgage, on the other hand, requires you to cover the cost of the mortgage month after month. If you pursue this path, you must carefully manage your money to ensure that it creates enough income to cover your mortgage payments.
Mortgages that are reversed
A reverse mortgage may provide retirement income if you are at least 62 and living on a fixed income. They allow you to convert your home equity into a loan and are officially known as home equity conversion mortgages. The proceeds can be received in the form of a flat sum, a series of recurring installments, or a line of credit. Because it is a loan, not income, one of the most tempting aspects of a reverse mortgage is that no income tax is required on the money you receive.
However, reverse mortgages are complicated and not for everyone. This is because if you take out a reverse mortgage, your debt to your reverse mortgage lender grows with each payment. When you die or move out of the house, you must repay the mortgage, which is commonly done by selling the property.
