Retirement looks different for everyone. Some people retire in their 50s, many work well into their 70s. But one thing retirees have in common is the need to understand ways to structure retirement income so they are financially secure when they stop working.
There are several factors in play when structuring retirement income, including the types of income you will have, what age you plan to retire, investments, and considering things like inflation.
Types of Retirement Income
Retirement income can come from many sources. One important step to structure retirement income is understanding these streams of income and how they work.
The main types of retirement income include:
Social Security
Social Security retirement income is a monthly payment from the Social Security Administration (SSA). The payment is based on a person’s lifetime earnings and is calculated by averaging the highest 35 years of income where they made contributions to Social Security.
The age a person can start receiving social security retirement payments is 62, but the SSA considers the full retirement age between 66 and 67, depending on birth year. Payments will increase gradually each year they delay retirement until a maximum payout is reached at the age of 70.
Social Security only makes up about 40% of pre-retirement income, and so it is important to consider other methods of retirement income besides Social Security.
Pensions
A pension is a retirement plan offered by some employers. The employee receives the pension at full retirement age in either monthly payments or, less commonly, in a lump sum payment. Employers decide which type of benefit plans to offer.
There are two types of pensions:
- A defined-contribution pension is a plan where the employee makes contributions to the retirement account. Money deposited is usually tax-free. The employer sometimes matches the employee's contribution. At retirement age, the employee can withdraw from the account, either in monthly payments, a lump sum payment, or roll the money into a different type of account. Penalties occur if funds are withdrawn before the age of 59.5. In this type of plan, the employee selects from an option of plans that offer various risk levels. The IRS sets contribution limits for defined-benefit plans, which is one limitation. Examples of defined-contribution benefit plans are 401(k), 403(b), and 457(b) plans.
- A defined-benefit plan is a plan where the employer guarantees a certain payout in retirement. The monthly payment is usually calculated based on things like the employee’s years of employment, salary, and age at retirement. The payment is not dependent on the success of the investments. Unlike a defined-contributions plan, the employer selects the investments. The employer makes up for any shortages not covered by the investment pool. This type of plan is becoming less and less common.
Annuities
An annuity is a type of insurance regulated by each state where a person makes payments to the insurance company. The funds are later dispersed to the person as income. Like 401(k) plans, withdrawals before the age of 59.5 might incur a penalty.
Other Earnings
Some retirees have other streams of income that should be considered when structuring retirement finances. These can include alimony, holding some type of employment, or passive income from things like rental properties.
Have a Plan to Manage Your Money
Having a structured plan to manage your retirement income can help ensure you have enough money to live a comfortable retirement.
Budget
To create a budget for retirement, you will need to look at the line items you expect to spend. This includes things like a mortgage payment, rent, groceries, utilities, insurance, and automobile expenses.
The more detailed your budget, the better you will be able to plan your income. When you have a budget, you will be able to estimate how much money you will need to retire, and develop a plan for how you will allocate your money once you are retired.
One thing to keep in mind when budgeting is inflation. The value of the dollar will likely be lower when you get to retirement age, and so coming up with a plan using today’s prices will lead to a shortfall in retirement.
Hire A Professional
With so many variables in retirement planning, it is important to work with a qualified financial advisor. They can not only help you manage investments, but also help with withdrawal schedules and budgeting for retirement.
