Managing Different Sources of Income in Retirement

  by Shelley Seagler

Most people have multiple sources of retirement income, such as Social Security, 401(k)s, pensions, and Roth IRAs. Each of these accounts has different rules that influence when and how much you can (or should) take out. You can maximize your retirement income by familiarizing yourself with these rules.

Let’s take a look at the most common sources of income in retirement and best practices for drawing on each of them.

Social Security

Social Security is a common source of retirement income for many Americans—although it shouldn’t be your only one.

The size of your Social Security benefit depends on your work history and when you decide to take benefits. While you can take reduced benefits as early as age 62, full benefits don’t kick in until age 65 or older, and you can postpone benefits until age 70 to earn the maximum possible benefit.

For example, if you turn 62 in 2020, your benefit would be about 28.3% lower than it would be at your full retirement age of 66 and 8 months. You would also receive an eight percent increase in your Social Security benefits for each full year that you delay it until age 70 (if you were born after 1943).

Spousal benefits can further complicate these decisions. If you and your spouse earned equivalent lifetime earnings, you should draw on your individual accounts to provide the greatest benefit. If one of you earned substantially more, it’s worth exploring alternative strategies to maximize your benefit.

The Social Security Administration (SSA) provides an easy tool to Find Your Full Retirement Age as well as a Social Security Retirement Planner that can help you come up with a plan.

Defined Benefit Plans

Defined benefits plans, such as pensions, are becoming less common in the private sector, but remain a popular way for governments to recruit talent.

Download our Retirement Readiness Checklist to ensure that you’re prepared for retirement before making the jump.

These plans are a great source of retirement income since they provide stable guaranteed income that’s insured by the Pension Benefit Guaranty Corporation (PBGC)—a federal organization to protect defined benefit plans. In addition to Social Security, pensions provide a solid foundation of fixed income for many retirees.

Pension income often depends on how long you’ve worked for a company, what you earned when working, and your retirement age. Before you retire, you should verify that you’re fully vested and eligible to collect a pension. You may not receive the full amount if retiring earlier or later than expected.

You must also decide between taking a lump sum or monthly payments. While most people take the “life annuity” option, a lump sum may give you more control over how the money is managed. The danger is that you may spend too much and exhaust your pension income before you die. If you need income from this portion of your investments, the higher guaranteed withdrawal rate of the annuity option makes this the best approach in most cases. You may also have the choice for annuity payments to extend over your spouse’s life at a lower rate.

If you take a lump sum, you may want to consider investing it in an annuity that provides guaranteed payments or into income-generating investments. For instance, the Snider Investment Method involves holding high quality equities and writing covered calls against them to generate an income.

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Defined Contribution Plans

Defined contribution plans, such as 401(k)s or SIMPLE IRAs, enable you to contribute to a plan that an employer runs.

These plans do not provide any guarantees, but many employers will match contributions up to a certain amount during employment. If you switch jobs, you can usually move or rollover these assets to your new employer’s plan or an individual retirement account (IRA), although these rollovers may involve certain fees.

While Social Security and defined benefit plans force you to withdraw certain amounts each month, defined contribution plans enable you to remain invested until age 72 when you must take Required Minimum Distributions. Withdrawals from these accounts are also taxed at your income tax rate for the year.

These plans should be one of the last things that you draw down on the list. The only exception is if you’re retiring early (e.g. after you turn 59 and 1/2). You may want to delay taking early Social Security to avoid reduced benefits and instead start drawing down defined contribution plan accounts. We encourage clients to roll defined contribution plans into an IRA once they retire or end employment to increase investment options, have greater control and potentially reduce costs.

Individual Retirement Accounts

Individual retirement accounts, or IRAs, are accounts set up outside of work to save for retirement or rolled out of employer-sponsored retirement plans.

Traditional IRAs enable you to defer paying taxes on contribution amounts until withdrawing the capital, while Roth IRAs enable you to pay taxes now rather than when withdrawing the capital. As such, Roth IRAs can help you minimize tax exposure during retirement.

If you have a low tax year, you may also want to consider rolling over any traditional IRAs or defined contribution plans into a Roth IRA. You will incur an immediate tax on the amount in the current year (at a low rate), but you will not owe any tax on the amount or capital gains in the future.

Like defined contribution plans, you can keep the money in IRAs invested to earn capital gains, dividends, and interest over time. You also face required minimum distributions once your reach age 72. These plans should also be one of the last things that you draw down on the list after Social Security and defined benefit plans to maximize the value of your nest egg.

Retirement Income

Home Equity & Reverse Mortgages

Many retirees have paid off their mortgage by the time they retire, which means that they have a lot of equity. In fact, for many retirees, their home is their largest financial asset.

Don’t forget to download our Retirement Readiness Checklist to ensure that you’re prepared for retirement before making the jump.

Downsizing enables you to use some of the sale proceeds to fund your retirement. The Taxpayer Relief Act of 1997 allows you to sell your home and receive tax-free gains of up to $250,000 if you are single and $500,000 if you’re married. You can also purchase a smaller home outright or obtain a small mortgage.

Reverse mortgages are an option for anyone age 62 or older living on a fixed income. Rather than selling your home, you can convert your home equity into a tax-free loan. The debt is repaid when you pass away or move out of the home by selling the property, which could limit your estate’s value for heirs.

The Bottom Line

Many people have multiple sources of retirement income and it’s important to know the rules affecting each of them. For example, you may want to defer taking Social Security and draw down on defined benefit plans before taking out anything from a defined contribution plan or an individual retirement account.

The Snider Investment Method can help you generate an income in retirement without drawing down your assets. Using covered call options, you can maintain a portfolio of high quality stocks and generate a higher income than fixed income investments.

Take our free e-course to learn more or explore our asset management options.

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