Here’s a million-dollar question: How will you transform your savings into income that will last throughout your retirement?
There are probably as many answers to that question as there are retirees. However, all retirees may rely on some of the same income sources and strategies. For instance, we all hope Social Security benefits will provide a portion of our income during retirement. Many people plan to combine those benefits with other sources to generate a reliable income stream over several decades.
Social Security Benefits
The Social Security Administration estimated the average monthly Social Security benefit paid to retired workers in January 2017 to be $1,360. The maximum benefit paid at full retirement age (FRA) is estimated at $2,687. (1) Talk with your tax or financial professional about whether you’re likely to owe taxes on your benefits.
Make sure you know your FRA. For Americans born between 1943 and 1954, FRA is age 66. However, if you were born in 1955, FRA is 66 years and 2 months. The FRA increases (in two-month increments) until age 67, which is FRA for Americans born after 1960. (2)
As you can see, Social Security income most likely will not be enough to cover your basic living expenses, much less the retirement lifestyle you’re hoping to achieve. Social Security plays an important role in reducing poverty among the elderly, but you can’t depend on it if you are accustomed to a comfortable standard of living.
If you think your financial needs will drop significantly during retirement, think again. As a general rule of thumb, consider that you may need as much as 85 percent of your pre-retirement income in retirement.
Employer-sponsored Lifetime Income Solutions
If you’re like most Americans who are saving for retirement, the majority of your retirement savings are likely invested in your 401(k) plan or another employer-sponsored plan. Some of these plans offer lifetime income options intended to help plan participants create income streams.
Systematic withdrawals are offered by 73 percent of plans. (3) Many plan sponsors offer systematic withdrawal options that allow participants to take regularly scheduled distributions from their accounts.
Depending on plan provisions, payments may be made in specific dollar amounts or determined by a set withdrawal percentage or a specific period of time. In some plans, participants are provided with modeling tools to help them determine payment amounts. Alternatively, they can choose to work with a financial professional to determine how much to take each year. (4)
In-plan managed payout options are offered by 15 percent of plans. (3) These investments are usually managed to “provide sustainable retirement income, either over a fixed time horizon or over the lifetime of the investor.” Income is not typically guaranteed. (5)
Qualifying longevity annuity contracts, or QLACs, are deferred income annuities that begin making required payments no later than age 85. Retirees who want reassurance they will not outlive their savings may want to consider investing a portion of their savings in a QLAC. (6)
If you’re not familiar with your employer-sponsored plan or you have a limited understanding of what it offers, make an appointment to go over it with your plan representative and speak with your financial advisor.
Health Savings Accounts (HSAs)
You may be wondering why we’re bringing up Health Savings Accounts (HSAs) in a discussion about retirement income. Please note that HSAs should not be confused with flexible spending accounts (FSAs). They are not the same. You must participate in a high-deductible health plan to have an HSA, (7) and you can contribute more to an HSA than to an FSA. (8)
Many savvy investors leverage HSAs for retirement. In fact, it’s one of the most tax-efficient savings vehicles available because it offers triple tax savings. Contributions are tax-deductible, interest and earnings may grow tax-free, and distributions are tax-free for qualifying medical expenses.
You can accumulate assets into retirement and use your HSA as a healthcare fund. With the rising cost of healthcare, you may find it helpful to use distributions to pay for healthcare tax-free.
Best of all, after age 65, you can even use the money in your HSA for nonmedical expenses—whether that’s household bills or a sailboat. (7) It’s up to you! Don’t let the name fool you. An HSA can be a smart tool for tax savings and creating retirement income.
Individual Retirement Accounts (IRAs) (Traditional, Roth, and other types)
Many people have substantial assets tucked away in IRAs, whether it’s a traditional IRA, Roth IRA, or one of the other types. The funds in your IRA can be systematically withdrawn, invested for income or growth, or utilized in other ways.
Keep in mind that your age and the type of IRA you have may affect the role it plays in your retirement income strategy. When it comes to retirement planning, many investors choose tax-efficient retirement income strategies, which means they try to minimize taxes during retirement. Tax-efficient strategies typically affect the order in which assets are withdrawn. (8)
An individual retirement account (IRA) is a vehicle that allows you to save for retirement in a way that offers tax advantages—either tax-free growth or on a tax-deferred basis.
With a traditional IRA, you can make contributions that you may be able to deduct on your tax return. Any earnings from those contributions can potentially grow tax-deferred until you withdraw the funds in retirement. If you expect to be in a lower tax bracket than you’re in pre-retirement, this tax-deferral means the money you withdraw at that point in the future may be taxed at a lower rate.
On the other hand, with a Roth IRA, the contributions you make are after-tax, meaning you’ve already paid income taxes on it. The money in a Roth may potentially grow tax-free, and you can take tax-free withdrawals in retirement, as long as you meet certain conditions.
In either case, whether you choose a traditional IRA or a Roth, you’ll be able to take advantage of tax benefits that enable your retirement savings to potentially grow and compound in a tax-advantaged way.
The Bottom Line
The strategy you choose to create retirement income should be tailored to your specific lifestyle and financial goals. It should also balance the level of risk you’re willing to accept against the level of income needed. A financial professional can help with formulating your retirement income strategy.
Sources:
(1) https://www.ssa.gov/news/press/factsheets/colafacts2017.pdf
(2) https://www.ssa.gov/planners/retire/retirechart.html
(3) https://www.willistowerswatson.com/en/insights/2016/08/lifetime-income-solutions (or go to https://s3-us-west-2.amazonaws.com/peakcontent/Peak+Documents/Jan_2017_WillisTowersWatson-Lifetime-Income-Solutions.pdf)
(4) http://www.plansponsor.com/magazinearticle.aspx?id=6442513735
(5) https://www.advisorperspectives.com/articles/2015/07/28/are-managed-payout-funds-better-than-annuities
(6) http://www.benefitspro.com/2014/10/27/2015-hsa-and-fsa-cheat-sheet?page=3
(7) http://www.kiplinger.com/article/insurance/T027-C000-S002-health-savings-accounts.html
(8) https://www.fidelity.com/viewpoints/retirement/tax-savvy-withdrawals
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
