Whether you’re watching the nightly news or browsing online, it’s hard to escape the popular topic about baby boomers and America’s shifting demographics.
The nation’s aging population — specifically people ages 65 and older — will grow to 81 million by 2050, up from 37 million in 2005.
As this wave of Americans begins the transition into retirement, I thought it would be a great time to revisit the basics of retirement income.
Switching from being an employee with a regular paycheck to living on a fixed income can seem intimidating and a little scary. In addition, perceptions (see the chart below) don’t match reality when people finally retire.
We often hear questions about retirement income and spending during the initial years of retirement. How much can I spend? When do I take Social Security benefits? Where will my pay come from during retirement?
Many retirees will be living on a combination of investment income from their portfolio and Social Security benefits. The lucky ones will have three primary sources of income; a pension, Social Security, and investment income.
It’s important to identify your primary sources of retirement income and understand the details for each one.
Personal Savings and Investment Income: Your investment portfolio consists of your retirement accounts (IRAs, 401k, etc.), personal savings, and your brokerage accounts (taxable accounts). How much can you spend? Historically, a sustainable withdrawal rate on investment portfolios has been 3 percent to 6 percent per year; however, many individual factors can affect your optimum withdrawal
Tip: As long as you don’t take out too much each year, your portfolio can continue to grow while providing you with additional income each year. Of course, if you choose a higher withdrawal rate, then you increase the likelihood you will spend down your principal too quickly.
Social Security: This is a primary source of retirement income, so you must have a strategy for maximizing Social Security benefits. Social Security benefits represent 70 percent of annual income for the average retiree. After all, Social Security is a government-guaranteed, inflation-adjusted, lifetime annuity.
Tip: Most people rush to take benefits early because they want their money, but a rushed decision could have a lasting impact on you or your spouse. Do you know your options when you file for benefits?
Pensions: Also called Defined Benefit plans, pensions are common for federal employees, local and state government employees, and members of the US military. If you’re lucky enough to have a pension, make sure to request a pension illustration or an outline of your pension benefit options. Most pension plans will give you multiple benefit options, including payouts with a survivor benefit, without survivor benefits, and lump-sum payments.
Tip: These options can be confusing and leave you scratching your head. You only get one chance to select your option and the outcome is final, so make sure to review all of your options. You may want to discuss the pros and cons of each pension benefit option with a professional financial adviser.