Whether one is contemplating retirement or already retired, the primary need for this stage of life is sustainable income. The challenges of rising medical expenses, inflation, taxes, and uncertain U.S. Social Security retirement benefits greatly complicate the equation. The key question for retirees changes from “Can I afford to retire?” to “Can I afford to stay retired?”
Income Needs During Retirement
Many people assume they will need less income in retirement than they did during their working years. Others are surprised to find they need the same amount of income or sometimes more to maintain their desired retirement lifestyle. Income needs during the early years of retirement are largely driven by leisure activities, such as travel. Later in retirement, the need for more, and sometimes more expensive, healthcare drives up the income need.
When planning retirement, workers must acquire sufficient assets and income sources to last them for the rest of their lives. Longer life expectancies, combined with a desire for early retirement, could mean the retirement period lasts as long as the retiree’s career of 20 or 30 years!
Sources of Retirement Income
In the United States, Social Security income will make up one source of guaranteed income for most retirees, providing a financial safety net designed to keep workers from becoming destitute once they become too sick or too old to work. In addition to Social Security retirement benefits, other potential sources of retirement income include: pensions, personal savings & investments, and earned income from full or part-time work after attaining normal retirement age.
Payable for the lifetime of the recipient, Social Security retirement benefits ensure that at lease some income will always be available during retirement. These benefits are periodically increased via cost-of-living adjustments (COLAs) to keep pace with inflation. Even though Social Security was never designed to fund all of a retiree’s income needs, it does ensure that money will be available for very basic needs.
Government and corporate pensions are another potential source of retirement income. Unless one works for the government, however, the likelihood of having a pension benefit at work is negligible. Over the years, most corporate employers have phased out the obligations to pay lifetime pensions and replaced them with self-directed contributory retirement accounts, such as 401(k) plans.
A third potential source of retirement income is personal savings and investments. Tax qualified retirement accounts, such as 401(k) or similar plans, are an excellent way to save money pre-tax and accumulate earnings on a tax-deferred basis. Individual retirement accounts (IRAs) are another tax-advantaged method to save for retirement. Investments within these accounts typically include stocks, bonds, and mutual funds.
Income from a part-time or even full-time job after reaching retirement age is also a source of cash flow for retirees. Some seniors continue to work because they choose to do so, often in a different career field. Others discover they must return to work in order to meet their financial obligations when Social Security and personal savings are insufficient to support their retirement expenses.
Pre-Retirement Investment Planning
During their working years, people must balance the need for current income to pay living expenses with the need to save for future retirement. Often, the need for current income to pay credit card debt and other consumer loans overrides the desire to set aside money for the future. As a general rule of thumb, developing the discipline to curtail spending and set aside at least 10% of one’s income for retirement investing on a regular basis can help build a comfortable nest egg. Saving more than 10% can significantly increase the odds for those who wish to retire early.
Setting aside a portion of one’s income for retirement is only part of the process. Over time, inflation and taxes will erode the spending power of retirement savings. As one ages, the frequency and rising cost of healthcare becomes a significant challenge for retirees. Without a steady paycheck, it is critical for retired investors to carefully choose a mix of stocks, bonds, and cash instruments to generate a sufficient amount of retirement income that will last for the rest of their lives.
Designing a Retirement Income Plan
Engaging the services of a certified financial planner or similar trusted advisor can help address the complicated forecasts and analyses surrounding life expectancy, future taxes, inflation forecasts, investment performance, and more. In addition to analyzing how much income a retiree is likely to need during retirement, the financial planner can also identify customized strategies for generating retirement income, preserving principal, and reducing or avoiding taxes.
With fewer employers offering a retirement pension to employees, Social Security retirement benefits may seem like the only guaranteed income source left for retirees. However, financial planners are showing their clients how to create additional lifetime streams of retirement income by using commercial annuities. Allocating a portion of the retirement investment portfolio to a deferred or immediate annuity is a simple way to convert a portion of assets to an additional stream of income that lasts until the death of the annuitant.
When one considers the challenges facing retirees these days – fewer employee pensions, uncertain Social Security benefits, rising taxes and healthcare costs – it is no wonder many older workers feel apprehensive as retirement approaches. However, some careful planning and investment discipline, along with the assistance of a financial planner, can help ease the transition from the world of work to a carefree and relaxed retirement.
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