Retirement Income: The "Three-Legged Stool"Traditionally, retirement income has been described as a "three-legged stool" comprised of Social Security, traditional employer pension income, and individual savings and investments. With fewer and fewer individuals covered by traditional employer pensions though, the analogy doesn't really hold up well today.
Social Security retirement income
Today, about 93% of U.S. workers are covered by Social Security. The amount of Social Security retirement benefit that you're entitled to is based on the number of years you've been working and the amount you've earned. Your benefit is calculated using a formula that takes into account your 35 highest earning years.
The earliest that you can begin receiving Social Security retirement benefits is age 62. If you decide to start collecting benefits before your full retirement age (which ranges from 66 to 67, depending on the year you were born), there's a major drawback to consider: your monthly retirement benefit will be permanently reduced. In fact, if you begin collecting retirement benefits at age 62, each monthly benefit check will be 25% to 30% less than it would be at full retirement age. The exact amount of the reduction will depend on the year you were born. Conversely, you can get a higher payout by delaying retirement past your full retirement age; the government increases your payout every month that you delay retirement, up to age 70.
If you begin receiving retirement benefits at age 62, however, even though your monthly benefit is less than it would be if you waited until full retirement age, you'll end up receiving more benefit checks. For example, if your normal retirement age is 66, if you opt to receive Social Security retirement benefits at age 62, you'll receive 48 additional monthly benefit payments.
The good news is that, for many people, Social Security will provide a monthly benefit each and every month of retirement, and the benefit will be periodically adjusted for inflation. The bad news is that, for many people, Social Security alone isn't going to provide enough income in retirement. For example, according to the Quick Calculator on Social Security's website, an individual born in 1954 who currently earns $100,000 a year can expect to receive approximately $26,184 annually at full retirement age, which in this case would be age 66. Of course, your actual benefits will depend on your work history, earnings and retirement age. The point is that Social Security will probably make up only a portion of your total retirement income needs.
Traditional employer pensions
If you're entitled to receive a traditional pension, you're lucky; fewer Americans are covered by them every year. If you haven't already selected a payout option, you'll want to carefully consider your choices. And, whether or not you've already chosen a payout option, you'll want to make sure you know exactly how much income your pension will provide, and whether or not it will adjust for inflation.
In a traditional pension plan (also known as a defined benefit plan), your retirement benefit is generally an annuity, payable over your lifetime, beginning at the plan's normal retirement age (typically age 65). Many plans allow you to retire early (for example, at age 55 or earlier). However, if you choose early retirement, your pension benefit is actuarially reduced to account for the fact that payments are beginning earlier, and are payable for a longer period of time.
If you're married, the plan generally must pay your benefit as a qualified joint and survivor annuity (QJSA). A QJSA provides a monthly payment for as long as either you or your spouse is alive. The payments under a QJSA are generally smaller than under a single-life annuity because they continue until both you and your spouse have died.
Your spouse's QJSA survivor benefit is typically 50% of the amount you receive during your joint lives. However, depending on the terms of your employer's plan, you may be able to elect a spousal survivor benefit of up to 100% of the amount you receive during your joint lives. Generally, the greater the survivor benefit you choose, the smaller the amount you will receive during your joint lives. If your spouse consents in writing, you can decline the QJSA and elect a single-life annuity or another option offered by the plan.
The best option for you depends on your individual situation, including your (and your spouse's) age, health, and other financial resources. If you're at all unsure about your pension, including which options are available to you, talk to your employer or to a financial professional.
Most people are not going to be able to rely on Social Security retirement benefits to provide for all of their needs, and traditional pensions are becoming more and more rare. That leaves the last leg of the three-legged stool, or personal savings, to carry most of the burden when it comes to your retirement income plan.
Your personal savings are funds that you've accumulated in tax-advantaged retirement accounts like 401(k) plans, 403(b) plans, 457(b) plans and IRAs, as well as any investments you hold outside of tax-advantaged accounts.
Until now, when it came to personal savings, your focus was probably on accumulation, building as large a nest egg as possible. As you transition into retirement, however, that focus changes. Rather than accumulation, you're going to need to look at your personal savings in terms of distribution and income potential. The bottom line: you want to maximize the ability of your personal savings to provide annual income during your retirement years, closing the gap between your projected annual income need and the funds you'll be receiving from Social Security and from any pension payout.
Some of the factors you'll need to consider, in the context of your overall plan, include:
If you've determined that you're not going to have sufficient annual income in retirement, consider possible additional sources of income, including:
What if you still don't have enough?
If there's no possibility that you're going to be able to afford the retirement you want, your options are limited: