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Understanding and Generating Retirement Income

One of the most important consideration to take when planning retirement is how to generate retirement income. Planning for retirement brings with it many unknowns. Knowing how much to save, how much to allot each month, where to live, healthcare, and so on. The list is long.

In days gone by pension plans guaranteed income in retirement. Today pensions have given way to 401(k)s and Individual Retirement Accounts (IRA). These types of accounts are owned by the investor, so if you change jobs, you take your money with you. Individuals are responsible for setting aside and investing money to build their own retirement fund. Once individuals retire, they must budget their investments to make them last. A 401(k) or IRA can be an excellent alternative to a pension. Or can be used in addition to a pension or other form of guaranteed income. In this series, we will examine three ways to generate retirement income.

First, you’ll need to determine how much income you will need. One way to clarify how long will your nest egg will last is to use a retirement income calculator:

https://www.raymondjames.com/wealth-management/advice-products-and-services/financial-and-retirement-planning/retirement-planning-calculator

If your current expenses exceed the income you’ll receive from pensions or retirement accounts you need to consider other income sources. You can also decide ways to cut your expenses in retirement. If the gap between your expenses and assured income is relatively small — or if your nest egg is so large that you run very little risk of running through it during your lifetime – then you may very well be able to rely on withdrawals from savings for any additional income you need.

As always, consult with a qualified financial professional who can be objective when it comes to your individual income needs.

Types of Guaranteed Retirement Income

You have several options when it comes to a guaranteed source of income in retirement. Each source brings their own requirements, benefits, and disadvantages. When reviewing each choice, consider your personal situation and needs to decide the best fit for you and your future.  Some options to consider are:

  • Social Security

  • Annuities

Social Security

Social security provides a guaranteed income determined by the amount an individual paid into the system and the age at which they begin drawing funds. Once you start to use social security, you are locked into the monthly amount in most instances. Generally, the longer you wait to begin collecting social security the higher the monthly payment you will receive.

A major perk of social security is that you can continue to draw payments for life; unlike nest eggs or investments with a limited amount of money that may run out over time. The downside of social security is that the monthly payment is seldom enough to cover the cost of living.

When Should I Draw Social Security?

Deciding to collect Social Security is a big decision. It can be tempting to start getting money as soon as possible. However, the sooner you begin drawing the less you will receive. Several factors can help you determine the best age to start collecting. Consider the big picture. Your health, marital status, any investments and savings you have to make the right decision for your situation.

Understanding Eligibility

A few requirements must be met to qualify for social security. You must have paid into the program for 10 years, and you must be at least 62 years of age. In some instances, individuals who lost their spouse can begin collecting spousal benefits at age 60.

Run the Numbers

Waiting until full retirement age (FRA) makes it possible to maximize your benefits. Full retirement age is determined by your birth year, so this value is not the same for everyone. Once you begin to collect social security, you are locked into an amount.

Cost of living adjustments may impact that amount, but your benefits cannot be recalculated when you reach FRA. Waiting until FRA to collect can mean receiving almost 30 percent more than drawing at age 62. Each year you hold off collection past age 62 works out to an 8 percent increase annually. It pays to wait, but your unique situation can influence whether it is worth the delay.

Employment Status

You can collect social security and be employed. However, if you do so before reaching FRA, your benefits are reduced by $1 for every $2 you earn over the limit. The earnings limit increases each year and is currently about $17,000. Drawing social security while working will also raise the taxes you pay. Continuing to work may diminish how much you can collect, it may be worth waiting to draw or reducing hours or pay to ensure you come in under the limit.

Health and Longevity

If you have an illness that prevents you from working or proves to be a financial hardship you may not have the luxury of waiting to collect social security. Collecting a lesser amount now may enable you to cover expenses you wouldn’t be able to otherwise.

Evaluate your health and assess how long you expect to live. This can be difficult, but understanding how long you will likely live helps you determine your financial needs. Look at factors like your health, as well as the medical history of your parents and other relatives.

Annuities

An annuity is an investment that pays out monthly, creating retirement income. Several factors, such as the amount invested and the age of the investor impact the amount an annuity pays out. Annuities offer the confidence that comes with consistent and guaranteed income. This income may also provide the luxury of being more aggressive with other investments. There are to different types of annuities, a deferred annuity, and an immediate annuity. We will take a look at both. Each has specific benefits and one may fit your specific needs more than the other. All annuities are different, so do your homework to find the best fit.

Understanding different annuities

A fixed annuity is a long-term, tax-deferred insurance contract designed for retirement. It allows you to create a fixed stream of income through a process called annuitization. It also provides a fixed rate of return based on the terms of the contract. Fixed annuities have limitations. If you decide to take your money out early, you may face fees called surrender charges. If you’re not yet 59, you may also have to pay an additional 10% tax penalty on top of ordinary income taxes. You should also know that annuities contain guarantees and protections that are subject to the issuing insurance company’s ability to pay for them.

With variable annuities any withdrawals may also be subject to income taxes and, prior to age 59 1/2, a 10% federal penalty tax may apply. Withdrawals from annuities will affect both the account value and the death benefit. The investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. An annual contingent deferred sales charge (CDSC) may apply.

Withdrawal Benefit Rider on a Deferred Annuity

If you are planning further out, a withdrawal benefit rider or deferred annuity can provide a dependable source of guaranteed income in retirement. A deferred annuity can be a good fit if you are at least 10 years away from retiring and beginning to make withdrawals. As the account value grows, the annuity company will lock into the new higher value income base annually. When you decide to start withdrawing funds, your guaranteed income is generated from the account value or the income base value.

With a deferred annuity, your funds are deposited with an insurance company -investing in either a fixed, variable, equity-indexed, or longevity annuity contract. The taxes on any investment gains are deferred until such time as you take a withdrawal.

When choosing a deferred annuity be certain you have the option to turn your deferred annuity into an immediate annuity after a certain amount of time has passed.  Essentially you are letting your earnings defer until such time as you need to turn the investment into a guaranteed stream of income.

Immediate Annuity

If you plan to retire sooner rather than later, an immediate annuity may be the best solution. Immediate annuities begin to pay out right away, making them ideal for individuals at or nearing retirement. Some annuity options payout for life, while others even offer a joint lifetime option for married investors. An immediate annuity is a tool for ensuring a regular income. Most often it’s used to provide a consistent income for retirees. Whether it is a good choice for your particular needs, however, depends upon your circumstances.

An annuity is a contractual financial product. In most cases, it accepts and grows funds from an individual and then pays out an agreed-upon amount each year.

An immediate payment annuity is purchased with just one lump-sum payment and starts paying out right away. For example, you could sell your home and put the entire amount into an immediate annuity. You would then have an agreed-upon income for a set number of years. Or even for the rest of your life.

Annuities are a form of insurance, and insurance is a risk management tool. When you buy an immediate annuity, you are attempting to ensure a particular outcome. The outcome you are purchasing is life-long income. The key to using an immediate annuity properly is to understand what you are insuring and how to value the benefit being provided.

When you purchase an annuity the insurance company will determine the amount of monthly income based on factors such as:

  • the type of annuity

  • the term of the annuity

  • your age and gender (to estimate life expectancy)

Annuities have some significant drawbacks. For one, you must be willing to sock away the money for years with deferred annuities. If you make a withdrawal within the first five to seven years you could be hit with surrender charges or high taxes. Annuities also often charge commission fees, sometimes as much as 10% of your initial investment.

It is important to understand the fee structures within annuities can be unclear and complex. It is very important you review the contact and ask lots of questions to be certain you understand exactly what the fees are and how the annuity will work over time. Before you invest you should consult with a quailed financial advisor to help you understand all your options.

Adding Guaranteed Income to Your Retirement Budget

Retirement planning is about finding a balance between investments, savings, and guaranteed income. With careful planning, guaranteed retirement income is possible. Depending on how close you are to retiring and your specific situation, you have a variety of options.

From the type of jobs you choose to the way you invest your money, you can ensure you will have an income each month to help cover your expenses during your retirement.

A critical mistake people can make when it comes to retirement income planning is limiting their strategy.

Generating income in retirement is important, yet there are other considerations as well. Regardless of where you choose to live and how you choose to structure your life in retirement- your goals, time horizon and risk tolerance — are important parts of generating income in retirement. Planning for that time now, not later, may help you reduce stress, gain clarity and most importantly help you live the most fulfilling retirement possible.

 

Disclaimers:

*Any opinions are those of Chip Munn and not necessarily those of RJFS or Raymond James. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete.

*Before investing, investors should carefully consider the investment objectives, risks, charges and expenses of the variable annuity and its underlying investment options. The current contract prospectus and underlying fund prospectuses, which are contained in the same document, provide this and other important information. Please contact your representative or the Company to obtain the prospectuses. Please read the prospectuses carefully before investing or sending money. Variable annuities are generally considered long-term investments.

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