How will you finance your retirement?

Once you know how much your retirement will cost, then you should figure how you will finance it.  Yes, there’s still work you must do.

So, let me just say . . . this is definitely the most complicated part of retirement planning – well, besides putting together a budget.

There may be several options available to you, depending on:

• how much you have saved so far
• what types of savings you have
• how many different places you’ve worked
• how long you’ve worked

It can get a bit complicated, but I’ll try to break it down here.

Check out the article on calculating how much your retirement will cost.

Potential Sources of Income for Retirement

1.Retirement Plans

Do you have a retirement plan at your current place of employment?  Do you have a retirement plan from your previous employment?  Will it be enough to finance your retirement?

A Defined Contribution (DC) retirement plan is a way for you to save a certain percentage of each paycheck towards retirement.  It is usually taken out before tax and therefore reduces your taxable amount (lowering your tax percentage).  There are several types of retirement plans, depending on the type of organization for which you work(ed).

Some are listed below:

401(k)

A 401(k) is a DC plan, usually offered by for-profit organizations.  As an employee, you would make regular contributions from your paycheck.  Those contributions can be either before or after-tax, depending on your retirement plan options. The money goes into your 401(k) account which is held by the company you work for until you leave the company.  Choosing the investments for your 401(k) funds is generally your responsibility.  You will have a list of investments from which to choose.

Solo 401(k)

The Solo 401(k) plan is an IRS approved qualified 401(k) plan (DC) designed for a self- employed individual or the sole owner-employee of a corporation.

403(b)

A 403(b) plan is a DC retirement plan for specific employees of public schools, tax-exempt organizations and certain ministers. These plans can invest in either annuities or mutual funds. A 403(b)plan is another name for a tax-sheltered annuity (TSA) plan.

457

The 457 plan is a type of non-qualified, tax-advantaged DC retirement plan that is available for governmental and certain non-governmental employers in the United States. The employer provides the plan and the employee defers compensation into it on a pre-tax or after-tax (Roth) basis.

IRA

An individual retirement account is an investing tool used by individuals to earn and earmark funds for retirement savings.

SEP IRA

A Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) is a variation of the IRA used in the United States. Business owners adopt these plans to provide retirement benefits for themselves and their employees.

Simple IRA

A Savings Incentive Match Plan for Employees Individual Retirement Account, commonly known by the abbreviation “SIMPLE IRA”, is a type of tax-deferred DC employer-provided retirement plan in the United States.  It allows employees to set aside money and invest it to grow for retirement.

Roth IRA

A Roth IRA is a DC retirement plan under US law.  It is generally not taxed, provided certain conditions are met. The tax law of the United States allows a tax reduction on a limited amount of savings for retirement.

What if you’ve worked multiple places?

If you have worked for multiple companies that had retirement plans to which you contributed, your juggling days are over.  You can handle the funds from the previous organization(s) by rolling them into the your new plan (at the new company).  No more spreadsheets with all your retirement plans listed.

Another option is to open an IRA with an investment firm (like Fidelity) and roll everything into one account.  This generally gives you many more investing options than your employer offers for your 401(k).  You can make your own investment decisions or even have a representative adviser assigned to you if your account is large enough.  The investing / adviser rules differ from firm to firm.

To Contribute or Not to Contribute – That is the Question

Some companies/organizations match a certain portion of the money you contribute to your retirement plan.  If so, it’s definitely a win for you!  Let’s say your company matches the first 3% that you contribute.  You will have to put in 3% of your income from each paycheck during the year, but the company matches that 3%.  The good news is – 6% is being deposited into your retirement plan each year.  If you contribute nothing, the company contributes nothing.  It would be foolish not to take advantage of the “free money” provided by your employer.

For example, if your weekly paycheck is $1000, you will contribute $30 (before taxes) to your retirement plan, your company will also contribute $30 to your retirement plan.  At the end of the year, instead of $1,560 (your contribution) in your plan, you will have $3,120.

Note:  You are allowed to contribute up to $18,500 per year (as of 2018 tax rules) to your retirement plan.  The employer may only contribute 3%, but you can still max out your contributions every year.  Employer contributions do not count toward that limit.  Oh, and by the way, if you are over age 50 you can make $6000 additional  catch-up contributions to your retirement plan each year.

How much should you withdraw when you retire?

How can you figure out how much income you will get out of your retirement plan each year?  The general rule of thumb is 4%, meaning you may be able to take out around 4% of the balance of your retirement account per year.  This is based on a couple of assumptions – that you’ve left your funds in some sort of mutual fund or bond (stock market) and the market is doing fairly well OR you have moved your funds into some sort of annuity with a guaranteed income close to 4% per year.

2.Pension Plan

Do you have a pension from where you work now or someplace you’ve worked in the past?  This can be a really sweet deal.  Pensions are Defined Benefit plans (DB).  They guarantee a specific amount of monthly income in retirement.

With a DB plan, your employer sets aside money into an investment pool and use it to pay pension benefits to retired employees.  They use a formula which includes the number of years you have worked for the company, your earnings and age.  For example, your employer may promise you a pension benefit that’s equal to one percent of your average salary over the last five years times your total years of employment with the company. With this plan, your employer is basically guaranteeing you’ll receive a defined amount of money when you retire.  The investment risk is on the plan provider, so regardless of how the investment pool performs, you should receive your pension each month. Unfortunately, many of us won’t experience the benefit of a guaranteed pension at retirement because pensions are becoming few and far between.

Since the Enron financial crisis several years ago, there are many, many government regulations in place designed to protect employees with pensions.  In fact, unless your company goes entirely bankrupt, it’s probably a pretty good bet that you’re covered.  Take your pension and be thankful.  But is it enough to finance your retirement?

3.Annuity

An annuity is an insurance product that pays out income.  It can be one part of your retirement strategy.

You invest in an annuity, either one lump payment or a series of payments, then it makes payments to you at a future date.  You can elect to take a lump sum payment out or a series of payments over time (monthly, quarterly or annually).

The size of your payments is determined by a variety of factors, including the length of your payment period.

You can choose to receive payments for the rest of your life, or for a set number of years. How much you receive depends on several factors:

1. how long you wish to receive payments
2. whether you’ve chosen a guaranteed payout (fixed annuity) or a payments determined by the performance of your annuity’s underlying investments (variable annuity).

Annuities allow you to defer paying taxes on the amount you pay into the annuity.  But you must be willing to wait several years before making a withdrawal – usually five to seven years.  If you take a withdrawal early, you will pay surrender charges – maybe 7% of your investment or more.  Annuities often charge higher fees:

• an upfront commission (as much as 10% of your investment)
• ongoing investment management fees and other fees

The fees alone can amount to as much as 2 – 3% of your investment per year.

If you are considering an annuity, make sure that you ask a lot of questions and carefully review the fine print first.

4.Whole Life with cash value

Generally, if you have never taken out a loan or any other withdrawals on a life policy with cash value option, you can withdraw cash from it.  A cash-value withdrawal up to your policy basis, which is the amount of premiums you’ve paid into the policy, is typically non-taxable.  This should not be considered a stream of income when you retire, but might get you over a rough bump if needed.

Note:  Any withdrawal over the policy basis is taxable income during the year it is withdrawn.

5.Social Security

Social security is a federal program that provides income and health insurance to retired persons, the disabled, the poor, and other groups. The program started in 1935 with the signing of the Social Security Act, which was an effort to provide a safety net for the millions of people who had suffered through the Great Depression.

Most retirees are eligible for Social Security if they worked long enough (rules are outlined on the Social Security website).

The subject of Social Security is so huge, it could fill volumes (and actually does).  I’m going to point you to the Social Security website SSA.gov where there is a great deal of information.  If you have specific questions, someone will be able to answer them for you.  The main thing is – you can set up your own account with the Social Security office and get personalized reports based on your actual work history.

6.Part-Time Work or a Side Hustle

What if you’ve done the calculations and you still can’t make the numbers work?  You have some options:

• continue working and contributing to your retirement plan until you think you have enough saved
• retire and find a part-time job
• go ahead and retire, then pursue some side-hustles

This topic is fairly large as well.  There are many, many different types of side hustles you can do to make extra funds after you retire.  For example, if you like to write, many organizations need writers to help with writing projects.  Companies will pay you to write for them.  If you do arts and crafts, you can sell them online.

The subject of side hustles, is large enough it requires a separate article to do it justice.

7.Winning the lottery

If you win the lottery, that will probably finance your retirement.  You won’t even care about any of this advice.  But, you just need to remember one thing . . . I am your long lost sister.  My name is spelled Dianne (with 2 n’s).

Summary

Aside from winning the lottery, retirement is a complicated subject, isn’t it?  I’ve tried to give you some basic information to help you understand different sources of income you might have in retirement.  It’s just a starting point, though.  You will have to do the real investigation.  Contact your current and past employers, log onto the Social Security website, and talk to a financial planner if you can.  There’s a lot of information on the web – you can probably find answers to any of your questions.  If you start early enough, you have more reaction time.

Please Note:  There’s no way one article can cover all the intricacies of retirement plans, Social Security and pension plans, etc.  I’m not a certified financial planner, so all of the advice I offer is based solely on my experience as I went through planning for my retirement.  I really don’t want to give you bad information.  PLEASE check out everything with a REAL financial planner or do your due diligence by researching topics.