You've worked your entire life and now you're ready to end the daily grind and start doing the things you've always dreamed of, such as traveling, starting a business or getting deeply involved in a hobby. The only question is: How do I fund my retirement?
This issue is facing millions of Baby Boomers and Gen Xers who are retiring every day. In this article you’ll find some of the best retirement income strategies so you can not only survive your retirement, but thrive.
The Importance Of Planning For Retirement
Every retirement guide tells you that the earlier you start planning for your retirement, the better, giving you time to save more money. But, the reality is that most of us spend our early years establishing a career and building a family, and our middle years providing for our loved ones. Retirement kind of sneaks up on most of us, but if you have put in place the right retirement income strategies, the transition to retirement can be painless.
Different Types Of Retirement Income
Throughout your working life, you've probably received a regular income through salary or dividends, and in your retirement, you want to continue receiving a regular income stream. That income can come from:
- Social Security
- Pensions
- Annuities
- Investments.
It's important that you understand the different types of retirement income so you choose the ones that are right for you.
With inflation running at 4.0%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz.
How To Choose The Right Retirement Income Strategy
The best retirement income strategy for each of us depends on how old we are, our current income and what our financial goals are.
1. Social Security provides monthly income and how much you receive is dependent on how much you earned during your working years and when you elect to begin receiving your Social Security payments. The Social Security Administration calculates how much you will receive monthly based on your 35 highest-earning years, adjusted for inflation, and the age at which you elect to begin receiving benefits.
For people born in 1956, the full retirement age, or FRA, is 66 and 4 months, for those born in 1957, it is 66 and 6 months and for people born in 1960 or later it is 67. The earliest you can begin receiving reduced Social Security benefits is 62, however, each month you delay between your FRA and age 70, the higher your monthly payment will be. For example, if you delay retirement until age 70 and your FRA was 67, you could receive 124% of your calculated benefit, while those having a FRA of 66 could receive 132% of their calculated benefit if they delay receiving benefits until age 70.
A spouse can receive a Social Security payment equal to 50% of that of the higher-earning spouse's payment if that amount is greater than payments based on their own work. A former spouse can claim payments based on what an ex-spouse earned if the marriage lasted for more than ten years, and should one spouse die, the surviving spouse can claim Social Security survivor's benefits. Before claiming any Social Security benefits, spouses should consider the timing of their retirements in order to maximize their benefits.
For most retirees, the amount they receive monthly reflects their Medicare Part B premium having already been deducted. In 2023, the standard monthly Medicare Part B premium is $164.90. For existing Social Security recipients, the law prohibits premium hikes from decreasing the amount of a Social Security payment, but premium hikes can take a bite out of any cost-of-living adjustments.
You don't have to pay income tax on Social Security income unless your monthly income exceeds a certain threshold. This income can come from a pension, part-time work, interest and dividends or IRA withdrawals. According to the IRS, if your income exceeds $25,000 per year and you file as an individual, you must pay taxes on up to 85% of your Social Security benefit. The same applies to those filing a joint return and who earn greater than $32,000 a year. To get a rough estimate of what you can expect your Social Security payments to be, the IRS provides a Quick Calculator.
2. Pensions: Once a common perk of employment, unfortunately, pensions are becoming a thing of the past, replaced by 401(k) plans. A pension plan requires an employer to make regular contributions to a pool of money from which payments are made to employees once they retire. 401(k) plans are funded primarily by employees rather than employers.
According to the Pension Rights Center, only a third of American retirees receive retirement income from a traditional pension. Pensions are more commonly offered by state or municipal governments, with the Bureau of Labor Statistics estimating that 92% government workers had access to a pension.
3. Dividends: You can achieve a steady income stream from dividends from stocks or real estate investment trusts (REITs). Preferred shareholders are guaranteed dividends having a fixed rate, while the dividend rate for common stock shareholders is variable. Assets can be evaluated based on their dividend yield, which is the annual dividend payment divided by a stock's current share price. The dividend yield reflects the amount of future income you can expect given a stock's current share price.
In a recent article, my colleague Cory Mitchell has assembled a list of the ten best dividend stocks for June 2023. The companies comprising that list and their dividend yields are shown below:
- Texas Instruments (TXN), 2.8%
- Lockheed Martin (LMT), 2.7%
- Merck (MRK), 2.6%
- Air Products and Chemicals (APD), 2.6%
- Automatic Data Processing (ADP), 2.4%
- Broadcom (AVGO), 2.3%
- Microchip Technology (MCHP), 2.0%
- Tractor Supply Company (TSCO), 2.0%
- Rockwell Automation (ROK), 1.7%
- Hershey (HSY), 1.6%
Downsides of dividend income are that a company experiencing a downturn may choose to suspend their dividend payments. Also, you pay taxes on dividend income at your normal income tax rate, which is higher than the capital gains tax rate on the sale of appreciated stock.
By law, REITs must distribute at least 90% of their taxable income to their shareholders in the form of dividends. REITs having the highest dividend yields as of this writing include:
- Two Harbors Investment (TWO), 20.3%
- Brandywine Realty (BDN), 19.9%
- Orchid Island Capital (ORC), 19.4%
- Armour Residential REIT (ARR), 18.6%
- Annaly Capital Management (NLY), 18.5%
- Chimera Investment (CIM), 17.8%
- KKR Real Estate Finance (KREF), 16.9%
- Ares Commercial Real Estate (ACRE), 16.2%
- Uniti Group (UNIT), 15.8%
- Office Properties Income, 15.8%
With inflation running at 4.0%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz.
4. Bucket Strategy: Any investment strategy must balance a desire for investment growth and the need for easy access to your money. The “bucket” retirement strategy involves separating your savings into three buckets with bucket #1 containing money you'll need for living expenses over the next several years, and a sufficient amount for an emergency fund. To ensure liquidity, you should invest bucket #1 money in a high-yield savings account. However, the top annual percentage yields (APY) I could find were under 4.85% while inflation is currently running at 4%, so you are just coming out ahead. .
Bucket #2 should contain money that you can afford not to touch for between three and ten years. You can invest this money in either bonds or certificates of deposit (CDs). Bond yields are currently high, with the yield on the 10-Year Treasury note near 3.7%, and if interest rates were to fall, you could sell your bond for more than you paid for it. Besides Treasurys, there are also corporate bonds, municipal bonds, bond funds and bond exchange-traded funds (ETFs).
Bucket #3 should contain money you won't need to access for more than ten years. You can invest this money in stocks, real estate, real estate investment trusts (REITs), angel investing or even alternative investments such as art or antiques.
5. Annuities: An annuity is a contract between you and an insurance company, bank or brokerage firm whereby you make a lump-sum payment and the company pays out an income stream, possibly for as long as you live.(For more see “Best Annuities For Reliable Income”) However, annuities come with some serious drawbacks:
- High fees, with average fees on a variable annuity at 2.3% of the contract value
- Lack of liquidity–if you need to get your money out of an annuity, you will have to pay early withdrawal charges, penalties and taxes; withdrawals are subject to ordinary income tax, and if taken before age 59 1/2, they may be subject to a 10% IRS penalty
- The duration of annuities is long, and if you withdraw your money during the surrender period, typically between two and ten years, you will incur a surrender charge of up to 20%.
6. Earning Money During Retirement: Many retirees have been waiting their entire lives to do work that is meaningful and enjoyable to them, and that also brings in some extra income. Examples of these "side gigs" include starting a carpentry business, providing flowers for weddings or special occasions and setting up a pet grooming business. Other strategies include buying real estate and then renting it out either long-term or as an Airbnb. Another exciting option is to invest in a business that you see as promising.
Tips For Making Your Retirement Income Last
The best way to make your retirement income last is to limit your outflows of cash. One big outflow is taxes and once you start withdrawing money from your 401(k) or a traditional IRA, your withdrawals are taxed as ordinary income. However, distributions from a Roth 401(k) or a Roth IRA aren't taxed because the tax on them has already been paid. Distributions from these types of accounts have no impact on the taxability of your Social Security benefits.
If you sell equity shares you have held for less than a year, any profit is subject to a short-term capital gains tax, which is at the same rate as your income tax bracket. Profits from the sale of shares held for a year or longer are subject to long-term capital gains taxes, which are 0%, 15% or 20%, depending on your taxable income and filing status. You can reduce taxes by placing profits from stocks in a tax-advantaged account, by holding shares for greater than a year and by offsetting any gains with losses.
Another way of minimizing outflows is by reconsidering your living situation. Consider trading in a large house that comes with high heating and cooling costs, high maintenance and high real estate taxes for a smaller one with less expenses in a more affordable area. Look at the states offering the lowest real estate taxes, such as Hawaii, Alabama, Colorado, Louisiana, the District of Columbia, South Carolina, Delaware and West Virginia. Also, look at the states with the lowest energy costs, such as Idaho, Wyoming, Utah, Oklahoma and Nevada. In the “10 Cheapest States To Live In For 2023” you;ll find the least expensive states to live in which include: Mississippi, Kansas, Alabama, Oklahoma and Georgia.
You can limit food costs by shopping at so-called "dented can" stores, which offer name-brand groceries whose packaging may be damaged or that are approaching or are beyond their expiration date. According to the U.S. Department of Agriculture, the manufacturer's expiration dates refer to quality and not safety, and most shelf-stable foods are safe indefinitely. Canned goods are safe to eat for years so long as the can is intact.
Consider shopping for clothes at a second-hand or resale shop. Many organizations, such as Goodwill, run resale shops in your community, and the internet is rife with stories of people who scored designer clothing at these shops for pennies on the dollar. Resale shops also offer perfectly serviceable home goods, electronics and furniture.
Take advantage of any freebies offered by your community, such as movies in the park or free concerts. Many communities have Senior Centers that provide free activities and even free lunches. Don't be embarrassed to take advantage of senior discounts offered by restaurants, shops, hotels and travel companies. Check out AARP's list of states offering free college classes to seniors. For example, in Utah residents aged 62 and older can take classes for free at any public college or university, paying only a registration fee that ranges from $25 at the University of Utah to $10 at Salt Lake Community College. California's massive State University System offers free classes to seniors at any of its 23 campuses. A bonus is that health facilities fees are waived, meaning you can use gyms or swimming pools for free.
Best Retirement Strategy FAQs
What is the difference between Social Security and a pension?
Social Security is funded through payroll deductions while pensions are funded privately by employers and employees. Social Security provides income should you become disabled while pensions are not required to do so.
What is an annuity?
An annuity is a contract between you and an insurance company, bank, brokerage firm, or mutual fund company whereby you pay into an account and the company guarantees you an income stream during your retirement.
What are the risks of investing in annuities?
You're betting that the issuer can continue to make payments into the future, if the issuer goes bust, your money is lost. Cash invested in an annuity is not liquid and should you need to withdraw it, you will be subject to early withdrawal charges, penalties and taxes. Annuities tie up your money for long durations and the fees charged by issuers can be sizable.
How much money do I need to save for retirement?
The answer to that question is different for everyone. Obviously, if you plan to retire to a shack in a forest and live off the grid, your costs will be minimal and you won't need to have saved much. If your idea of a comfy retirement is a villa in Cannes, you will need to have saved much more.
When should I start taking Social Security benefits?
This is a "chicken and the egg" question because if you elect to receive Social Security benefits at age 62, you will receive more payments but they will be of a lesser amount than if you wait until your full FRA of 66 or 67. Your payment amount will be even higher if you wait to receive benefits until age 70, but you will receive fewer payments. The best answer is to start receiving Social Security benefits when you feel that you need them.
With inflation running at 4.0%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz.
