Where will my paychecks come from during retirement?

You’ve finally decided that you are ready to retire 6 months from today, congratulations! Now, what do you need to know?…

First, let’s take a step back. Have you talked to a retirement professional before you decided that now is the time to retire? Ideally, before you’ve decided to retire, you’ve been working with a financial planner you can trust for a while now. During that time of conversation and planning, they’ve put a retirement plan together for you so that you’ll have an idea of what type of income you can expect in retirement.

What next? Where is this income going to be coming from since you won’t be working anymore? Most individuals will have at least 2 sources of income when they retire and some will be fortunate enough to have 3.

The first source for most people will be social security. According to the Social Security Administration, “among elderly Social Security beneficiaries, 53% of married couples and 74% of unmarried persons receive 50% or more of their income from Social Security”. Again, this is just one of the two (maybe three) sources of income expected during retirement. However, the unfortunate reality is that about 1 in 4 couples rely on social security as 90% of their income in retirement. Why’s that scary? According to the Social Security Administrations website the average retired worker’s social security benefit is $1,335/mo. Working under the assumption that both spouses received the average worker’s social security benefit, their gross income from social security would be $2,670/mo. This means that roughly 25% of retired couples have less than $3,000/mo in gross income during retirement! Depending on what your situation is and the standard of living in your area, $3,000/mo may or may not cover your basic living expenses. Even if it does cover your basic expenses it probably doesn’t leave much left over to achieve the dreams that you had for retirement when you were younger. This is why we say let social security be just one of your incomes during retirement.

So, what other sources of income are there? The second source of income that some people will have is an employer sponsored defined benefit plan, which most people know as pensions. Pensions are becoming more and more scarce because they are extremely expensive for employers. This is because the employers are assuming the majority of the risk when it comes to each employee’s retirement. Furthermore, as humans live longer -thanks to advances in modern medicine- the risks to employers of longer-living employees will continue to grow.

You may have heard the phrase “frozen pensions,” which many employers will do for employees that have worked for them for a long period of time. A “frozen pension” simply means that either 1) employers are no longer putting money into these pensions for the employees or 2) they will offer lump sum buy-outs of these pensions in order to get them off of their books. Given the amount of liability that the employer assumes when giving employees pensions and how expensive these plans are; these trends are likely to continue in the future.

Many people want to know how much a pension is worth to you in terms of dollars. Let’s do the math. Let’s assume you receive a pension of $3,000/mo or $36,000/yr and you begin receiving this pension at age 65. If you live to age 95 (30 years) your employer will pay you $1,080,000! This is assuming they pay only on your life. If you have a spouse who receives this same amount for their lifetime and they outlive you by 5 years, that means the employer would pay $1,260,000 over the lifetimes of you and your spouse. Now if that employer has this same obligation to over 1,000 employees, you can see how fast these numbers get astronomical.

Given that pensions are becoming more and more scarce and also that Social Security will likely need to undergo some major changes in the future, the most important thing for people to do is take advantages of defined contribution plans. What is that? Well, for most people, a defined contribution plan is a 401k/403b. This is the third source of income that we will discuss, and for most people, this is the piece that they will have the most control over.

So, let’s start with how much you should contribute to these types of accounts while you’re working. The easy answer is: as much as you possibly can up to the maximum amount allowed by the IRS. For reference, in 2016, the IRS allowed up to $18,000 if you are under age 50 and $24,000 if you are over age 50. We all understand that putting this much away is out of reach for some people, but nevertheless, it’s a great goal to have because we’ve never had a client say that they had too much money to retire. On the other end of the spectrum though, the absolute minimum you should contribute is however much your employer will match. The employer match is like getting a 100% return on your investment. There aren’t many investments in your lifetime that will give you a 100% return, and I would doubt that any of them are essentially guaranteed like the employer match is.

Now, keep in mind that some employers will either not offer a 401k or will not match any contributions that an employee puts into these accounts. Does that mean that you shouldn’t save for your retirement? I guess if you never wanted to retire, you wouldn’t need to save for it; however, most people plan on retiring. Another reality is that at some point, you may be unable to work any longer due to health conditions or other circumstances. It is YOUR retirement which means that it is YOUR responsibility to save for it, whether your employer will help you or not. If your employer does not offer a 401k plan, you can still open up an Individual Retirement Account (IRA). IRA’s are similar to a 401k/403b, and once you retire, most people roll their 401k/403b into an IRA. The main difference between the two is the IRS defined contribution limits. For an IRA, in 2016, the IRS contribution limits are $5,500 if you are under age 50 and $6,500 if you are over age 50.

So, as I stated in the beginning, most people will have at least 2 “checks” in retirement which will come from social security and your 401k/403b/IRA’s. Some people will be fortunate enough to have 3, if their employer offers a pension. However, the check that you have the most control over is the one your IRA dollars will give you. There are two things that you can do to help determine how much this check will be: 1) either save more while you’re working or 2) withdraw less while in retirement. You don’t have much say in how much your social security check will be or how much your pension will be. The keys to retirement and financial security is to be prepared in your finances as much as possible, take control of your future income, and make sure you have due diligence with a financial planner before you decide to retire.