As you plan for retirement the most important question to ask yourself is “where will my income come from during retirement?” Typically, there are three different sources of funds that retirees have Social Security, Savings, Pension. This is where the term three-legged stool comes from.
Social Security
Starting off with the first source of income is Social Security. You’ve probably heard of Social Security before because most retirees use it as their main source of income. You can apply for Social Security when you hit the age of 62 or continue to wait until you reach full retirement age at 65. If you decided however, you don’t want to apply at 65 and want to wait. Your Social Security benefit amount will increase up to the age of 70. Once you’ve applied for Social Security there are a few things you need to know in terms of taxes. If you are filing taxes as an individual and your combined income is in excess of $25,000 you have to pay taxes on up to 85% of your Social Security benefits. If you are filing taxes joint and your combined income is in excess of $32,000 you have to pay taxes on up 85% of your Social Security benefits. If you cross this threshold, you’ll owe quite a bit in taxes at the end of the year. Thankfully there are a few more options you have to plan for retirement.
Savings/Investment Accounts
The second source of income retirees typically have come from their savings. This savings isn’t just the one at the bank, it’s comprised of brokerage accounts and IRA’s as well. This can be a big source of income after retirement depending on how you plan to save. One of the unique benefits that these accounts all harness is their ability to compound. Compounding interest is huge because it allows the funds within the account to grow larger as time passes by. When it comes to tax sheltered accounts such as an IRA, there are unique tax benefits that these accounts offer, that way you can maximize your growth while saving for retirement. Unlike IRA’s brokerage accounts don’t have a limit on how much you can contribute. This means you can add as much funds as you’d like to continue to build your nest egg. Lastly most savings accounts are a good place to grow your cash that you need short term for expenses. Many times, interest rates at traditional banks are quite low. However, there are online savings accounts that offer competitive interest rates.
Pension
The third leg of the stool is your company’s pension. If you are fortunate enough to have the Traditional Pension plan or a Cash Balance plan, you’re in good hands. Traditional Pension plans are funded completely by your company and after you retire you will get a monthly payout for the rest of your life. These payment amounts are usually based off the last 5 years of service with the company. Those who are on a Cash Balance plan are given yearly pay credits while working and at retirement are given a lumpsum of funds. Most companies are beginning to phase out pension plans and transition to defined contribution plans.
A defined contribution plan is funded by both the employee and employer. Depending on where you work you will most likely have a defined contribution plan. These are more commonly known as 401k, 403b, 457 plans. These plans encourage employees to save for retirement by offering them a matching contribution. If an employee contributes a certain percentage to their plan the company will contribute to the plan as well. Just like an IRA there are several similar tax benefits to contributing to your company’s plan.
Because retirement planning can be challenging, this can be a great time to work with a financial advisor. Working with an advisor can help you navigate through these challenges as well as maximize your tax savings. At Wisely Advised we can help assist you with retirement and investment planning to ensure that you are prepared for your golden years of retirement.
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