Retirement income planning has seen a dramatic shift in focus in recent years from an accumulation of assets approach to one focused on how best to create income streams in retirement. Shifts in demography and an emphasis on employee-directed savings programs will result in an increasing number of retirees bearing the responsibility of developing and managing their own retirement income plans. With this in mind, it is important for workers to accurately identify the sources of income available to them in retirement.
During our working years, our sources of income are often relatively few in number. In contrast, retirees may have multiple sources of retirement income, each with different rules related to taxation, eligibility and transferability. Following are some important considerations surrounding retirement income sources:
- Have a complete inventory: benefits may come from a current or former employer(s) and may include income from a variety of other sources, including investment and retirement accounts, Social Security or other government retirement programs, annuities, rental properties, royalties or commissions, the sale of a business, deferred compensation arrangements, trust income, cash value life insurance, reverse mortgage, or the sale of assets. The list may also include salary continuation, consulting or part-time work and other sources.
- Determine the amount: is the payment dependent upon attaining a certain age? Is the income already earmarked for a specific purpose and, thus, not available for retirement? Is the income governed by a contract and subject to forfeiture or a reduction if the terms are not honored?
- Is the income consistent or variable? Income from sources such as a pension, fixed annuities or Social Security are not directly dependent on external factors such as investment returns, while other income sources such as withdrawals from investment accounts or IRAs may fluctuate or cease depending on investment performance.
- Is the income guaranteed? Qualified pension benefits offered by private sector employers are secured by the Pension Benefit Guarantee Corporation (PBGC), but benefits are subject to limitations and claims paying ability; public pensions offered by a state or municipality have no such guarantee and municipal pensions may be at added risk, as evidenced by the recent bankruptcy filing in Detroit. Income from investment accounts, IRA accounts and the like are not guaranteed and are subject to varying degrees of market and/or credit risk.
- When does the income begin and end? Does the income cease at the death of one person or does it continue to a surviving spouse or partner? Is the income collected immediately or deferred to be collected at a later date?
- Is the income adjusted for inflation? Certain income sources such as private sector pensions are generally not inflation protected while state or municipal pension plans often are. Social Security benefits are inflation protected and may be paid over the joint lives of the worker and their surviving spouse.
- Is the source reliable? Qualified private sector pension benefits are generally considered to be quite secure, while private sector supplemental retirement plans and municipal pensions may be subject to varying degrees of credit risk. Social Security is projected to have funding adequacy until 2033 with possible reductions thereafter- assuming no changes are made to the plan.
- How is the income source taxed? Retirement income may be taxed as ordinary income, tax-free income or capital gains. Some benefits, such as Social Security, may be subject to taxation based on a taxpayer’s income. Retirement accounts may be subject to minimum withdrawals and certain income may be only partially taxable. Understanding how each is taxed can help you make more informed income planning decisions.
Next, we suggest you create a system to account for the various income items. A sample might look something like the one below.
|Retirement Income Sources|
|Fixed Sources||Beginning Date||Ending Date||Taxation||Guaranteed?||Inflation Protected?||Reliability (1-5)||Annual Amount||Notes|
|Qualified Pension||1/1/2016||My Death||Ordinary Income||Yes||No||4||20,000|
|Supplemental Pension||1/1/2016||My Death||Ordinary Income||No||No||3||10,000|
|Rental Income||1/1/2016||None||Ordinary Income||No||Yes*||3||10,000||*subject to market conditions|
|Social Security||1/1/2020||Second Death||Ordinary Income||Yes*||Yes||4||25,000||*subject to plan funding|
|Total Fixed Sources||$ 65,000.00|
|Variable Sources||Beginning Date||Ending Date||Taxation||Guaranteed?||Inflation Protected?||Reliability (1-5)||Annual Amount||Notes|
|Portfolio Withdrawals||1/1/2016||Second Death||Mixed||No||Yes*||3||10,000||*subject to market conditions|
|Trust Income||1/1/2016||My Death||Mixed||No||No||2||5,000||*subject to trustee discretion|
|Total Variable sources||$ 15,000.00|
A comparison of retirement expenses and income can help us determine if our retirement is on track, or if corrective measures may need to be taken. In our next blog post we will discuss how to put the retirement budget and income together to develop a dynamic retirement income plan.
John Male, CFP®
The Gassman Financial Group
G&G Planning Concepts, Inc.
The Retirement Maven
9 East 40th Street, Suite 1500
New York, NY 10016