Melissa A. Seamon, CFP®
Retirement income typically comes from multiple different sources such as pension plans (also known as defined benefits plans), defined contribution plans, IRAs, investment income, and Social Security. One of the first steps leading up to retirement is determining how much you will receive in Social Security retirement benefits and then you can decide how much additional income you’ll need each month. After all, you spend your entire working life paying into Social Security with the expectation of receiving future benefits. However, over the past decade, as more and more baby boomers have left the workforce and started receiving their benefits, the Social Security Administration has calculated that the current tax revenues, and the liquidation of the bonds held in the Social Security trust, will only be able to maintain Social Security payments until the year 2034. This excludes the impact COVID-19 has had on government spending and budgeting. A new 2021 report indicates that Social Security benefits will be cut to 78% of promised benefits by 2034 if Congress takes no action to address funding. Of course, Social Security long-term funding has been a concern for a long time, but it appears that a snowball effect caused by the Covid-19 pandemic has shortened the timeline.i
While the future of these benefits is unknown, it may behoove pre-retirees to prepare for the worst and hope for the best. After all, having more retirement income than is needed will always trump the reverse scenario. Here are a few options to consider when preparing to supplement a potential gap left by diminished Social Security benefits.
1) Individual Retirement Accounts (IRAs)
There are two types of Individual Retirement Accounts (IRAs) to choose from: traditional IRAs and Roth IRAs. It’s possible you have one or both of these accounts set up and have been making contributions regularly for years and the potential growth of these accounts could make up for Social Security reductions. But, as you get closer to retirement, don’t forget to consider the following about each type of account as these stipulations can affect your overall retirement income amount. Traditional IRAs Depending on your individual circumstances, contributions you make to a traditional IRA may be fully or partially deductible. Once you reach age 72, you must begin taking Required Minimum Distributions (RMDs) from your IRAs in order to avoid penalty. Withdrawals from traditional IRAs are taxed as ordinary income and, if taken before age 59 1/2, may be subject to a 10 percent federal income tax penalty. ii
Roth IRAs iii
Roth IRAs differ from traditional IRAs because contributions are made with after-tax dollars and are then able to be withdrawn tax-free in retirement. To withdraw money from a Roth IRA without tax or penalty, you must:
- Be age 59 ½ or older
- Have owned the Roth IRA for at least 5 years
Some exceptions apply such as using a Roth IRA for qualified education expenses or if the owner dies.
2) Workplace Defined Contribution Plans
If your employer offers a defined contribution plan, such as a 401(k), 403(b), or 457 plan, the accumulated income in these accounts could supplement Social Security, especially if this amount has had time to grow. With the possibility that social security benefits are reduced in the next decade or so, you may consider contributing more to these plans than you have in the past. Of course, we always recommend at least contributing up to the employer match to take advantage of the extra boost in savings coming from your employer’s pocket; but, if you aren’t maxing out the limits on these accounts each year, this may be one strategy that could help to generate more retirement income.
3) Investment Income
Most investors will also approach retirement with an investment portfolio; of course, the amount that you rely on your investment income to supplement your cash flow will depend on (1) your other available resources and (2) your personal retirement tax planning strategy. Some retirees will rely more heavily on their workplace retirement plans while others receive more from other sources such as income from real estate investments or pension plans.
The investment portfolio may be one of the most flexible places from which to generate income should social security come up short. A financial advisor could help match you with investments to meet your income needs.
4) Continued Employment
Many retirees find it both mentally and financially beneficial to work during retirement. Some people enjoy the social interaction and mental stimulation that working provides, while others decide to work during retirement to defer taking government benefits and avoid depleting their assets. If social security benefits lessen, you may decide to work a few years longer in order to (1) allow your assets to continue to grow before drawing down on them, (2) increase your lifetime earnings report which directly impacts how much you qualify for in social security benefits, and (3) be able to put more into your workplace retirement accounts before you retire.
Untouched assets continue to compound over time, increasing your overall spending threshold and retirement longevity, depending on your preference and risk tolerance. A higher earnings record translates into a higher earned benefit, and it is never a bad idea to spend a few more years socking away extra cash to grant yourself that extra cushion and peace of mind in retirement.
Plan for It in Advance, Rather Than Regretting It in Retrospect
Again, it’s likely you’ll have multiple sources of income in retirement, but if Social Security constitutes a large chunk of your income, then a reduction in benefits will certainly be challenging. But even if Social Security is only a small portion of your income plan, having a strategy for how to fill the gap ahead of time will eliminate any unwanted financial surprises from keeping you up at night.
At Gardey Financial Advisors, we pride ourselves on helping our clients—both retired and working—plan for the unexpected so that their financial lives continue to run smoothly no matter what policy changes or benefit disruptions may occur. We can’t control what the government will do, but we can assist with how to react.
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i www.ssa.gov/policy/docs/ssb/v70n3/v70n3p111.html 25 January 2021
iii www.schwab.com/ira/roth-ira/withdrawal-rules 25 January 2021