While maintaining your health is often the first thought when you enter retirement, finances are often the second. Without the steady revenue stream of a job, how can you maintain your lifestyle and enjoy the luxury of retirement?
The obvious answers are investments. Such as your employer sponsored 401(k) or pension plans and government programs like social security. But within those spaces there’s a lot to learn despite it really never being taught.
This article’s goal is to help you understand the basic strategies for understanding and managing your different income streams, while also going over some basic rules of thumb to make sure you’re able to manage effectively.
While this article is meant to be educational and is using interviews and sources from certified sources, it is not itself a certified source. Please speak with a licensed financial planner and thoroughly understand your options/choices before making any decisions.
What is a 401(k)/IRA?
401(k)’s and IRAs are both contribution plans. Most of these plans are offered through employers, but you can buy into them on your own as well. A 401(k) is simply a tax-advantaged way to save for retirement.
There’s a lot to 401(k)’s, but the most important things to consider are the variables you’re able to control, which are: how much can I put toward it? Do I choose a Roth or traditional 401(k)? And what do I do with it when I retire?
How much do I Pay?
It is always recommended to donate as much as you possibly can into your 401(k) while not jeopardizing your livelihood. If that seems like too much, the other best recommendation is to always, at least, match any contributions your employer might give you. That way you’re essentially earning extra income.
Roth vs Traditional Plans
The difference between a Roth/Traditional 401(k) is when you pay taxes. With a Roth 401(k) you pay taxes as it is deposited into your retirement account. With a traditional 401(k), you pay taxes when you pull money out of your retirement account.
The general rule of thumb in deciding between the two is, if you’re expect to be making more money when you retire, choose Roth. If you’re going to be making less/the same amount of money when you retire, choose a traditional plan. But of course, we recommend you contact a financial planner or use a retirement account calculator before making these choices.
Okay, I Retired, now what?
This is where things get tricky, and I feel like not a lot of people know what’s going on. Once you retire you have four choices: you can “rollover” your 401(k) into an IRA, you can leave it with your employer, or you can take the money.
If you “rollover” your 401k, then you really should make sure you go through the proper channels. Basically, if you act as the middleman for your own rollover, you’re subjected to a 20% tax on that transfer. This is obviously not ideal. To avoid that issue, work with your IRA and your employer to have the 401(k) officially rollover into an IRA.
If you leave it with your employer, you cannot contribute anymore, but it will still grow over time. You can make withdraws, but they will be subject to taxes and fees based on your employer’s plan.
If you take the money, you’ll have to pay taxes and fees, but once its yours, its yours. Just know that if you withdraw the money prior to being age 59 1/2, you will be subject to a 10% early withdrawal penalty. In cases where you retire before age 59 1/2, it might be better to move your 401(k) into an IRA or to keep it with your company until you're the right age.
Ultimately, 401(k)’s are an excellent tool to make sure you’re putting money away for the future. There are just often a lot of choices involved, and you can often feel like you might be making the wrong ones. In order to best manage that, be mindful, do your research, and take it one step at a time. Remember that you can have a 401(k) on top of other retirement saving plans (such as a pension, social security, and IRA’s), and there’s definitely nothing wrong with being over prepared for retirement.
What is a Pension? Will I Get it?
Pensions are an often sought out job benefit. By working somewhere with a pension plan, you’re setting yourself up to have an income during retirement… kind of.
There are a lot of misconceptions surrounding pension plans and that can often lead to “pension envy.” This makes sense, if you assume pensions are basically free money, then yeah, you’d probably be upset if your retired friends have them and you don’t. But that’s not what pensions are.
Pensions, just like social security or your 401(k), are based on money you are paying. You pay for your pension through payroll deductions during your tenure as an active employee. The big difference is that your pension doesn’t “run out” and that the employer (or unions) set the rules. One of the drawbacks to pension is that there is no “one set” way that they work and that they are dependent on your employer’s financial status. Since these are variables you can’t control, pensions aren’t always as amazing as they might seem—still, if you’re offered one you should definitely consider it. Be sure to talk with your employer for more information if pensions are offered.
Generally, pensions have a built-in start date based on a minimum age for all employers. When you begin your retirement process you might need to make certain choices about your pension. The biggest choice is deciding between a lump-sum and a monthly annuity.
Lump-Sum vs Monthly Annuity
Being paid a lump-sum means you get a single large taxable payout from your pension upon retiring. This money only comes once and is usually based directly on your contributions to the pension fund.
A monthly annuity is more akin to a paycheck. You’ll receive an allotment of your pension benefits every month until the plan expires, the pension dissolves or you pass away. Some monthly annuities account for inflation, others do not.
Depending on your type of pension plan, the rate of inflation, and your trust in the company managing the pension, there are too many variables to suggest there’s a “right answer.” Just remember that inflation, taxes, and investments are all important things to consider while making your choice.
What is Social Security? When do I start using it?
Social Security is a government sponsored retirement plan. Like pensions and 401(k)s, Social Security takes a portion of your paycheck, invests it in a group fund, and then gives that money back to you when you retire in the form of a monthly check.
When it comes to Social Security you don’t have many choices outside of when you should start pulling money from your social security. Like most financial choices the choice varies based on your own life and funding.
The big choice is whether or not you file “early” as in before your age group’s expected retirement age or if you file “late” as in after your age group’s expected retirement age. If you file early you receive smaller payments, but for a longer period of time. If you file late, you receive larger payments, but for a shorter period of time.
The variables to consider while making this decision are: will I affect my standard of living if I delay my benefits? Do you think you’ll invest the money if your file early? Does a member of your family need benefits that can only come in once you’ve filed?
Once you’ve answered those questions, you’ll be able to make a more informed choice on when to file.
Ultimately, money is always a sore spot. It’s tough to have all the answers, especially when there are so many variables involved. By talking to a financial planner and by doing your research, you’ll be able to set yourself up for success when it comes to your income. With all that being said, if you consider your options and plan ahead, you can easily set yourself up for a comfortable retirement.