How to Start Building Diversified Income Streams for Retirement
Retirement income planning can feel overwhelming. You might not feel completely confident about how much income you can count on, where it will be coming from, and how to manage the risks you face — and that’s before you’ve even started considering taxes or estate planning!
Building predictability and diversification into your retirement income plan can help. As an investor, you might know about diversifying among asset classes to help minimize risk for a given level of returns. You can do something similar for income planning: diversified income sources can help to buffer yourself against risks to any one income stream while you strive to maintain the lifestyle that you envision for retirement.
Here are a few income sources to think about as you get started.
Social Security is the cornerstone of retirement income for many people: over half of married retirees count on Social Security to provide more than 50% of their retirement income, with an average benefit of $1,335. Social Security is indexed for inflation and provided for life — a level of consistency that is probably appreciated by most, regardless of their benefit amount.
However, when you start taking benefits can have a major impact on your income. While most beneficiaries are eligible to start receiving Social Security at age 62, waiting until age 70 can significantly increase a retiree’s monthly Social Security income (it’s important to note that there’s no benefit to waiting past age 70).
In other words, each year that you delay taking Social Security income, your benefit rises. For example, for those born between 1943 and 1954, the “full” retirement age is 66. That means you’ll be eligible to get 100% of your benefit at age 66. But waiting until age 70 entitles you to 132% of your benefit. This can provide an important annual income boost for retirees who have the flexibility to wait.
Of course, the choice to start taking benefits at any given time is highly personal. In making your decision, the Social Security Administration recommends considering factors like your employment status, whether your family tends to be long-lived, your health, and your other income sources, among others.
Retirement Assets: Consider diversifying for taxes
Another way to plan retirement income is with your qualified retirement savings accounts. This can go much further than simply saving as much as you can: depending on your personal situation, it might make sense to “diversify” your savings among both Traditional and Roth accounts. That’s because taxes play an important role in retirement income planning: if you can plan your finances to minimize your tax burden, you may be able to get more out of both your assets and your account distributions.
Roth accounts can be a useful counterpoint to Traditional accounts, in which contributions are tax-free but withdrawals are taxed at your usual income tax rate. Subject to certain restrictions, your contributions to a Roth account are not tax-deductible; however, your withdrawals in retirement are tax-free.
Having the option to withdraw retirement income from one account or another might help you minimize your overall tax burden in a given year. For example, if you took on a consulting job one year and earned extra money but don’t want to risk being pushed into a higher tax bracket, it might make sense to withdraw from a Roth IRA instead of a Traditional IRA.
Please note that to qualify for tax-free and penalty-free withdrawals, a Roth IRA must be in place for at least 5 tax years, and the distribution must take place after age 59.5 or due to death, disability, or a first time home purchase (up to a $10,000 lifetime maximum). Additionally, Traditional IRAs and 401(k)s are subject to required minimum distributions beginning at age 70.5, and plan distributions may be subject to tax and a 10% penalty if withdrawn before age 59.5. As always, before taking any specific action, be sure to consult with your tax professional.
Also, it’s important to remember that your eligibility to contribute to a Roth in any given tax year is dependent on your income. However, no matter how much you earn, you can convert a Traditional qualified retirement account into a Roth. This means that you’d pay a tax bill today in exchange for avoiding one in retirement. Just keep in mind that this is a complex decision that is best undertaken with the guidance of a financial advisor or tax professional, as it could have significant implications for your tax burden in a given year.
That being said, if it makes sense for you in terms of taxes, future income estimates, and your retirement income goals, opening and contributing to different types of retirement accounts over the course of your working life could provide a unique measure of flexibility later in life.
Investment and insurance choices
Of course, investment and insurance products can also provide income options for retirement. Some people look to generate income from financial assets, including variable annuities, while others invest in “hard” assets like real estate — or choose a combination of both. Insurance products like fixed annuities might also have a place in certain retirement income plans.
However, it’s difficult to provide blanket advice: choosing between the numerous options available to you is a highly personal process that often benefits from the advice of an advisor. Each potential income source carries costs, benefits, and risks, and it’s important to match those characteristics to your own particular needs.
Before deciding to adjust your asset allocation or enter into an insurance contract, carefully consider your risk tolerance, goals, time horizon, and other potential income sources. You might also want to browse through our investor education center, which offers information and advice on numerous topics and products related to retirement income planning.
Bonus: Think about Going mortgage-free
Another way to potentially “boost” your retirement income is to help it stretch further by reducing your costs. A major cost-center for most people is their home mortgage.
Depending on your personal situation, having your house paid in full could free up a significant portion of your income, which could in turn provide more flexibility in managing your retirement finances. Many retirees consider downsizing to a more modest home once they hit their golden years (not only is it often cheaper, but it’s also less work!), while others simply make it a priority to reduce their mortgage burden in the years leading up to retirement.
As usual, the right path depends on your individual goals and needs. Going mortgage-free might not make sense in every situation, but it is one option to consider when strategizing for a retirement that strives to be as stress-free as possible.
After all, diversifying your income is just one way to reduce risk — saving on the headache of an additional monthly bill is another!