Today’s workers who are retiring without traditional pension benefits have to put together their own income from a variety of sources. If you haven’t sat down and thought about where and when this money is coming from, you might have a hodge-podge pile of scraps that could leave a few holes in your plan. Here are five of the most common sources of retirement income along with some advice about how to avoid the expensive pitfalls that can cost you money.
FROM SOCIAL SECURITY
Deciding on the month and year to file for your Social Security benefit is quite possibly one of the most important decisions you make once you retire. It’s common for people to file as soon as they can, which usually means age 62. Reasons for filing might include:
- I better get it while I can.
- I could get hit by a bus tomorrow.
- My neighbor told me I should.
None of these are especially good reasons to file early because, at the age of 62, you’ll be locking in a 25 percent income penalty for the rest of your life. How bad is this penalty? Let’s take a look:
Imagine your benefit at Full Retirement Age (FRA) is $2,200 a month, but you file early at the age of 62, so your monthly benefit amount is reduced to $1,650. That means you’ll be giving up $6,600 a year until the day you stop fogging up the mirror. If you live to the age of 82, that’s $132,000.
FROM A JOB
Ironically enough, working during retirement can also cost you in higher taxes and penalties. First, if you are working while claiming your Social Security benefit, they will penalize $1 for every $2 you earn above the annual limit. For 2017, that limit is $16,920 until you reach FRA. The year you turn FRA, they will only penalize you $1 for every $3 you earn above $44,880, (again, these are 2017 income limits) but they are nice enough to only count earnings BEFORE the month you reach your full retirement age.
FROM AN IRA
Your IRA can also be another sticky wicket if you aren’t paying attention to your tax bracket. Just because you CAN take out your IRA money once you hit age 59 ½ doesn’t mean that you should. If you are still working while you take out your distributions if could mean you will pay higher taxes depending on your income bracket. This can also affect the amount of taxes you pay on your Social Security income.
On the other hand, expensive problems can arise if you retire early and take out a withdrawal before age 59 ½. The IRS will charge you a 10% fee that you must pay in addition to the income taxes you already own on this money. What might that look like?
Imagine you are in the 25% tax bracket and you have an IRA worth $100,000. At the age of 58, you want to take out $20,000 to supplement your Social Security income. You would owe $5,000 in regular income tax and $2,000 for the early withdrawal penalty. In the end, you would only be getting to keep $13,000 of your own money.
FROM A MARKET INVESTMENT
Subscribers to the 4% rule rely on the interest rate earned by market investments by taking out 4 % a year and then adjusting for inflation. Experts nowadays have lowered this rule to 3% and some have even lowered to 2% given today’s volatile conditions. Still, people hope to capitalize on market earnings every year and live off that money.
There are so many expensive pitfalls with this option, it really deserves a book-length discussion. This 4% rule was invented in the 90s before news abroad had the power to so quickly decimate our markets. Not only do you risk taking a loss if you have to sell when prices are fall, but there are also problems with bond fund options. While many people think of them as a safe money option, we are entering into an interest rate environment that can really only go one way, which means your bond funds will likely be worth less in the future when you need them.
FROM A VARIABLE ANNUITY
In spite of the negative attention that annuities sometimes get, they are protected from lawsuits, they keep your money growing tax-deferred, and they are specially designed to pay out monthly income that can’t run out on you. Pitfalls can arise if you get the wrong kind of annuity at the wrong time, and some annuities are much more expensive than others.
The two most common problems we see are:
- The investor is sold a variable annuity when they don’t even need an income. The income rider on a variable annuity is sometimes not explained fully, and so the consumer thinks they are getting an investment that is growing at a guaranteed rate. Instead, they are paying for an income rider they don’t need, and the real account value of their investment can still lose money. If you think you might have this kind of annuity, please reach out to us and we’ll run a test to see what we can do to help.
- The investor is not told about all the fees inside the variable annuity. Variable annuities are one of the most expensive investments you can own because you are charged fees for the management of the investments and for the protection of the insurance company that backs the investment. The insurance company is required to disclose its fees, but to find all the fees charged by the different sub-accounts, you have to read the prospectus. If your statement says you are earning 8 percent, for example, and your fees add up to 6 percent, then you’re really only earning 2 percent. Be sure you understand the cost of any annuity before you commit your hard earned cash.
You shouldn’t have to pay more in penalties and fees than you have to, and you don’t have to expose your money to market loss in order to get a good investment. You deserve to know about all your options. Get a second opinion today. Find out if your retirement income is costing you more than it should. The cost to you is nothing – it’s free to reach out to us and let us know what’s on your mind. We look forward to helping you shop around and compare.