Retirement planning takes into consideration a number of diverse financial variables to develop a comfortable and sustainable lifestyle. A typical case would be one in which the individual retires at 65 years of age, has $640,000 in an individual retirement account, and receives a monthly Social Security check of $1,900. Whether this combination will be sufficient is a matter of careful consideration of possible income, expenses, tax consequences, and individual circumstances.
Anticipated sources of income
Social Security benefits
For retirees, Social Security benefits can be started as early as age 65. However, keep in mind that full retirement for individuals born in 1960 or later is 67 years. If they take their benefit at age 65, they will receive a reduced benefit, about 86.7% of the full benefit amount.
In this example, the client expects to draw $1,900 per month, or $22,800 annually.
IRA withdrawals
The 4% rule has been the common rule of thumb applied in retirement withdrawal, meaning annual withdrawal rate that keeps the risk at the bottom of completely using up the retirement resources. For one retiring at the age of 65 years, probably 3.7% would be about right. Thus, $23,680 results from taking a 3.7% income off of $640,000.
Adding the IRA withdrawals to the Social Security benefits suggests that this couple has a total pre-tax income of $46,480 per year.
Taxation of the benefits
The retirement income has to be considered for possible taxation carefully. Withdrawals from the traditional IRA are subject to federal income taxation. Besides, tax may be imposed on Social Security benefits if the combined income of the retiree exceeds a threshold level. Combined income is defined as adjusted gross income, plus nontaxable interest, plus half of the Social Security benefits.
If the combined income of a person exceeds $34,000, then 85% of the Social Security benefits can be taxable.
Here;
Combined income: $23,680 (IRA) + $11,400 (half of Social Security benefits) = $35,080
Taxable Social Security benefits: 85% of $22,800 = $19,380
Total taxable income: $23,680 (IRA) + $19,380 (Social Security) = $43,060
Federal income tax rates vary, but for illustrative purposes, assuming a 12% tax bracket:
Estimated federal taxes: 12% of $43,060 = $5,167
Adding for federal taxes would bring down the net income for a retiree in retirement to about $41,313 annually or approximately $3,443 per month.
Assessment and life expenses
To determine whether this amount of income is adequate, retirees need to take into consideration how much they will have to spend in order to have a decent lifestyle that includes housing, health care, food, transportation, and some forms of entertainment. A detailed budget, considering both current and future needs, has to be developed, with inclusion of inflation and potential healthcare costs.
Inflation and longevity risks
Inflation can erode purchasing power over time, and so retirement savings need to take the impact of inflation into consideration. Finally, with improved life expectancies, retirees have to consider that their retirement could be quite long and their savings should be sufficient to last their lifetime.
Strategies to improve retirement security
Retirees who are concerned about the adequacy of their income may consider a number of strategies:
- Delayed retirement: Retiring late allows more deposits into retirement accounts and may include a higher income from Social Security.
- Part-time employment: The use of part-time jobs complements the meager income a retiree could be receiving to reduce reliance on retirement savings.
- Annuity: Buying an annuity guarantees a steady flow of income. However, terms and conditions in an annuity purchase should be carefully considered because of possible negative features.
Expense reduction perhaps entails downsizing housing or making a move into areas that significantly cuts down the cost of living.
