As we work over the course of our careers, many of us have an eye on retirement. Saving money toward retirement makes smart financial sense, yet on average, American workers are not setting aside enough funds for their lives after they retire. There are many retirement plans available to workers, from employer-sponsored 401(k) plans to individual accounts like IRAs, mutual funds, and even government pensions. Each of these plans has their own strengths and weaknesses, and when it comes to planning for one’s retirement, knowledge is power.
In this two-part article, we will discuss sources of retirement income and how those traditional income sources may not be sufficient to protect you and your family’s financial stability after retirement. We will then introduce a potential solution to ensure a comfortable and secure financial future, referred to as a tax-deferred annuity, or TDA.
Sources of Income in Retirement
When a person retires and is no longer drawing a paycheck, how will he or she pay for life’s expenses? What sources of income are available for retirees? Typically, retirees rely on three primary sources of income:
Social Security benefits – for our entire careers, we pay into the Social Security fund with a portion of our paychecks. Once retirement age is reached, we can then tap into these benefits. However, the average retiree-only receives about $1300 per month, which may not be sufficient to pay expenses.
Employer-sponsored retirement plans and pensions – retirement plans offered by employers, such as IRAs, pensions, and 401(k) accounts represent a common source of income for many retirees. It is critical to take advantage of these employer-sponsored plans to fill the gaps created by insufficient Social Security benefits.
Personal retirement accounts and financial assets – for many workers, the amount of Social Security benefits and pension payments they receive are not enough to meet financial goals and needs. For these people, individual retirement plans like traditional or Roth IRAs are a good solution. The equity one has built up in his or her home ownership, insurance and annuity contracts, and investments in mutual funds, stocks and bonds, or brokerage accounts also represent valid sources of retirement income.
Facts about Social Security Benefits
While the Social Security was established in 1935 to provide income for retirees, this government-sponsored program has had its share of detractors and problems over the years. For many retirees, benefits provided by this program are simply not enough to pay for expenses after retirement. There are several things to consider when discussing Social Security, as the program has changed substantially since it was first created.
First, the retirement age, as far as Social Security is concerned, is going up. In fact, there is something called the Social Security Normal Retirement Age, which is 66 for those born between 1943 and 1954. For those people born after 1954, the Normal Retirement Age is 67. In addition, early retirement (before the Normal Retirement Age) results in a permanent reduction in Social Security benefits. Someone who retires at age 62 instead of the Normal Retirement Age of 66 will receive 25% less benefits that a person who waits until age 66 is attained.
For a worker retiring at the full retirement age in 2017, the maximum monthly benefit is $2687. This is a fraction of the monthly income many workers make during their careers, and for those people accustomed to a certain standard of living, relying solely on Social Security for future expenses may not make financial sense. It is important to also consider the average monthly benefit under the program, which is just over $1300. With these figures in mind, it becomes clear that additional retirement income is needed to continue to enjoy financial security. Another consideration is the spousal benefit, provided when the person drawing the Social Security benefit passes away. Under current laws, the spousal benefit is limited to a maximum of 50% of the retired worker’s benefit. This can cause a loss of financial security for the surviving spouse.
For years, financial experts have warned that the Social Security plan flawed and is in need of reform to correct its inefficiencies and insolvency; serious benefit reductions or high tax increases are some of the factors that the government may have to impose to keep the program operating the way it should.
Don’t Wait to Fund Retirements
Financial professionals agree that the sooner one takes charge of retirement planning, the better off they’ll be. Starting at an early age to set aside money for retirement helps ensure a bright and stable financial future.
As an example of how starting early can benefit you, consider this: if you save only $100 every month, starting at age 20, and this savings accrues a 5% rate of return (through investment growth), by the time that person reaches age 65, he or she will have amassed just under $200,000. Now, if that same person waits until age 35 to save $100 per month, only $81,000 will be ready for retirement expenses. At age 55, starting saving $100 per month with the same 5% rate of return means that a mere $20,000 will accrue. The point of this example is that it is never too early to start planning for your retirement.
Tax-Deferred Annuities – What Are They?
For a number of employees, a tax-deferred annuity or TDA is available as a potential solution for gaps in retirement income. What is a TDA? Financial experts define TDAs as a contract between a life insurance company and an individual; in exchange for premium payments, the insurance company promises both a competitive rate of return on the premiums as well as a minimum interest rate guarantee. Each plan is different, and each has its own established guarantees and rates of return, some with variable or fixed rates. The “deferred” portion in the title of this annuity means that income distributions, whether in a lump sum or in payment of installments by the insurer, are delayed until the account holder desires (typically at retirement age). Taxes are paid on the income distributions just as if they were regular income, but the premiums and interest growth are tax-free.
TDAs are most commonly available to employees of public school systems in the United States and those working for registered 501(c)(3) non-profit organizations.
In our next article, we’ll go even further into discussing TDAs, how they work, and some of the advantages they present to those planning for retirement. Stay tuned for more!