Retirement income has often been described as a three-legged stool. The three legs are pension income, Social Security and personal investment income. When all three are strong, the stool is stable. When one is short or missing, the other two have to carry more weight. Understanding each leg, and what to do if one is missing, is the foundation of a sound retirement plan.
The First Pillar: Pension Income
A traditional pension, also called a defined benefit plan, pays a set monthly income for life based on your salary and years of service. For earlier generations it was a common benefit. Today far fewer private employers offer one, and most have shifted to defined contribution plans such as 401(k)s, which move the responsibility for saving and investing onto the employee.
If you do have a pension, the key decisions usually come at retirement: whether to take a lump sum or monthly payments, and whether to choose a survivor option that keeps paying your spouse after you die. Those choices are often permanent, so they deserve careful comparison.
The Second Pillar: Social Security
Social Security provides an inflation-adjusted income for life, but it was never meant to cover everything. A popular rule of thumb is that you will need about 80% of your pre-retirement income in retirement, and for an average earner Social Security replaces only about half of that.
When you claim makes a large difference. For people born in 1960 or later, full retirement age is 67. Claiming as early as 62 permanently reduces your benefit, by up to about 30%. Waiting past full retirement age increases it by 8% for each year you delay, up to age 70. For married couples, the higher earner’s decision also affects the benefit the surviving spouse will receive. You can see your own estimates by creating an account on the Social Security Administration’s website. Our article on Social Security tips for couples covers the joint decision.
The Third Pillar: Personal Investment Income
The third leg is what you save yourself, in 401(k)s, IRAs, brokerage accounts and other investments. It is the most flexible pillar and, for most people today, the one doing the most work. Investments can provide dividends, interest and growth, and a well-planned withdrawal strategy turns them into a reliable paycheck. How they are invested, and in which accounts, affects both how long they last and how much tax you pay along the way.
When One Pillar Is Missing
Not everyone has access to all three. Many workers have no pension, and some people have gaps in their Social Security record. When a leg is missing, the plan has to substitute for it. That might mean saving more, working a few years longer, delaying Social Security to increase the guaranteed income, or using part of your savings to buy an annuity that works like a personal pension. Each option has trade-offs in cost, flexibility and what is left for heirs.
Working out the right substitute starts with a needs analysis: what you will spend, what income you can count on and where the gaps are. From there we build a plan that shows the strengths and weaknesses of each approach so you can choose with confidence.
Build a Plan That Lasts
A retirement income plan should be built for flexibility and durability, because this is a business of variables. Markets, tax laws, health and family circumstances all change. Once the three pillars are in place, the next step is to test them against those changes, which we cover in How to Stress-Test Your Retirement Plan. For an overview of every part of the process, see our retirement planning page, or call our Wallingford office at 203-949-1710.
This article is for general information only and is not individualized investment, tax or legal advice.