Sources of Retirement Income
Picture your grandparents at 70. They no longer have a paycheck from a full-time job. So where does the money for rent, food, and doctor visits come from? And if you start working at 18 and retire at 65, how much of that money will you need to build yourself?
The three main sources
Retirement income usually comes from several places at once. Financial planners often call this a "three-legged stool": if one leg is short, the stool wobbles.
| Source | Who provides it | Examples |
|---|---|---|
| Government | Federal government | Social Security retirement benefits |
| Employer | Your employer | 401(k) with a match, a traditional pension |
| Personal investments | You | Roth IRA, traditional IRA, savings, brokerage account |
| Work | You, after "retiring" | Part-time job, consulting |
Social Security was never meant to be your only source. The SSA's average retired-worker benefit is roughly $\$1{,}900$ per month (a rounded figure that changes over time). That is about $\$22{,}800$ a year: $1{,}900 \times 12 = 22{,}800$. Many households spend more than that.
Classify each as a source of retirement income provided by the government, by an employer, by personal investments, or by work: (a) Social Security benefits; (b) a…
Classify each as a source of retirement income provided by the government, by an employer, by personal investments, or by work:
(a) Social Security benefits;
(b) a 401(k) with employer contributions;
(c) a traditional pension;
(d) a Roth IRA the person opened;
(e) a part-time job after age 65.
Suppose the average retired worker receives about $\$1{,}900…
Suppose the average retired worker receives about $\$1{,}900$ per month from Social Security (a rounded figure). Calculate the yearly amount. Is this likely to cover all expenses for most retirees? Explain briefly.
Employer plans and the match
Many employers offer a 401(k). You choose a percent of each paycheck to contribute, and the money goes in before you ever see it. Often the employer adds a match: free money for contributing.
Matches come in different shapes. Compare these two for someone who earns $\$48{,}000$ a year:
| Plan A | Plan B | |
|---|---|---|
| Match rate | 100% | 50% |
| Matched up to | 4% of pay | 6% of pay |
If you contribute 4% ($\$1{,}920$) |
match = $\$1{,}920$ |
match = $\$960$ |
If you contribute 8% ($\$3{,}840$) |
match stops at 4%: $\$1{,}920$ |
match stops at 6%: 50% of $\$2{,}880$ = $\$1{,}440$ |
Jayden earns $\$2{,}000…
Jayden earns $\$2{,}000$ per month. His employer matches his 401(k) contributions dollar for dollar up to 3% of his pay. He contributes 3% each month. Calculate his contribution, the employer's match, and the total deposited that month.
Valeria earns $\$48{,}000…
Valeria earns $\$48{,}000$ a year and compares two employers.
-
Plan A: matches 100% of contributions up to 4% of salary.
-
Plan B: matches 50% of contributions up to 6% of salary.
(a) Calculate the employer contribution under each plan if she contributes 4% of salary.
(b) Calculate the employer contribution under each plan if she contributes 8% of salary.
(c) Explain which plan is better and why contributing at least up to the match limit matters.
Jayden earns $\$50{,}000…
Jayden earns $\$50{,}000$. His employer matches 50% of his 401(k) contributions, up to 6% of salary. Consider contribution rates of 0%, 3%, 6%, and 10%.
(a) For each rate, calculate his contribution, the employer match, and the total deposited per year.
(b) Calculate the "instant return" (employer match divided by his contribution) at 3% and at 6%.
(c) Calculate the extra employer money gained by moving from 6% to 10%.
(d) Argue how he should prioritize contributions relative to other goals, such as paying off a high-interest credit card.
Personal investments and time
The third leg is the one you build yourself. A traditional IRA or Roth IRA is an account you open on your own. A brokerage account or plain savings also count. Your biggest helper is time.
The Rule of 72 estimates how long money takes to double: divide 72 by the annual percent return.
$$\text{years to double} \approx \frac{72}{\text{annual return in percent}}$$At 8% a year, money doubles about every $72 \div 8 = 9$ years.
Use the Rule of 72. An investment earns 8% a year, so it doubles about every 72 ÷ 8 = 9 years. Emma invests $\$5{,}000…
Use the Rule of 72. An investment earns 8% a year, so it doubles about every 72 ÷ 8 = 9 years. Emma invests $\$5{,}000$ at age 25 and does not add more. Her friend Marcus invests $\$5{,}000$ at age 34 and does not add more. Both plan to retire at 61.
(a) How many doublings does each investment have?
(b) Estimate the value at age 61 for each.
(c) Explain what this shows about personal investments as a retirement source.
Finding your income gap
How much do you need? Planners compare retirement income with pre-retirement pay using the replacement rate: the percent of your final pay that your retirement income replaces.
If the gap is larger than expected, you can save more, work longer, reduce spending, or delay claiming Social Security (a later start means a larger monthly benefit). Working part time after 65 also helps. It is a fourth, smaller source.
Priya's final salary before retirement is $\$60{,}000…
Priya's final salary before retirement is $\$60{,}000$ a year. Suppose Social Security replaces about 40% of that income, and she wants to replace 80% in total.
(a) Calculate her yearly Social Security income and her yearly income goal.
(b) Calculate the yearly gap that must come from other sources.
(c) If she plans to withdraw 4% of her savings each year, how large must her savings be to cover the gap?
Emma is 65. Her expected Social Security benefit is $\$1{,}900$ per month, and she has no pension. She has $\$420{,}000$ in a 401(k) and plans to withdraw 4% a year. Her…
Emma is 65. Her expected Social Security benefit is $\$1{,}900$ per month, and she has no pension. She has $\$420{,}000$ in a 401(k) and plans to withdraw 4% a year. Her monthly expenses are $\$4{,}200$. She can also work part time for 5 years and earn $\$800$ per month.
(a) Calculate her monthly income from the 401(k) and her total monthly income without work.
(b) Calculate the monthly shortfall with and without the part-time job.
(c) Evaluate two ways she could close the remaining gap, such as reducing expenses, working longer, or delaying benefits.
Back to the start: your grandparents' income likely comes from Social Security, perhaps a pension or 401(k), and savings. If you start at 18, you will need to build the employer and personal legs yourself, and the match plus decades of growth do most of the work.