Traditionally, retirement income has been described as a “three-legged stool” comprised of Social Security, traditional employer pension income, and individual savings and investments. With fewer and fewer individuals covered by traditional employer pensions, though, the analogy doesn’t really hold up well today.

Social Security retirement income

Today, about 93% of U.S. workers are covered by Social Security.1 The amount of Social Security retirement benefit that you’re entitled to is based on the number of years you’ve been working and the amount you’ve earned. Your benefit is calculated using a formula that takes into account your 35 highest earning years.

Social Security Full Retirement Age

Source: Social Security Administration

The earliest that you can begin receiving Social Security retirement benefits is age 62. If you decide to start collecting benefits before your full retirement age (which ranges from 66 to 67, depending on the year you were born), there’s a major drawback to consider: Your monthly retirement benefit will be permanently reduced. In fact, if you begin collecting retirement benefits at age 62, each monthly benefit check will be 25% to 30% less than it would be at full retirement age. The exact amount of the reduction will depend on the year you were born. (Conversely, you can get a higher payout by delaying retirement past your full retirement age — the government increases your payout every month that you delay retirement, up to age 70.)

If you begin receiving retirement benefits at age 62, however, even though your monthly benefit is less than it would be if you waited until full retirement age, you’ll end up receiving more benefit checks. For example, if your normal retirement age is 66, if you opt to receive Social Security retirement benefits at age 62, you’ll receive 48 additional monthly benefit payments.

The good news is that, for many people, Social Security will provide a monthly benefit each and every month of retirement, and the benefit will be periodically adjusted for inflation. The bad news is that, for many people, Social Security alone isn’t going to provide enough income in retirement. For example, according to the Quick Calculator on Social Security’s website, an individual born in 1954 who currently earns $100,000 a year can expect to receive approximately $26,184 annually at full retirement age, which in this case would be age 66. Of course, your actual benefits will depend on your work history, earnings, and retirement age. The point is that Social Security will probably make up only a portion of your total retirement income needs.

Traditional employer pensions

If you’re entitled to receive a traditional pension, you’re lucky; fewer Americans are covered by them every year. If you haven’t already selected a payout option, you’ll want to carefully consider your choices. And, whether or not you’ve already chosen a payout option, you’ll want to make sure you know exactly how much income your pension will provide, and whether or not it will adjust for inflation.

In a traditional pension plan (also known as a defined benefit plan), your retirement benefit is generally an annuity, payable over your lifetime, beginning at the plan’s normal retirement age (typically age 65). Many plans allow you to retire early (for example, at age 55 or earlier). However, if you choose early retirement, your pension benefit is actuarially reduced to account for the fact that payments are beginning earlier, and are payable for a longer period of time.

If you’re married, the plan generally must pay your benefit as a qualified joint and survivor annuity (QJSA). A QJSA provides a monthly payment for as long as either you or your spouse is alive. The payments under a QJSA are generally smaller than under a single-life annuity because they continue until both you and your spouse have died.

Your spouse’s QJSA survivor benefit is typically 50% of the amount you receive during your joint lives. However, depending on the terms of your employer’s plan, you may be able to elect a spousal survivor benefit of up to 100% of the amount you receive during your joint lives. Generally, the greater the survivor benefit you choose, the smaller the amount you will receive during your joint lives. If your spouse consents in writing, you can decline the QJSA and elect a single-life annuity or another option offered by the plan.

The best option for you depends on your individual situation, including your (and your spouse’s) age, health, and other financial resources. If you’re at all unsure about your pension, including which options are available to you, talk to your employer or to a financial professional.

Personal savings

Most people are not going to be able to rely on Social Security retirement benefits to provide for all of their needs. And traditional pensions are becoming more and more rare. That leaves the last leg of the three-legged stool, or personal savings, to carry most of the burden when it comes to your retirement income plan.

Your personal savings are funds that you’ve accumulated in tax-advantaged retirement accounts like 401(k) plans, 403(b) plans, 457(b) plans, and IRAs, as well as any investments you hold outside of tax-advantaged accounts.

Until now, when it came to personal savings, your focus was probably on accumulation — building as large a nest egg as possible. As you transition into retirement, however, that focus changes. Rather than accumulation, you’re going to need to look at your personal savings in terms of distribution and income potential. The bottom line: You want to maximize the ability of your personal savings to provide annual income during your retirement years, closing the gap between your projected annual income need and the funds you’ll be receiving from Social Security and from any pension payout.

Some of the factors you’ll need to consider, in the context of your overall plan, include:

• Your general asset allocation: The challenge is to provide, with reasonable certainty, for the annual income you will need, while balancing that need with other considerations, such as liquidity, how long you need your funds to last, your risk tolerance, and anticipated rates of return.
• Specific investments and products: Should you consider an annuity? Bonds? What about a mutual fund that’s managed to provide predictable retirement income (sometimes called a “distribution” mutual fund)?
• Your withdrawal rate: How much can you afford to withdraw each year without exhausting your portfolio? You’ll need to take into account your asset allocation, projected returns, your distribution period, and whether you expect to use both principal and income, or income alone. You’ll also need to consider how much fluctuation in income you can tolerate from month to month, and year to year.
• The order in which you tap various accounts: Tax considerations can affect which accounts you should use first, and which you should defer using until later. Required minimum distributions (RMDs): You’ll want to consider up front how you’ll deal with required withdrawals from tax-advantaged accounts like 401(k)s and traditional IRAs, or whether they’ll be a factor at all. After age 70½, if you withdraw less than your RMD, you’ll pay a penalty tax equal to 50% of the amount you failed to withdraw.

Other sources of retirement income

If you’ve determined that you’re not going to have sufficient annual income in retirement, consider possible additional sources of income, including:

• Working in retirement: Part-time work, regular consulting, or a full second career could all provide you with valuable income.
• Your home: If you have built up substantial home equity, you may be able to tap it as a source of retirement income. You could sell your home, then downsize or buy in a lower-cost region, investing that freed-up cash to produce income or to be used as needed. Another possibility is borrowing against the value of your home (a course that should be explored with caution).
• Permanent life insurance: Although not the primary function of life insurance, an existing permanent life insurance policy that has cash value can sometimes be a potential source of retirement income. (Policy loans and withdrawals can reduce the cash value, reduce or eliminate the death benefit, and can have negative tax consequences.)

What if you still don’t have enough?

If there’s no possibility that you’re going to be able to afford the retirement you want, your options are limited:

1. Postpone retirement: You’ll be able to continue to add to your retirement savings. More importantly, delaying retirement postpones the date that you’ll need to start withdrawing from your personal savings. Depending on your individual circumstances, this can make an enormous difference in your overall retirement income plan.
2. Reevaluate retirement expectations: You might consider ratcheting down your goals and expectations in retirement to a level that better aligns with your financial means. That doesn’t necessarily mean a dramatic lifestyle change — even small adjustments can make a difference.

1 “Fact Sheet on the Old-Age, Survivors, and Disability Insurance Program,” Social Security Administration, December 2018

According to the Social Security Administration (SSA), approximately 71% of Americans elect to receive their Social Security benefits early. (Source: SSA Annual Statistical Supplement, 2017, released March 2018)

Your pension plan must provide you with an explanation of your options prior to retirement, including an explanation of your right to waive the QJSA, and the relative values of any optional forms of benefit available to you.