As Boy Scouts, my kids love their Swiss Army knives. They use them for everything and always take them camping. These all-purpose tools have a knife, file, screwdriver, scissors, tweezers, bottle opener, and more.
As you are planning for retirement, you may find you have a Swiss Army knife full of accounts, each with different functions. They all hold a unique place in your retirement plan.
Here are some of the different components that you may find in your retirement strategy.
Social Security
Social Security is the social welfare and insurance program managed by the U.S. federal government and funded by employee taxes. It issues retirement benefits as early as age 62, with the amount increasing on a yearly basis.
These benefits vary based on the number of years you work and contribute to Social Security, your salary during those years, and the age at which you opt into receiving the benefits.
Think of this as the main knife in your set. Most everyone will receive Social Security as a base for their retirement income.
Pension
Pensions are work-sponsored retirement funds accumulated from employer and employee contributions over the course of employment. The employer decides how to invest these funds and essentially guarantees a portion for the employee when they retire.
During retirement, pensions distribute either one lump sum or a monthly income using a formula based on an employee’s salary and years of service to a company.
Kind of like the scissors in a pocketknife, some people have them and some don’t. If you have a pension, it’s great!
That’s an extra layer of guaranteed income that you can count on.
Employer-Sponsored Retirement Plan
Corporations offer 401(k)s while public schools and tax-exempt organizations offer 403(b)’s. The three-digit numbers are based on the IRS code and refer to employer-sponsored retirement plans and both an employer and employee can contribute.
Unlike pensions, an employee gets a say with their 401(k) or 403(b)’s investment decisions and can choose from a specified list of stocks and bond mutual funds. These days, more and more companies, especially those in the private sector, offer 401(k)s instead of pension plans.
Think of these accounts as the Phillips head screwdriver. They serve a great purpose and are amazingly useful. Sometimes, they have hidden fees and they offer limited investment choices, or your employer may not offer a retirement plan. So they only work in certain circumstances.
Individual Retirement Account (IRA)
Individual retirement accounts (IRAs) are a type of savings account used for retirement planning.
You can set these up with a bank or brokerage firm and invest in your choice of stocks, mutual funds, bonds, and cash. It’s worth noting that there are different types of IRAs, but the most often talked about are the traditional and Roth IRAs, each of which come with their own tax benefits.
Unlike work-sponsored retirement accounts, IRAs have lower annual contribution limits.
Think of an IRA as your combination flathead screwdriver / bottle opener / wire stripper – it serves triple duty.
You get tax deferral on the growth and either tax deferral on the contribution or distribution (not both). Also, you get to control the investments that go in it, so you can choose the most cost-effective funds that suit your goals.
Regular Savings
Regular savings accounts are interest-paying bank accounts intended for both short- and long-term saving. We mostly think of these accounts as a vehicle for emergency expenses.
While withdrawing early from IRAs and other retirement-specific accounts can result in costly tax penalties, withdrawing from a savings account poses no such risk—though there’s often a limit to the number of free withdrawals you can make in a month.
Compared to other retirement tools, bank savings accounts have fairly low returns, with an average interest rate of 0.08 percent.
Savings accounts are the small knife. Useful for just about anything, easily accessible, and frequently accessed.
Rental Income
Owning real estate can go far in helping fund retirement. Not only does rental income provide a steady cash flow, but there are also a number of tax deductions available for landlords.
However, real estate investing can be challenging because it involves financial management, property upkeep, and tenant rental logistics. On top of that, mortgage payments, property taxes, maintenance costs, and other fees make it a “capital-intensive” investment—in other words, it isn’t cheap.
Just like the combination small flathead screwdriver / can opener, rental income not only helps your budget with current income but also looks to gain value the longer you hold it.
Health Savings Account (HSA)
Available to people covered under high-deductible health plans, health savings accounts (HSA) are funds set aside specifically for medical expenses. Employers and employees make tax-deductible contributions to these accounts, and withdrawals are tax-free so long as the money goes towards approved healthcare costs, like hospital fees and dental care.
HSAs aren’t necessarily intended for retirement, but they’ve become a useful retirement tool given their tax benefits.
You know that little round keychain piece on the knife? The one that nobody uses? That’s what this is. It may be there or it may not be there. Either way, it gets neglected.
Annuities
An annuity is an insurance contract, not an actual investment. You agree to pay the insurance company and they agree to issue you regular payments or one lump sum of money during retirement.
Buyers set their payout period so that they can expect to receive payments for a set number of years or for the rest of their lifetime. These accounts generally come at a hefty cost, though, with high annual fees and broker commissions.
This is the hook. Literally. That hook in your Swiss Army knife that you can never get out. You can’t open it, therefore you really don’t know what the tool is, what it does, or how it works. The hook can hold up to 200 lbs if it’s used correctly, and annuities can be used correctly. Often, though, they are not.
The tools on a Swiss Army knife are valued differently by different users. In much the same way, these different retirement tools may not be the best fit for everyone. For instance, not everyone has rental property that can be used to generate income.
Regardless, it’s a good idea to create diversified retirement sources that include more than Social Security and savings from your income. You wouldn’t use a Swiss Army knife for just one tool, after all. Take advantage of your different retirement planning options to optimize your retirement security.
Could you use a hand in utilizing all of the tools in your Swiss Army knife retirement plan? Let’s talk! Click here to schedule a complimentary intro meeting to get started.
Pathfinder Planning LLC provides personal financial planning advice and asset management for a simple fee to young adults and working families in North and South Carolina through group classes, one-on-one planning, and ongoing advice.
Your Financial Mom blog posts are not meant to be legal, accounting or other professional service advice. Content represents the opinion of the author only. Pathfinder Planning LLC is not responsible for the accuracy or validity of content contained in third-party comments.