The Key Types of Retirement Income

Key sources of retirement income

As you plan and save for your retirement, consider the different sources from which you might draw income streams: 

Social Security benefits

The Social Security Administration benefit is one of the most common sources of retirement income for retirees. Social Security provides monthly payments to eligible retirees, based on your own or your spouse’s work history. The amount of your monthly benefit is based on your (or your spouse’s) earned income during your career, and the age you start receiving Social Security benefits. Although you can start receiving payments at the age of 62, you may benefit from waiting until you reach the full retirement age of 67, or beyond. 

You can use the Social Security calculator to enter your age, earnings and anticipated retirement date to estimate how much you'll receive in monthly Social Security benefits. 

Pensions and employer-sponsored retirement plans 

Depending on your employer, you may have access to a defined-benefit pension (an increasingly rare retirement benefit) or a defined-contribution retirement plan like a 401(k) or a 403(b). 

With a pension plan, your employer commits to giving you regular monthly payments for the entirety of your retirement based on your years of service. These plans provide fixed, reliable payments. 

Employer-sponsored defined-contribution plans like 401(k) plans work differently. These retirement savings plans are investment accounts funded with pre-tax dollars. If your employer offers a traditional 401(k) plan, your contributions and investment growth – and any matching funds from your employer – are not taxed. When you take distributions from these accounts in retirement, you will pay income tax at the ordinary rate for your income level. While not true in every worker’s case, conventional wisdom is that your retirement income will be lower than the income you earned when you were working, thus resulting in lower taxes, too. 

A growing number of employers also offer Roth 401(k)s, which are funded with after-tax dollars. While you don’t get the immediate benefit of lowering your taxable income with your contributions, money put into a Roth 401(k) can grow, tax-free, and your withdrawals in retirement are not taxed.

Some employers match retirement contributions up to a certain level. For example, an employer might offer a dollar-for-dollar match on your contributions up to 3% of your salary. But the big disadvantage with 401(k)s compared with defined-benefit pensions is that you're responsible for choosing the investments you make, and your retirement balance will depend both on how much you contribute and on how your investments perform. 

IRAs and Roth IRAs

An IRA is a type of investment account you can use to save for retirement. You can think of it as being like a 401(k) that isn’t connected to an employer. 

There are two main kinds: traditional and Roth. Traditional IRAs are funded with pre-tax dollars. As with traditional 401(k)s, your investments grow, tax-deferred, and your withdrawals are taxed at your ordinary income tax rate in retirement. Annual contribution limits for IRAs are lower than for 401(k)s.

Roth IRAs have contribution limits and income limitations established by the IRS. These accounts are funded by after-tax dollars, but growth is tax-free and qualified withdrawals you make in retirement are tax-free, as well. 

Annuities

An annuity is a contract type sold by some insurers. It provides guaranteed retirement income, similar to a traditional defined-benefit pension. You can pay for an annuity via monthly premiums or a lump-sum payment (such as if you receive a payout from a life insurance policy).

Other ways to supplement your retirement income

Besides your primary sources of retirement income, there are other tools and strategies you can use to potentially increase your income in retirement: 

Taxable brokerage accounts

Retirement investment accounts like IRAs and 401(k)s have some restrictions. Since they're intended for retirement, you will be penalized for withdrawing money early (in most cases, before you reach the age of 59 ½). Any such withdrawals count as taxable income, and you'll pay an additional 10% early-withdrawal penalty. 

If you want more flexibility and control, a taxable investment account can be a smart supplement. While individual brokerage accounts lack the tax advantages of retirement accounts, you can withdraw money at any time without incurring a penalty. 

Depending on your investment strategy and which investment options you choose — stocks, bonds, mutual funds or exchange-traded funds (ETFs) — you have the potential to grow your money through capital gains, compound interest, dividend payments or some combination of those. 

Real estate and rental income

Rental properties — both long-term and short-term rentals — can potentially yield a stable source of income to supplement your retirement savings and earned benefits. However, rental properties come with the need to be managed. They require regular maintenance, and you’ll need to budget for expected and unexpected repairs, property taxes and insurance. It’s important to weigh the pros and cons before investing in property. 

Savings accounts and CDs

Savings accounts and certificates of deposit (CDs) are types of deposit accounts you can open with a bank or credit union. They pay interest, which helps your money grow. But they’re also not tax-deferred, so you pay taxes on your CD earnings each year. These types of accounts are covered by the Federal Deposit Insurance Corporation (FDIC), which guarantees bank deposits up to $250,000 per account owner and ownership category. This means there's no risk of losing money like you could face if you invest in the stock market. 

However, interest rates on these accounts tend to be lower than what you might be able to earn from investments, so financial advisors generally advise using them only as a complement to a broader retirement plan. 

Part-time work in retirement

Some retirees opt to work part-time or seasonally to supplement their retirement income. While this approach can help you stretch your savings, keep in mind that working in retirement can reduce your Social Security payments if you retire before your full retirement age. You may also pay more for certain Medicare benefits. If you want to continue working in retirement, consider meeting with a certified financial planner to discuss your situation and what makes the most sense for you. 

Building a reliable retirement income plan

You can fund your retirement in various ways. As discussed above, some of the most common retirement income streams are Social Security, pensions and investment accounts. The latter can include employer-sponsored defined-contribution accounts such as traditional 401(k)s and individual retirement accounts (IRAs), and post-tax accounts such as Roth IRAs and 401(k)s. 

Other options for meeting your financial needs in retirement include savings and investments in the market or real estate. You also may plan to continue working, possibly on a part-time basis, in your later years. When determining which combination of income streams will fit your lifestyle and financial goals best, there are a couple of other strategic points to consider.

Diversify your income sources

Diversification allows you to balance growth potential, risk and volatility. Combining different sources of income, such as Social Security plus IRA distributions, provides you with a strong safety net, helping to protect your finances from inflation and market shifts. Having savings in both tax-preferred and taxable accounts gives you additional flexibility. That’s especially the case once you reach the age at which the IRS mandates that you begin withdrawing required minimum distributions (RMDs) from tax-deferred retirement accounts. For people born after 1959, RMDs kick in once you reach age 73. 

Protect your finances with guaranteed income

Your retirement income will likely come from a mix of defined-contribution sources like a 401(k) or IRA and guaranteed income streams like Social Security. Especially as defined-benefit pensions become more rare, other options that deliver a guaranteed payment, like annuities, can help you mitigate risk. 

Some income sources, such as annuities, can give you the option of a lump-sum payout or fixed installment payments. When determining the best choice for you, consider your health, lifestyle and financial goals. Monthly payments offer steady cash flow that can help with budgeting, whereas a lump sum may give you more flexibility (while requiring more disciplined management).