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Are you planning for retirement? It may not seem urgent if you're young, but the earlier you start, the better prepared you'll be. Early planning allows you to harness the power of compound interest, where your investments grow exponentially over time. Even small contributions made early on can significantly boost your retirement savings.

Understanding where your retirement income will come from is an excellent first step in the planning process.

Sources of Retirement Income

401(k) Plans

A 401(k) plan through your employer is a wise choice, as it allows you and your employer to contribute to your retirement savings. According to the Department of Labor, nearly 60% of eligible workers participate in 401(k) plans.

With a 401(k) plan, you can save and invest a portion of your paycheck before taxes are taken out. The money in your 401(k) grows tax-deferred, meaning you will only pay taxes on it once you withdraw it in retirement. The sooner you start contributing to a 401(k), the more time your money has to grow.

Here’s how it works: You elect to have a portion of each paycheck deposited directly into your 401(k) before taxes are deducted. This reduces your current taxable income and allows that money to grow over time.

Many employers offer a matching contribution. This is free money that can significantly accelerate your retirement savings. Matching typically works on a percentage basis, such as 50% or 100% of your contributions, up to a specific limit. For example, if your employer matches 50% of your contributions up to 6% of your salary, and you contribute 6%, they’ll add another 3%. It’s the simplest and most effective way to boost your retirement savings.

How much should you invest? You’ll want to contribute enough to take full advantage of any employer match available. This is the easiest way to maximize your retirement savings. Even beyond that, consider increasing your contributions as your income allows. 

Thanks to the magic of compound interest, even small contributions can make a big difference over time. This is when your investment earnings generate additional earnings, creating a snowball effect. For instance, if you invest $5,000 annually with an average return of 7%, after 30 years, you could have over $432,000.

Individual Retirement Account (IRA)

IRAs are a popular choice for retirement savings and offer flexibility and tax advantages. There are two main types: traditional IRAs and Roth IRAs. Each has unique benefits, depending on your financial situation.

Traditional IRA

Contributions: You contribute pre-tax dollars, which lowers your taxable income in the year of contribution.
Tax benefits: Your investments grow tax-deferred, meaning you won't pay taxes on the earnings until you withdraw the money in retirement.
Withdrawals: Distributions are taxed as ordinary income when taken in retirement.

Roth IRA

Contributions: You contribute after-tax dollars, so you won't get an immediate tax deduction.
Tax benefits: Your investments grow tax-free, and qualified withdrawals in retirement are not subject to income taxes.
Withdrawals: You can withdraw your contributions at any time without taxes or penalties. However, withdrawals before age 59 and 1/2 may be subject to taxes and a 10% penalty.

Deciding between a traditional and a Roth IRA depends on several factors, including your current income and tax brackets, your retirement goals, and what other retirement savings you have, such as a 401(k). The experts at American Heritage’s Investment & Retirement Center (IRC) can offer guidance and help you find the best options for your individual situation.

Social Security

Created in the 1930s, Social Security provides a crucial foundation of retirement income for many Americans, acting as a safety net for their golden years. Funded through dedicated payroll taxes paid by both employees and employers, it ensures a steady stream of income for eligible retirees based on their lifetime earnings.

You can begin claiming Social Security benefits as early as age 62. However, your benefits will be reduced if you claim before your full retirement age (FRA), which varies depending on the year you were born. If you were born in 1960 or later, the FRA is 67. If you delay claiming benefits past your FRA, your monthly payments will increase up to age 70. This strategy can be beneficial if you want to maximize your monthly income.

The amount you receive from Social Security depends on your earnings history and the age at which you claim benefits. The Social Security Administration provides online tools to help you estimate your benefits at different ages. 

While Social Security provides a steady stream of income, it’s typically not enough to cover all your retirement expenses. That’s why it’s important to supplement your Social Security benefits with savings from other sources, such as your 401(k) and IRAs.

Other Sources of Retirement Income

Annuities

Annuities allow you to receive a steady income, starting now or during retirement. Here’s how annuities work: You pay a lump sum or a series of payments to an insurance company, and in return, they agree to make regular payments to you for a specified period or for the rest of your life. Certain annuities even give you the option to grow your money first. With annuities, you can manage, defer, and reduce taxes. Our American Heritage advisors can walk you through your options and help you manage your annuities.

Part-Time Work

Many retirees continue to work part-time in retirement, either for extra income or to stay active and engaged. This can be a great way to supplement your retirement savings and delay tapping into retirement funds.

Rental Property

If you own real estate, renting out a property can provide passive income in retirement, but you’ll want to weigh the potential benefits against the responsibilities of being a landlord, which include managing tenants, property upkeep, and legal compliance.

Your Home

Your home is a significant asset that can be leveraged for retirement income. You may want to downsize to a smaller, more affordable home and use the proceeds to supplement your savings. Or, if you are 62 or older, you might consider a reverse mortgage, which lets you borrow against the equity in your home and receive payments. Our mortgage advisors can guide you through the pros and cons of downsizing and reverse mortgages, answering any questions you have, and helping you make an informed decision.

Taking the Next Step

Retirement is a significant financial milestone and requires careful planning and preparation. The experts at American Heritage Credit Union are here to help. Our financial advisors can provide personalized guidance tailored to your unique financial situation and goals so you can plan your retirement with confidence. Why wait? Contact us today to get started.