What retirement income is and where it comes from

Retirement income is the money you live on after you stop working. It comes from several sources: money you saved yourself, employer pensions, Social Security, and sometimes part-time work or investments. Most people combine two or three of these sources rather than relying on just one.

The reason you need to understand where retirement income comes from is that each source has different rules about when you can take it, how much you get, and what happens if you take it early or late. A choice that makes sense for one source might cost you thousands of dollars with another. This guide explains how each major source works so you can see what you might have available.

Key Takeaways

  • Social Security is a government program that pays you a monthly amount based on your work history, and the amount you receive depends on the age you start taking it.
  • Employer pensions are less common now, but if you have one, it typically pays you a fixed monthly amount for life once you reach a certain age.
  • Money you save yourself — in regular savings accounts, IRAs, or 401(k)s — is yours to use whenever you want, but some accounts charge you a penalty if you withdraw before age 59½.
  • The order in which you withdraw from different sources matters financially, because some withdrawals trigger taxes on other income sources.
  • You do not have to stop working completely to receive retirement income, and part-time work can reduce how much you need from savings or Social Security.

Social Security: how the monthly payment works

Social Security is a federal program that pays you a monthly amount based on how much you earned during your working years. You become may be able to access to receive it once you reach a certain age and have worked long enough to earn credits. The Social Security Administration keeps a record of your earnings history and calculates your payment based on that record.

The age you start taking Social Security directly affects how much you receive each month. If you start at age 62, your monthly payment is smaller than if you wait until age 67 or 70. The difference is permanent — if you take it early, you receive less every month for the rest of your life. If you delay, your monthly payment grows by roughly 8 percent per year until age 70. You can view your own earnings record and see an estimate of your future payment by creating an account on the Social Security Administration website.

Social Security is designed to replace part of your income, not all of it. The average monthly payment varies depending on your work history, but most people find they need other income sources alongside it. If you are married, you may have options about which spouse claims first and at what age, and those choices can affect the total amount your household receives over time.

Employer pensions: fixed monthly payments for life

An employer pension is a promise from your employer to pay you a set amount each month once you retire. Pensions are less common now than they were 20 years ago — many employers have shifted to 401(k) plans instead — but if you worked for a government agency, a large corporation, or a union job, you may have one.

With a pension, you typically become may be able to access to start receiving payments once you reach a certain age and have worked there for a certain number of years. The amount you receive is usually calculated using a formula that includes your salary and how long you worked there. Once you start receiving it, the payment stays the same each month (though some pensions adjust slightly for inflation). The payment continues for your entire life, and some pensions continue paying your surviving spouse after you die.

If you leave a job before you are may be able to access for the pension, you may lose it entirely, or you may be able to take a lump sum payment instead. The rules vary widely by employer. If you have a pension, your employer should have given you a summary document that explains when you become may be able to access and how the payment is calculated. If you cannot find it, contact your employer's human resources or benefits department.

Retirement savings accounts: money you control

Money you save yourself for retirement typically goes into one of two types of accounts: a 401(k) (offered by employers) or an IRA (Individual Retirement Account, which you open on your own). Both accounts let your money grow without being taxed on the earnings each year, which means your balance can grow faster than it would in a regular savings account.

The key difference between these accounts and a regular savings account is that they have rules about when you can withdraw the money. If you withdraw before age 59½, you usually have to pay a penalty of 10 percent of the amount you withdraw, plus income tax on it. There are some exceptions — hardship withdrawals, first-time home purchases, and certain medical expenses — but the general rule is that the money is meant to stay in the account until you are close to retirement age.

Once you reach age 59½, you can withdraw as much or as little as you want whenever you want, though you will owe income tax on the withdrawal. Starting at age 73, the government requires you to withdraw a minimum amount each year from most retirement accounts (this is called a Required Minimum Distribution). The amount depends on your age and your account balance. If you do not take out the required amount, you owe a penalty.

The money in these accounts is yours — if you die before you spend it all, it goes to whoever you named as your beneficiary. This is different from Social Security or a pension, which stop paying when you die (unless you chose a survivor option).

How taxes affect which income source you use first

The order in which you withdraw from different retirement income sources matters because some withdrawals can trigger taxes on other income. This is especially true with Social Security: if your total income (including half of your Social Security benefit) exceeds a certain threshold, you have to pay income tax on part of your Social Security. The threshold is $25,000 for a single person and $32,000 for a married couple filing jointly.

This means that if you are withdrawing from a 401(k) or IRA at the same time you are receiving Social Security, the withdrawal can push you over that threshold and cause your Social Security to become taxable. A financial advisor or tax professional can help you plan the order of withdrawals to minimize taxes, but the basic idea is that you might want to delay large withdrawals from retirement accounts until after you have claimed Social Security, or vice versa.

Some retirement accounts are taxed differently. A Roth IRA, for example, does not count toward the Social Security income threshold, so withdrawals from a Roth do not make your Social Security taxable. This is one reason some people choose to convert money from a regular IRA to a Roth IRA before they retire, though the conversion itself creates a tax bill in the year you do it.

Part-time work and other income sources

You do not have to stop working completely to receive retirement income. Many people work part-time in retirement, either because they want to stay active or because they need the extra money. If you are receiving Social Security before age 67, there is a limit on how much you can earn from work before your Social Security payment is reduced. Once you reach your full retirement age, you can earn as much as you want without affecting your Social Security.

Other income sources in retirement might include rental income from property you own, dividends or interest from investments, or income from a side business. Each of these is taxed differently and may affect your may be able to access for certain programs or the amount of Medicare you pay. If you are planning to have multiple income sources in retirement, a tax professional can help you understand the full picture.

Planning for retirement income across multiple sources

Most people in retirement receive income from at least two sources — often Social Security plus either a pension or withdrawals from savings. The combination that works best for you depends on your specific situation: how much you saved, whether you have a pension, your health and life expectancy, and how much money you need to live on.

One useful exercise is to write down what you think your monthly expenses will be in retirement, then list what income sources you expect to have and what each one will pay. If your income sources add up to more than your expenses, you are in a good position. If there is a gap, you know you need to either save more now, plan to work longer, or adjust your retirement spending plans.

You can request a Social Security statement online to see your earnings record and get an estimate of your future benefit. If you have an employer pension, ask your benefits department for a statement showing what your monthly payment would be at different retirement ages. For retirement savings accounts, you can see your current balance on your account statements. Putting these numbers together gives you a realistic picture of what you might have available.

Frequently Asked Questions

What happens to my retirement income if I die before I spend it all?

Social Security and pensions stop paying when you die (unless you chose a survivor option when you started). Money left in a 401(k) or IRA goes to whoever you named as your beneficiary — usually a spouse, adult child, or other family member. You name your beneficiary when you open the account, and you can change it anytime.

Can I receive Social Security and a pension at the same time?

Yes. However, if your pension is from a job where you did not pay Social Security taxes, a rule called the Windfall Elimination Provision may reduce your Social Security benefit. This rule does not explore to all pensions, so check with Social Security to see if it affects you.

What if I need to withdraw from my retirement account before age 59½?

You can withdraw, but you will owe a 10 percent penalty plus income tax on the amount. Some exceptions exist: first-time home purchase (up to $10,000 lifetime), medical expenses, disability, and certain hardships. You can also take substantially equal periodic payments without the penalty if you follow specific IRS rules.

How do I know if my Social Security estimate is accurate?

The estimate assumes you keep working and earning at roughly your current level until the age you plan to claim. If your earnings will be very different, or if you plan to stop working earlier, the estimate will be off. The Social Security Administration website lets you adjust your assumptions to see how different scenarios affect your benefit.

Do I have to claim Social Security at my full retirement age?

No. You can claim as early as age 62 or as late as age 70. The earlier you claim, the smaller your monthly payment. The later you claim, the larger it. There is no single "right" age — it depends on your health, how much you need the money, and your life expectancy.