Why You Need to Check the Quality of Your Retirement Income

Last Updated Jun 11, 2010 10:06 AM EDT

When you look at projections from an online calculator, $1,000 of monthly income from Social Security looks the same as a $1,000 withdrawal from your 401(k) plan that is invested in Mongolian hi-tech startups. But you'll notice that there are significant differences in the reliability of these incomes. Below is a checklist for the quality of retirement income; the more items you can answer with a "yes," the higher the reliability and ability to withstand various economic challenges.

  • Is the income guaranteed by a reliable institution to be paid for the rest of your life, no matter how long you live? Such income sources include Social Security, pensions, and lifetime annuities.
  • Will the income continue to your spouse or other dependents after you die? Such sources include Social Security and, if you make the appropriate elections, pensions and lifetime annuities.
  • Does your income remain unchanged if there's a market downturn? Again, Social Security, pensions, and annuities fit this criteria. Investments in high quality bonds might also meet this criteria.
  • Does your income increase for inflation? Social Security satisfies this criteria. Most pensions do not. You can buy inflation protection with an immediate lifetime annuity, but that costs you more.
  • Does your income increase if you achieve good investment performance? Social Security, pensions, and fixed annuities don't fit this criteria, but withdrawals from invested retirement savings can.
  • Can you change the amount of retirement income along the way? Once again, Social Security, pensions, and fixed annuities don't meet this criteria, but withdrawals from retirement savings do, as do some annuities that have withdrawal features.
  • Does your income have special tax advantages? For many people, Social Security income is not taxed or is taxed at reduced rates. Assets sheltered by 401(k) plans and IRAs are sheltered from taxes until withdrawn. Income outside these sources can have tax advantages if you make the right choices; examples include income generated by capital gains or qualified dividends, municipal bonds, and index funds.
The best conclusion you can draw from this post is to increase the quality of your retirement income as much as possible, and to diversify your sources of it. These actions will help you sleep at night and focus on what's really important for your retirement years.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.