The economic impact of COVID-19 has been felt around the world. And, unfortunately for many pre-retirees, it could potentially impact your Social Security benefits as well. Social Security benefits are calculated by averaging 35 years of your highest earnings.1 But before final calculations are made, and to accommodate for economic changes, your earnings are adjusted by examining the National Average Wage Index two years before your retirement.2 To clarify, if retired in 2020, adjustments would be made based on the average from 2018.
Therefore, the economic downturn of 2020 creates some potential problems for pre-retirees. The average income would have fallen, meaning those that choose to retire in 2022 would see a lifelong reduction in Social Security benefits, compared to previous years. However, Social Security is not the only source of retirement income. There are a few options one can consider to supplement the potential difference.
Option #1: Individual Retirement Accounts
There are two types of Individual Retirement Accounts, or IRAs, to choose from - traditional IRAs and Roth IRAs. If you’ve had these accounts set up for some time and made contributions regularly, then the potential growth of these accounts could make up for Social Security reductions. However, there are a few things about your IRAs to consider toward retirement.
Contributions you make to a traditional IRA may be fully or partially deductible, depending on your individual circumstances. In most cases, once you reach age 72 you must begin taking required minimum distributions from your IRA. Withdrawals from traditional IRAs are taxed as ordinary income and, if taken before age 59 1/2, may be subject to a 10 percent federal income tax penalty.3 You may continue to contribute to a traditional IRA past age 70 1/2 as long as you meet the earned-income requirement.4
Roth IRAs differ from traditional IRAs because contributions are made with after-tax dollars. This means that Roth IRA contributions do not lower your yearly taxable income, but withdrawals made in retirement are tax-free.
To qualify for the tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59 1/2. Tax-free and penalty-free withdrawals also can be taken under certain other circumstances, such as a result of the owner’s death. The original Roth IRA owner is not required to take minimum annual withdrawals. Lastly, high-income taxpayers may have a lower contribution cap, or cannot contribute to a Roth IRA at all, depending on their yearly income and tax-filing status.5
Option #2: Defined Contribution Plans
If your employer offers a defined contribution plan, such as a 401(k), 403(b) or 457 plan, the accumulated income in these accounts could supplement Social Security, especially if this amount has had time to grow.
Be aware that distributions from a defined contribution plan are taxed as ordinary income unless they are Roth 401(k) or 403(b) accounts. Individuals are required to take minimum distributions at age 72, and any distributions before age 59 1/2 are subject to a 10 percent tax penalty.
Option #3: Defined Benefit Plans
Though not as common as they used to be, pensions are a common type of defined benefit plans. Benefits established by an employer take into account work history and salary to determine benefits.
Option #4: Personal Savings
Your personal savings could be used to help make up the difference in Social Security benefits. Funds tucked away in a savings account may be used to purchase more long-term options, such as an annuity. What works best for each individual will depend on their situation. If your savings will become your main source of Social Security supplementation, then consider consulting a financial advisor who can help you determine a long-term, more sustainable solution.
Option #5: Continued Employment
Unfortunately for some retirees and pre-retirees, if Social Security does not help make ends meet, and the above options are not available or don’t provide enough benefits, then it may be time to consider postponing your retirement. The good news though, is that working while collecting Social Security could potentially increase your benefit amount.6
Having multiple sources of income in retirement is important. But if Social Security is your primary source of income, then a reduction in benefits will certainly be challenging. Using the list above, one can consider their options to prepare appropriately. Remember to consult a financial advisor for more guidance and to receive an approach tailored to your financial situation.
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Beirne Wealth Consulting Services, LLC (“BWC”) is a privately owned, SEC Registered Investment Advisor with offices in Connecticut and Pennsylvania. BWC provides independent, fee-based investment management services and customized financial planning solutions. Our institutional business provides consulting expertise to defined benefit and defined contribution plans, endowments, foundations and non-profit organizations. Our private clients include high net-worth individuals and prominent families, many of whom bring complex wealth management challenges and multigenerational planning needs. For more information, please visit www.beirnewealth.com or give us a call today at 888-231-6372.
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