How to Generate Income in Retirement

Generating income in retirement means shifting focus from regular paychecks to alternative financial streams. This transition requires careful planning to ensure a steady cash flow for daily expenses, healthcare, and leisure activities. Developing a diversified income strategy is important for maintaining financial security throughout retirement.

Maximizing Social Security and Pension Income

Social Security benefits form a foundational income source for many retirees, with the amount largely determined by an individual’s earnings history and the age at which they begin claiming benefits. Your benefit amount is based on your highest 35 years of earnings, adjusted for inflation. Claiming benefits before your full retirement age, which is between 66 and 67 depending on your birth year, results in a permanent reduction in monthly payments.

Conversely, delaying Social Security beyond your full retirement age can significantly increase your monthly benefit. Delayed retirement credits add 8% per year to your benefit, up until age 70, at which point no further credits are earned. For example, if your full retirement age is 67, delaying until age 70 could increase your monthly benefit by 24%.

Spousal benefits allow an eligible spouse to claim up to 50% of the higher-earning spouse’s full retirement age benefit. To qualify, the claiming spouse must be at least 62 years old, or caring for a child under age 16 or a child with a disability, and the worker must have already filed for their own benefits. If a spouse has their own work record, they will receive the higher of their own benefit or the spousal benefit.

Survivor benefits are available to eligible family members, including spouses, ex-spouses, and children, of a deceased worker who paid Social Security taxes. A surviving spouse can receive up to 100% of the deceased worker’s benefit if they claim at their full retirement age, or a reduced amount if claimed as early as age 60 (or age 50 if disabled). Eligibility typically requires the deceased worker to have accumulated sufficient Social Security credits.

Social Security benefits may be subject to federal income tax depending on your provisional income. For single filers, provisional income between $25,000 and $34,000 may result in up to 50% of benefits being taxable, while amounts above $34,000 can lead to up to 85% being taxed. For married couples filing jointly, these thresholds are $32,000 and $44,000, respectively.

Traditional pensions provide a regular income stream in retirement. These plans typically offer various payout options. A single life annuity provides payments for the retiree’s lifetime, ceasing upon their death.

A joint and survivor annuity offers payments for the retiree’s lifetime and then continues, often at a reduced percentage, for the life of a designated beneficiary, such as a spouse. Other options might include a period certain annuity, guaranteeing payments for a set number of years even if the retiree passes away sooner.

Generating Income from Investment Portfolios

Drawing income from accumulated investment portfolios is a significant component of retirement income planning. Tax-advantaged accounts like 401(k)s and IRAs offer different tax treatments upon withdrawal. Traditional 401(k)s and IRAs are funded with pre-tax contributions, meaning withdrawals in retirement are taxed as ordinary income.

Roth 401(k)s and Roth IRAs are funded with after-tax contributions, allowing qualified withdrawals in retirement to be entirely tax-free. To be a qualified withdrawal from a Roth account, the account must generally be open for at least five years and the account holder must be age 59½ or older, disabled, or using the funds for a first-time home purchase (up to $10,000 lifetime maximum). Withdrawals from Roth contributions are always tax and penalty-free.

Required Minimum Distributions (RMDs) mandate that account owners begin withdrawing funds from most traditional tax-deferred retirement accounts, including 401(k)s and IRAs, once they reach a certain age. For those born between 1951 and 1959, the RMD age is 73; for those born in 1960 or later, it is 75. The first RMD must be taken by April 1 of the year following the year the account holder reaches the RMD age, with subsequent RMDs due by December 31 each year.

Failing to take the full RMD can result in a penalty of 25% of the amount not withdrawn. While RMDs are required from traditional accounts, Roth IRAs are not subject to RMDs during the owner’s lifetime.

For those who retire or leave their job in the year they turn 55 or later, the “Rule of 55” allows penalty-free withdrawals from the 401(k) plan of their most recent employer. While the 10% early withdrawal penalty is waived under this rule, the withdrawals are still subject to ordinary income taxes.

Taxable investment accounts, such as brokerage accounts, generate income primarily through dividends, interest, and capital gains. Dividends from stocks are generally taxed at preferential long-term capital gains rates for qualified dividends, while interest from bonds and other debt instruments is taxed as ordinary income. Capital gains from selling assets are taxed differently based on the holding period.

Short-term capital gains, from assets held for one year or less, are taxed at ordinary income tax rates. Long-term capital gains, from assets held for more than one year, typically receive lower tax rates, ranging from 0% to 20% depending on your overall income.

Annuities offer a way to convert a portion of retirement savings into a guaranteed income stream. An annuity is a contract with an insurance company where you make a payment, either a lump sum or a series of payments, in exchange for regular disbursements. Immediate annuities begin payments soon after the initial premium is paid.

Deferred income annuities allow your money to grow tax-deferred for a period before payments begin at a future date. Annuities can provide a predictable income for a specified period or for the rest of your life, helping to mitigate the risk of outliving your savings.

Active and Asset-Based Income Strategies

Beyond traditional retirement income sources and investment portfolios, retirees can generate income through more active engagement or by leveraging tangible assets. Part-time work or consulting allows individuals to continue earning while maintaining flexibility. Many retirees find opportunities in their former professions, offering their expertise as consultants or freelancers.

This approach can provide a supplemental income stream, keep skills sharp, and offer social engagement. Online platforms and professional networks can facilitate finding part-time or consulting engagements. The income earned from such activities is typically subject to self-employment taxes and ordinary income tax rates.

Owning rental property can provide a consistent and often growing source of income. This strategy involves purchasing residential or commercial properties and leasing them to tenants. Rental income can cover property expenses, including mortgage payments, property taxes, insurance, and maintenance, with any surplus contributing to retirement cash flow.

Managing rental properties can be time-consuming, involving tenant screening, repairs, and administrative tasks. Retirees may choose to handle these responsibilities themselves or hire a professional property manager to oversee the day-to-day operations for a fee, typically a percentage of the rental income.

Side hustles and small businesses offer diverse ways to generate income by leveraging personal skills, hobbies, or interests. Examples include online services like freelance writing, virtual assistance, or bookkeeping. Crafting and selling handmade goods, pet sitting, or tutoring are also common avenues.

Some retirees also consider driving for rideshare services or starting a small home-based business. These activities provide flexibility, allowing retirees to set their own hours and workload. The income earned from side hustles and small businesses is generally considered self-employment income and is subject to income tax and self-employment taxes for Social Security and Medicare.