How to Calculate Retirement Income

Most of our retirement income comes from only four sources: Social Security; earnings; pensions; and asset income. By estimating income from just these four sources, we can get an accurate estimate of our retirement income. Here’s how to calculate retirement income.

Social Security is the bedrock of the U.S. retirement system, accounting for 36.7% of the income for people aged 65 and older. The next largest sources of income for aged people are earnings (30.2%), pensions (18.6%), and asset income (11.4%). All other sources for this group account for only 3.1% of income.

Since Social Security, earnings, pensions and asset income account for 96.9% of the income for people aged 65 and older, it makes sense to concentrate on these four sources to calculate retirement income. These sources are described below, with guidance for estimating the amount of income you can expect from each. For most people, the sum of these amounts will be an accurate estimate of retirement income.

For a minority of people, the accuracy of this estimate can be improved by adding other sources of retirement income, which in the aggregate account for only 3.1% of this income. These other sources are also described below.

Fully 86% of people aged 65 and older receive monthly payments from Social Security, with a median payment of $1308 per month in 2010. Social Security accounts for more than half the income for 65 percent of retirees, and more than 90% of the income for 36 percent of retirees.

You can obtain estimates of your Social Security benefits from the Social Security Administration. Go to their estimator website at http://www.ssa.gov/estimator/, click “Estimate Your Retirement Benefits”, and follow the instructions. The estimator allows you to create “what if” scenarios so you can review the impact of career and lifestyle changes on your benefits. For example, you can change your “stop work” dates and your expected future earnings.

More people are counting on working part-time jobs after retirement to offset the impact of the Great Recession on their retirement savings. Per a recent Gallup poll, 71% of workers plan to work after retirement. In reality, however, many workers don't follow their plans to work after retirement because they cannot find suitable jobs or because of health issues. It turns out 26% of people aged 65 and older held a paying job or were self-employed in 2010. Their median earnings were $28,000 in 2010, which was much lower than their pre-retirement earnings.

To estimate your earnings, picture your life after retirement. Do you have interests that lend themselves to part-time employment? What are the wages for these jobs in your area? How many hours per week will you work? Will you have any health issues that could block your plans? Would you rather spend retirement giving back to your community by volunteering? It’s best to be conservative in estimating post-retirement earnings considering most people overestimate what they will be.

Pension income includes payments from defined benefit plans (traditional pensions), defined contribution plans (401k or 403b plans), individual retirement accounts (traditional and Roth), railroad retirement plans, and annuities.

About 42 percent of current retirees receive traditional pension benefits, with 27 percent having private pensions and 15 percent public pensions. Median pension benefits were $12,700 in 2010, with private sector retirees receiving a median of $8844 and public sector retirees receiving a median of $20,000. With the shift away from traditional pensions, the percentage of future retirees who will receive traditional pension benefits will be lower.

To estimate your pension income, consider if you will be entitled to any traditional pension benefits from your current or previous employer(s). If so, review your pension plan materials to get an estimate of your future benefits. Some employers provide periodic statements or online tools to provide these estimates. You can also ask the H.R. department at your company.

Then, estimate the future value of your defined contribution plans and IRAs when you retire. One way to estimate their value is to use an online savings calculator, starting with your current balances, and assuming you’ll make annual contributions of a certain amount until the year you retire, with average investment returns of perhaps 5%. Then, use the “4% rule” for distributions, assuming you’ll be able to safely withdraw 4% of the future value in the first year of retirement, and then increase the withdrawal amount each year by the rate of inflation.

Your total pension income is the sum of these amounts plus any annuity income.

Asset income includes interest, dividends, royalties, net rental income, and income from trusts. To estimate this income, make a list (or spreadsheet) of your stocks, bonds, savings accounts, CDs, rental property, intangible property, and other assets. Then, estimate the amount of income you will receive from each asset. For example, if you own 500 shares of stock in ABC Company, and it pays a dividend of $1.20 per share, you can expect dividend income of $600 per year from this stock. Finally, add up the income you will receive from all of your assets to estimate your asset income.

As mentioned above, most people can accurately estimate their retirement income by adding their Social Security, earnings, pensions and asset income. However, some people can expect other sources of income such as: home equity (if it can be monetized by down-sizing, moving to a less expensive area, or taking a reverse mortgage); inheritance; or public assistance. Complete your estimate by adding any income from these other sources.