Sources of income during retirement | Investments and retirement | Financial literacy | Khan Academy

Let's talk a little bit about sources of income during retirement.

So, we're assuming you're retired, you're not working, so you're not going to get that income. But one of them is perhaps just your straight-up investment income. You save money over time; you've invested it in, let's say, dividend-paying stocks. The dividend is an income. Maybe you've bought rental properties; those rents, after paying all the expenses, those can be income.

But there's also things that are a special purpose for retirement. Probably the most common is Social Security. You pay into Social Security; when you get your paycheck, you will see that some of it is essentially taken out for Social Security. Then, when you become the age where you can start collecting that Social Security, you get a payout, up to a cap. It is related to how much you have actually paid into Social Security.

Now, above and beyond Social Security, many employers will have employer-sponsored plans. That is money that you pay in, and oftentimes the employer will add some money to that. They'll match some percentage of what you put into that plan, for example, a 401k. You can put money into it on a pre-tax basis.

So, what does that mean? Normally, let's say you make an incremental ten thousand dollars, and your marginal tax rate is say 20 percent. Well, you're going to have to pay two thousand dollars of tax on that ten thousand dollars. But something like a 401k, you could put that ten thousand dollars into the plan and not have to pay taxes on it up front. Then you can invest it within the plan.

You can find out different types of investment vehicles, ways to invest that money within the plan. There's not unlimited choices, but they usually have several choices within the plan. Then, when you're of retirement age, you can take it out, and then you pay taxes.

Now, you might say, "Well, I'm going to pay taxes one way or the other." But when you pay taxes when you're retired, one, you deferred those taxes by many years—usually many, many decades. And also, when you're retired, it’s possible that your income is lower, and so your marginal tax rate is lower. You might actually have to pay fewer taxes on those same dollars.

So, you have Social Security, you have employer-sponsored plans like 401ks, and then you have individual retirement plans. The most common one is called an IRA, Individual Retirement Account. That's an individual plan that you usually go and get with a bank or broker on your own; it's not connected to an employer.

There are two types: there’s a traditional IRA, where, similar to a 401k, you can put money in on a pre-tax basis up to a cap, and 401ks also have a cap. You can invest it without taxes, and then at some future date, you're going to pay the taxes on it.

There’s also something called a Roth IRA, which you pay the taxes up front, put the money in, but then you can invest it tax-free. When you take it out at retirement, you don’t have to pay taxes on it. So, those are the basic ways that you're going to get income in your retirement. It's good to start thinking about them early.