Many people retire expecting a pension to cover most of their income - but most workers today don't have one, and even those who do often need more. A 2024 Federal Reserve report based on 2023 data found that 80 percent of retirees had one or more sources of private income beyond Social Security, including 56 percent with pension income and 48 percent with interest, dividends, or rental income.1 Building a reliable income floor takes real planning - and each option carries a different cost structure.
What Retirement Income Sources Beyond Pensions Typically Cost to Set Up
The cost of building non-pension retirement income depends entirely on which vehicle you use. A 401(k) or IRA costs little to open - most brokerage platforms charge nothing upfront - but the real "cost" is opportunity cost from contribution limits. According to the IRS, the basic limit on elective deferrals is $23,500 in 2025, rising to $24,500 in 20262. Workers 50 and older get a catch-up amount on top of that.
Annuities are a different story. A fixed or variable annuity purchased through an insurance company carries surrender charges - mortality and expense fees, and in some cases administrative fees that can run 1 to 3 percent of the account value annually. According to insurance.ca.gov, annuities typically earn less money than stocks and bonds after those costs are factored in.3 A simple brokerage account holding index funds typically costs 0.03 to 0.20 percent per year in fund expenses - a fraction of an annuity's load.
What Drives the Price Up or Down
Three factors move the real cost of each income source: tax treatment - fees, and withdrawal timing. Tax treatment is the biggest lever. Roth IRA withdrawals in retirement are tax-free; traditional 401(k) withdrawals are taxed as ordinary income. For someone in a 22 percent marginal bracket pulling $40,000 per year, the difference between a Roth and a traditional account is about $8,800 in annual tax - a real number that compounds across decades.
Fees compound in the opposite direction. Consider two workers each saving $200 -000 over 20 years. Worker A holds low-cost index funds at 0.10 percent per year; Worker B holds a variable annuity at 2 percent per year. At a 6 percent gross return, the fee drag on Worker B's account erases roughly $60,000 to $80,000 in terminal value - money that would otherwise be income.
Annuity pricing has another wrinkle. According to insurance.ca.gov, some annuities offer a higher guaranteed interest rate for the first year only - a teaser rate - after which the interest goes down.3 A rate that looks attractive in year one may look quite different in year three.
Where the Money Actually Goes in Each Vehicle
Inside a 401(k) or IRA - money flows into funds - equities, bonds, or a mix - and grows tax-deferred. The IRS requires withdrawals to start at age 73. According to the IRS, the required minimum distribution is the minimum amount a person may need to annually withdraw from a retirement plan after reaching that age.4 Fail to take it and the penalty is steep: up to 25 percent of the amount not withdrawn, though that has been reduced under current rules if corrected promptly.
Inside an annuity - a portion of every premium dollar goes to the insurance company's general account or separate sub-accounts . The insurer keeps mortality and expense charges, and the contract value is what remains. According to insurance.ca.gov, with an equity-indexed annuity specifically, the insurance company decides how much of the index gain the owner receives - and the owner won't get all the extra interest that the stock market might earn.3 That participation cap isn't a minor detail; in strong equity years it can mean receiving 50 to 60 percent of the market's actual gain.
Dividend income from a taxable brokerage account flows directly to the investor. Qualified dividends are taxed at the lower capital gains rate . Rental income from real estate lands on Schedule E and is taxed as ordinary income, though depreciation deductions offset part of it.
The Hidden and Surprise Costs Most People Miss
Early withdrawal penalties catch people off guard. For most retirement accounts - pulling money before age 59½ triggers a 10 percent penalty plus ordinary income tax. The IRS does provide limited exceptions - for instance, beginning with distributions made after December 31, 2023, a distribution to a domestic abuse victim isn't subject to the 10 percent early withdrawal penalty.5 But most early withdrawals don't qualify for an exception, and the combined penalty-plus-tax hit can consume 30 to 40 cents of every dollar withdrawn.
Annuity surrender charges are a second surprise. Most deferred contracts lock in the principal for 5 to 10 years; withdrawing early can trigger a charge starting at 7 or 8 percent in year one and stepping down each year. Also - according to insurance.ca.gov, if money is taken from a deferred annuity before age 59½, a tax penalty applies unless the owner becomes disabled or rolls the money into another annuity.3 That double layer - surrender charge plus tax penalty - is a real risk for anyone who buys an annuity and later needs liquidity.
Rental property carries costs that rarely show up in the original projection: vacancy months, repairs (budget roughly 1 to 2 percent of property value per year), property management fees - and the occasional major capital expenditure like a roof or HVAC system. A property generating $18,000 per year in gross rent may net closer to $10,000 to $12,000 after these real-world expenses - a side-by-side contrast with the gross figure that matters a great deal in income planning.
Where People Slip Up
First mistake: treating Social Security as a pension substitute. Social Security replaces roughly 40 percent of pre-retirement income for an average earner - not 70 to 80 percent, which most financial planners consider the minimum replacement target. Relying on it as the primary source creates a gap most people underestimate.
Second mistake: buying an annuity purely for the teaser rate. The first-year rate a salesperson shows is often not the rate that governs year two onward. Read the renewal rate history and the minimum guaranteed rate - not the introductory figure.
Third mistake: ignoring required minimum distributions until they arrive. A large traditional IRA or 401(k) balance at age 73 can force distributions that push taxable income into a higher bracket, trigger Medicare IRMAA surcharges, and make Social Security benefits partially taxable. Strategic Roth conversions in the years before age 73 reduce this forced exposure - but only if planned early.
Fourth mistake: treating a taxable brokerage account as a last resort. Because it has no contribution limit and offers flexibility on timing and amounts, a taxable account is often the right complement to tax-deferred vehicles, particularly for early retirees who need income before age 59½ without penalties.
When to Talk to a Professional
This article is general information only. It's not tax - legal, or investment advice, and no figure here is guaranteed to apply to any individual situation - rates, limits, and rules change and vary by circumstance.
Talk to a fee-only fiduciary financial planner before buying any annuity product - particularly a variable or equity-indexed contract. These products are complex, commissions are high, and the suitability standards that apply to them have changed in recent years under Department of Labor rules. A planner who charges a flat fee or hourly rate, rather than commissions, has less incentive to steer toward the highest-fee product.
Consult a CPA or enrolled agent before making large Roth conversions - taking early withdrawals, or selling rental property - each of those moves has tax consequences that are hard to reverse and easy to miscalculate without current knowledge of the tax code.
The next step is straightforward: list every income source expected in retirement, estimate the annual after-tax dollars from each, and compare that total against a realistic spending figure. That gap - if there's one - is what needs to be filled, and filling it with the right mix of vehicles is a concrete problem a qualified planner can help solve.
Sources referenced: IRS (irs.gov); Federal Reserve 2024 Survey of Household Economics and Decisionmaking; California Department of Insurance . Figures are approximate and subject to change; verify current rules with a qualified professional before making financial decisions.
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Disclaimer
This article is for general informational purposes only and isn't financial - investment, insurance, or tax advice. Rates, fees, and rules change and vary by lender and situation. For decisions about your own money - consult a qualified financial professional.
