Social Security in Retirement

Posted on March 29th, 2011 in Newsletter Articles, Retirement Planning by wayne

I have met few baby boomers who are not concerned about their ability to have an abundant retirement.  Except for the very wealthy, Social Security income is an important factor in supporting a successful retirement.

Social Security is a complex system that few people truly understand.  Effectively, Social Security is an “immediate annuity” that increases in value with both the rate of inflation and by each year in which you delay receiving benefits (up to age 70).  Let’s consider how you can maximize this important benefit.

A common misperception about Social Security is that, if benefits are available, you should begin taking them as soon as you retire.  If a healthy person retires in 2011 at age 62, they are eligible for a monthly payment that is approximately 75% of the Social Security benefits that they would receive at age 66, their Full Retirement Age (FRA).

Assuming that the FRA Social Security benefit is $2,000 per month, the benefit at age 62 would be only $1,500 per month.  At age 85, with 0% inflation, a person will receive $414,000 in Social Security benefits if they begin taking them at age 62.  If the same person waits until their FRA of 66 before receiving benefits, they would receive a total of $456,000 in benefits by the time they reach age 85.

It is especially important to delay taking Social Security benefits before your FRA, if you have any significant earned income.  Earning more than $14,160 in any year before FRA will decrease Social Security benefits by $1 for every $2 earned above that amount.

Many believe that they should begin taking Social Security benefits no later than their FRA, at which time they will receive 100% of benefits due.  However, for each year beyond FRA that Social Security benefits  are postponed, the monthly benefit increases by 8%.  Thus, with a FRA of 66, postponing benefits until age 70 will provide monthly benefits that are 132% of FRA benefits.

If FRA benefits are $2,000 per month, waiting until age 70 to begin receiving benefits would increase the monthly Social Security benefit to $2,640 (with 0% inflation).  Upon reaching age 85, the total (non inflation adjusted) amount that would be collected is $475,200, $61K more than starting benefits at age 62 and  $19K more than the benefits collected starting at FRA.  When inflation is considered, these additional amounts are significantly larger.

For a married couple, in good health, in which one spouse has earned significantly higher Social Security benefits than their partner, it is often prudent for the higher earner to delay starting Social Security benefits until age 70.  If spouses are both age 66 and in good health, the odds that at least one spouse will live past age 90 is almost 40%.  If the higher earning spouse is the first to die, the remaining spouse can claim 100% of the deceased spouse’s benefit.  Thus, the monthly payments for the higher earning spouse, representing an inflation adjusted 132% of FRA benefits, continues until the second spouse passes.

If you retire before age 70, delaying Social Security benefits will require spending more retirement savings than would otherwise be necessary.  However, for most people, their primary retirement concern is running out of money before they die.

For those that have saved adequately during their pre-retirement years, running out of money will often only occur if one spouse lives well beyond “normal” life spans.  If you or your spouse (or both) are alive at age 90 or beyond, having an additional 32% of inflation adjusted Social Security income (or 76% more than those who take Social Security benefits at age 62) could provide a significant boost to your lifestyle.

A successful retirement requires that you make informed decisions concerning Social Security benefits.   Your health, age, income differences with your spouse and the amount of other financial resources available must all be considered.  Working with a financial advisor who understands the vagaries of Social Security system can help provide thousands of extra dollars for your retirement years.

When Can I Retire? Part 2

Posted on March 29th, 2011 in Newsletter Articles, Retirement Planning by wayne

In our previous article, we provided an easy to calculate approach to determining if you will be able to retire when you wish.  For some people, this simple calculation helps confirm that they will be able to retire when they wish.  For others, the “income gap” is too large to safely retire when they would like.  In this article, we explore ways to decrease income gaps.  We will also provide techniques to convert financial resources into income that is required for an abundant retirement.

The following are simple approaches to reducing the income gap:

1.    Continue to work past your projected retirement age.  This provides three advantages by a) delaying the need to begin taking Social Security benefits, b) increasing these benefits when they are begun and  c) reducing the number of retirement years by each additional year worked.

2.    Increase savings while working.  Lowering your current expenditures could substantially increase your annual retirement funds.

3.    Spend less in retirement.  Lowering your discretionary spending in retirement will decrease the income gap and increase the number of years that your retirement income will last.

4.    Increase returns on your investment assets.  By carefully monitoring your investment assets you will likely increase investment returns, providing a larger retirement asset base.

Once all acceptable steps for reducing your “income gap” have been taken, the next step is determining  the best approach for converting financial resources into income.

Many people use a systematic withdrawal plan (SWP), in which they withdraw between 4% and 5% of total retirement savings each year.  With an SWP, it is important to carefully consider the tax consequences associated with withdrawals from each type of investment.

Typically, it is prudent to first withdraw funds from taxable accounts, as these assets provide the most flexibility in tax planning.  With tax deferred accounts, such as IRAs and 401(k) plans, all withdrawals are taxed at the same rate as earned income.

For most people, the most tax efficient withdrawal approach is to use taxable accounts for withdrawals before age 70½, after which you withdraw only the required minimum distribution (RMD) from tax deferred accounts, for as long as you are able to do so. If possible, avoid using any Roth IRA funds.  Roth IRA funds are the perfect inheritance in that they can continue to grow on a tax free basis throughout the lifetime of the beneficiary.

With the SWP approach, the retiree assumes all of the income risk.  This often leads to a significant portion of the total portfolio being put into less risky investments.  This conservative investment allocation may reduced long term investment returns, thereby reducing funds that are available in retirement.

Another approach is to use immediate annuities to fill the “essential income gap.”  This approach can help assure that the funds required for your essential well being are available for the rest of your life.  Since inflation will eat into these funds, it is prudent to provide for at least 33% more income than is required.  In the early years, this additional income can either be reinvested or used to fill the “discretionary income gap.”

If you chose to use immediate annuities to fill deficits in your “essential income gap,” a systematic withdrawal plan (SWP) of remaining funds can provide for your discretionary spending.  Since your essential expenses are covered, it is possible to use a riskier investment allocation for the remaining funds that provide for your discretionary spending.

There are many variations to the above approach, including laddered immediate annuities, laddered long term treasury bonds, laddered TIPS etc.  Details of how to use each of these approaches is beyond the scope of this article.

The key to a successful retirement is working long enough to assure that both your essential and your discretionary incomes gaps can be filled by a combination of your Social Security, pensions, investment income and retirement savings.  Once this is accomplished, maximize retirement income by determining the most tax efficient methods to convert your savings into retirement income.  If this task appears overly burdensome, find a capable financial advisor who can help you accomplish your retirement goals.