I met with a prospective new client this week and he asked me the question I get asked by most people during introductory meetings:
“When can I afford to retire?”
We spent about an hour working through some numbers and coming up with the answer. I thought seeing a real world example would be helpful to some of you, so I asked him if I could share the details as long as I kept his name confidential. Here are the basic facts:
- He and his wife are 61 years old
- He has worked for his current employer for 41 years
- His 401(k) is worth around $700,000
- They have another $600,000 in savings and investments
- His estimated Social Security benefits are $1,900 per month if he retires early at 62 and $2,500 per month if he waits until full retirement age at 66.
- His wife does not work outside the home and has not qualified for Social Security
- Their house is paid for and they have no other debt
- They need an income of $60,000 per year in retirement
Step 1 in deciding when to retire is answering the question “How much income do I need?” As George Foreman said, “The question isn’t at what age I want to retire, it’s at what income.” In this case, the client (Let’s call him Jim) wants to have about $60,000 per year gross (i.e. Before taking out taxes).
Step 2 is figuring out where that money is going to come from. If Jim retires at 62, he will get $1,900 per month from Social Security. That’s $22,800 per year. He wasn’t expecting his wife to receive any Social Security because she hadn’t worked the 40 quarters required to qualify. Needless to say, he was happy when I told him that she qualifies for a spousal benefit. Spouses are entitled to receive the higher of their benefit (in this case $0) or half their spouses benefit (in this case $950 per month). That adds another $11,400 in income per year.
So they need a total of $60,000 and $34,200 of that is coming from Social Security. That means their personal investments will need to generate the remaining $25,800. Is their nest egg up to the task?
They have a total of $1,300,000. As we have discussed here many times before, research shows that a safe withdrawal rate from a portfolio is around 4 percent. Taking a 4 percent withdrawal from their portfolio would get them about $52,000 per year, which more than covers the $25,800 they need. So looking at the numbers, Jim and his wife could afford to retire at 62. But should they? I advised him to seriously consider waiting a few years. Here’s why:
- They will almost certainly need more income than they are expecting. Jim told me that his $60,000 estimate is the absolute minimum they’d need to maintain their lifestyle. If anything unexpected happens and they need to draw more, they could run out of money sooner than expected.
- They are both in good health and have parents that are alive and in their nineties. Given their health and family history, there’s a good chance that they will live for a long time. If that’s the case, their money needs to last. Working for a few more years not only gives them a chance to save more, but also means that they won’t be drawing income from their savings yet, which will help it last longer.
- The breakeven point on their Social Security (where it makes sense to wait until full retirement age to claim benefits) is about 12 years. That means if they plan on living past age 74, it probably makes sense to wait to begin collecting benefits until full retirement age rather than taking a reduced benefit at 62.
- Another potential reason to wait is health care. Right now, Jim’s employer pays the cost of his health care, but that would stop if he retires. Since he and his wife won’t be eligible for Medicare until age 65, retiring now would mean either going without health care or paying out of pocket for coverage. To continue his current coverage using COBRA would be about $900 per month. Waiting to retire until they are eligible for Medicare would eliminate that expense.
- Finally, we’re living in an uncertain time. Inflation is tame now, but could easily get much worse. The markets are volatile. Interest rates are low. All of these things can damage a portfolio’s ability to generate enough income.
Conclusion: Jim and his wife can afford to retire now, but as long as they’re in good health and Jim is relatively happy at his job, waiting could greatly increase their security during retirement. I hope that example helps shed some light on the process of deciding when you can afford to retire. Touch base if you have any questions or if there’s ever anything I can do for you.
I’m back from the land of the midnight sun and trying to get caught up on any retirement news I missed while on the road. One item that caught my eye was the Social Security Administration’s decision to provide online statements for estimated retirement benefits. You may have noticed that they quit mailing the paper statements last year in a bid to save about $70 million a year in mailing costs. Saving money is good, but being in the dark about your potential benefits is bad, so I’m glad they’re making the change.
To access your statement, go to www.ssa.gov and create a secure account. Once done you will be able to see your complete earnings history as well as the total Social Security and Medicare taxes paid over your career. More importantly, you can see the retirement benefits you can expect to receive at different ages (i.e. 62, full retirement age, and 70) so you can factor that information into your planning.
For more information on Social Security, just scan through the list of related posts below. Have a great weekend and touch base if I can ever help.
If you’re like most, you know what Social Security is, but you’re a little hazy on the details. Don’t feel bad. There are 78 million others in the same boat. Retirement is on the horizon, though, so it’s time to bring you up to speed. Give me 10 minutes and I’ll give you answers to the 10 most frequently asked Social Security questions.
Q: Is Social Security enough to live on?
A: I won’t say it’s impossible, but it’s not easy. For 2011, the maximum monthly benefit for a person retiring at full retirement age (66) is $2,366. That assumes you earned the maximum taxable amount of income every single year after turning 21. Not many people are in that category. In fact, the average monthly payment was $1,177 for 2010. Multiply that times 12 and you’re officially below the poverty line. Social Security is a great way to supplement your income, but being totally reliant on it is not a retirement plan. In all likelihood it means that your retirement planning has failed.
Q: Can I count on Social Security?
A: Those at or near retirement will probably receive most (if not all) of what was promised. Those with a long ways to go probably won’t be so lucky. Why? Social Security is a self-financed program that uses tax dollars from current workers to pay the benefits of current retirees. In 1945 there were 40 workers for every person collecting benefits. Now there are about 3 workers for every retiree. High unemployment and a wave of retiring baby boomers have put further strain on the program.
Benefits being paid already exceed tax revenues collected and in their 2011 report, the Social Security Board of Trustees estimated that the program will only be able to pay promised benefits through 2036 (one year earlier than previously estimated). At that point the Social Security trust fund will be exhausted and revenue from workers will only be able to pay about 75 percent of promised benefits. Expect taxes to be raised and benefits to be cut long before we get to that point.
Q: When can I begin collecting benefits?
A: If you are eligible to receive Social Security benefits, you can begin collecting reduced benefits as early as age sixty-two. Most people (all 78 million baby boomers included) will need to be on the downhill slide to seventy before becoming eligible for full benefits. Click here to see a detailed chart of full retirement ages.
Q: What if I retire early or late?
A: Retire early and your benefits will be permanently reduced. Retire late and they will be increased. How much depends on how early or late in relation to your full retirement age. Retire up to 36 months early and your benefits will be reduced by 5/9ths of 1 percent per month. Anything over 36 months results in a 5/12ths of 1 percent reduction per month. For example, if your full retirement age is 66 years and 8 months and you retire at 62 (56 months early), then you can expect an almost 30 percent reduction in benefits.
Those retiring late get a credit for each year they wait. If you were born after 1943, the credit is 8 percent per year and it is paid to a maximum age of 70. For example, if your full retirement age is 67 and you retire when you’re 70, then you will have a 24 percent permanent increase in your monthly benefits.
Q: Will my benefits be subject to tax?
A: Maybe. If you have income sources in addition to Social Security, you may need to pay taxes on a portion of your benefits. If your modified adjusted gross income (MAGI) plus half of your Social Security benefits exceed a certain amount ($34,000 if you’re a single filer and $44,000 if you’re a joint filer), you will likely need to pay taxes on 85 percent of your Social Security benefits. If your MAGI is less than that, but still more than $25,000 for single files or $32,000 for joint filers, then you may need to pay taxes on 50 percent of your benefits. For further information on taxation of Social Security benefits, see IRS Publications 554 or 915. Tax law is complicated and subject to change, so always consult a trusted tax adviser.
Q: Will continuing to work affect my benefits?
A: You can work while collecting benefits, but if you haven’t reached full retirement age, your benefits will likely be reduced. I say likely because you are allowed to earn a certain amount of income before they begin docking your benefits. For 2011, the earnings limit is $14,160. If you are under full retirement age, your benefits will be reduced $1 for every $2 you earn above that limit. In the year you reach full retirement age, the penalty will be reduced to $1 for every $3 of earnings and the earnings limit will be increased. Once you reach full retirement age, you are free to earn as much as you want with no reduction in benefits. Also, the earnings test reduction is not permanent. At full retirement age your benefits will be increased to compensate for the benefits withheld because of your earned income.
Q: How do spousal or family benefits work?
A: Others in your family may be entitled to receive Social Security benefits based on your earnings history. This could include a spouse, former spouse of at least 10 years, disabled children, unmarried children under age 18, or children under 19 who are full-time students. These benefits are in addition to the benefits that you are entitled to and could be worth as much as 50 percent of your benefit for each person who qualifies. Each family has a maximum benefit that they can receive, however, which is roughly equivalent to 150 to 180 percent of your full retirement benefit. If this amount is exceeded, your benefits won’t be affected, but everyone receiving benefits based on your work history will see their benefits reduced proportionately.
Q: How can I get an estimate for my Social Security benefits?
A: Unfortunately, the Social Security Administration no longer sends out annual statements that show a record of your earnings and accumulated benefits. You can still estimate your benefits, but it will take a little work. Go to http://www.ssa.gov/ and click on “Estimate Your Retirement Benefits.” Begin by entering your name, Social Security number, date of birth, place of birth, and mother’s maiden name. If that information matches what they have on file, you will be able to use the estimator to enter your planned retirement date and expected future wages. That information is then combined with your past earnings history (already on file with SSA) to generate a reliable estimate of your expected future benefits.
Q: How do I apply for benefits?
A: You can apply online at http://www.ssa.gov/ using the Internet Social Security Benefit Application. You can also apply by phone, mail, or in person at any Social Security office. To cut down on your wait time, it’s recommended that you call 1-800-772-1213 (TTY 1-800-325-0778) to make an appointment. You will need certain documents to apply, such as your birth certificate, naturalization papers, U.S. Military discharge papers, and/or W-2 forms (or self employment tax returns if applicable) for last year.
Q: When should I file for benefits?
A: You basically have four choices. You can file early, file on time, delay filing to accrue increased benefits, or file and suspend. If you are married, your spouse has the same options. Most want to maximize the benefits they receive, so it makes sense to choose the option or combination of options that result in the greatest cash flow for you and your family. In the interest of space, I’ll leave it at that for now. In a future post I’ll talk much more in depth about how to maximize benefits and decide which option is best for you and your family.
Well, those are the 10 most frequently asked Social Security questions. If you have a question that I didn’t answer, touch base with me and I’ll do my best to help. Thanks for reading!
Here it is:
Every year during retirement, everything you buy will cost more than it did the year before.
Such is the nature of inflation. In 1990 a stamp was 25 cents. Today it has almost doubled to 44 cents. A gallon of gas was $1.16. Today you can expect to pay triple that. A new home in 1990 was $149,800. Today it is…well, let’s just say housing has hit a bit of a soft patch.
Multiply those increases across all the goods and services you buy during retirement—dinner out, a new car, a vacation—and over a 20-year retirement, you can expect prices to more than double (assuming 4 percent annual inflation). That means you’ll need twice as much income later in retirement to buy the same goods and services you bought at the beginning of retirement.
How can you combat this nemesis of inflation? Most people’s retirement income comes from two different sources: Social Security and personal savings. Let’s look at ways to overcome inflation in each.
Social Security has a built in annual cost of living adjustment, so most people assume that it will keep pace with inflation. Unfortunately, that may not be the case. Social Security adjustments are based on the Consumer Price Index or CPI. For decades, the Bureau of Labor Statistics (BLS) calculated the CPI in a fairly straightforward manner. They looked at a basket of goods, and determined how much it would cost. The following year they would price out that same basket of goods and the CPI would go up or down based on the new price.
In the 90s, some in government began to argue that inflation was overstated. They argued that as prices increased people would substitute less expensive alternatives, so the “basket of goods” should be adjusted each year. If steak got too expensive, they assumed that consumers would substitute something cheaper like hamburger. So why not remove steak from the basket, put hamburger in and voila, inflation is under control. Rather than implementing this “variable basket”, the Clinton administration implemented a different process that essentially achieved the same results. The BLS began to weight items in the basket differently. Basically, items that were increasing in price were given less weight than items that were decreasing in price.
To make matters worse, the BLS went on to make another change based on what they called “hedonics.” In short, hedonics doesn’t simply consider the price of an item, but the value that you get from that item. So if the price of a new car increases 10 percent, but there are new features on the car like airbags or heated seats that increase the “value” to the consumer by 15 percent, then the BLS would essentially say that the price of that car had decreased by 5 percent even though you’re paying more for it.
Applying this to your Social Security check, you can see that the annual cost of living increase built into the program won’t necessarily help you to keep pace with inflation if it is based on the fuzzy math of the CPI. A case in point: there were no cost of living adjustments in either 2010 or 2011, even though prices for things like food, fuel, and medical care undoubtedly increased over that period.
The best way to overcome this hurdle is to build your own inflation factor into your Social Security benefits. How do you do that? Rather than waiting until full retirement age or later, the average person retires at 62 and takes a roughly 20 percent permanent reduction in benefits. Rather than following their lead, if you wait a few years you can retire on full benefits. Even better, retire a few years “late” and you can add as much as a third to your annual benefit (8 percent per year for those born after 1943 to a maximum age of 70). The annual cost of living adjustment will still be understated, but it will be based on a much higher benefit amount.
In the same way that inflation eats away at the value of your Social Security income, the purchasing power of your savings and investments are also constantly being eroded. Failure to keep pace will result in your money becoming worth less until it is eventually worthless. As we saw earlier, even a modest rate of inflation of 4 percent can wipe out nearly all of the purchasing power of your nest egg during a 20-year retirement.
To overcome this problem, you need to invest in things that have the possibility of outpacing inflation. Understandably, however, the volatility and uncertainty of the last few years has caused many to shift their investments into things like money markets, certificates of deposit (CDs) and other “safe” investments.
Unfortunately, safe can be risky.
Consider a day in the hospital. In 1980, a day in the hospital cost $344. Today that same day costs around $5,310 (according to statistics published by the Wall Street Journal). For the sake of our example, let’s assume that 30 years ago you wanted to start planning ahead for your retirement. You thought that someday you might end up in the hospital for an illness and you wanted to set aside enough money to pay for a two-week hospital stay. You didn’t want to risk losing the money however, so you just put the cash into your safe-deposit box.
Fast forward three decades and you’re hospitalized with pneumonia for two weeks. When the bill arrives, you remember the cash that you stashed away so many years ago. You make a trip to the bank, open the box, and find exactly $4,816. Looking at the bill, you realize you’re about $70,000 short. By not outpacing inflation, your money lost almost all of its purchasing power.
Now let’s assume that instead you invested that $4,816 into the S&P 500 back in 1980. Even with all the ups and downs, it would have grown to nearly $135,000 by 2011. That’s enough to pay your entire hospital bill with plenty to spare.
So what are some ways to preserve the purchasing power of your nest egg? First, as we just saw, you should resist the temptation to be too conservative. You aren’t doing yourself any favors by having a portfolio dominated by “safe” investments like cash, government bonds and CDs. These investments are less likely to outpace inflation and could even lose a significant amount of their value during high inflationary periods. Most investors should keep at least a portion of their investments in quality stocks.
Second, consider investments in real estate, commodities or precious metals. These types of “intrinsic value” investments tend to do well during inflationary times. As we have seen with the current downturn, however, they can also be more volatile and less liquid than stocks and bonds, so keep that in mind.
Finally, consider investing in a real return mutual fund. These funds invest in a wide range of investments that are designed to battle inflation, such as inflation protected treasury bonds, real estate investment trusts, floating rate bonds, non-U.S. debt, natural resource stocks, high yield bonds, currencies and commodities.
Clearly, a fixed income retirement strategy in a rising cost world is a recipe for running out of money. By investing in a well balanced portfolio that is designed to keep pace with inflation, you can help ensure that your money not only lasts for your lifetime, but also provides you with the income necessary for security and independence during retirement.
Thanks for reading. Touch base if I can ever help.
It’s understandable if you’re feeling a bit anxious. Not only was the U.S. credit rating just downgraded for the first time in history, but over the last few years we’ve had a housing bubble, a credit bubble, runaway government spending, soaring gas prices, a global recession, high unemployment, the risk of a U.S. debt default, and a fiscal crisis in Europe.
Add to that things like the tsunami and nuclear disaster in Japan or the Arab revolts in the Middle East and you can almost see our national blood pressure rising. This is especially true if you, like 78 million other baby-boomers, are getting close to retiring.
In the face of so much uncertainty, how can you minimize anxiety and head into retirement feeling confident and assured?
Answer: Focus on things you can control.
Legendary basketball coach John Wooden once said: “The more concerned we become over the things we can’t control, the less we will do with the things we can control.”
Here’s an exercise that can help keep the focus on things you can actually do something about:
Take out a piece of paper and divide it into two columns. At the top of the left column, write “Things I can control about retirement.” At the top of the right column, write “Things I can’t control about retirement.” Now start filling in each.
You’ll probably notice that the right column is full of the things we mentioned earlier, like the markets, political uncertainty and unemployment.
The left column will be made up of things like saving, reducing debt, creating a retirement budget, evaluating housing options, creating a distribution plan, deciding when to take Social Security, planning meaningful pursuits and completing your estate plan.
As you look at those two columns, ask yourself this question: “During my typical day, do I spend my time and attention focusing more on the left column or the right column?” If you answered the right column, chances are that your stress level is high and your productivity is low. Focusing on things you can’t control is a recipe for frustration.
If you shift your focus to those things in the left hand column, you’ll notice that your productivity will go up and your anxiety will begin to go down. This is especially true in the area of your finances, because that is what is causing most people to lose sleep.
According to a recent poll by Gallup, the No. 1 retirement fear (held by 53 percent of Americans) is not having enough money. Only about a third of people felt that way when Gallup did the same poll in 2002. Thankfully, this is an area that you can actually do something about. Here are eight things you can do to boost your income security.
One obvious way to pad your nest egg is to save more. If you are still working, make saving a high priority. Both 401(k)s and IRAs have higher contribution limits for people over 50. Take advantage of those limits by putting away as much as possible. The maximum 401(k) contribution for 2011 is $16,500 plus an additional $5,500 if you’re over 50. IRA contribution limits are $5,000 plus an additional $1,000 if you’re over 50.
That means that a working, married couple could delay retirement by five years and sock away an additional $280,000 simply by maximizing their 401(k) and IRA contributions. The delay also could give markets time to move higher which, when coupled with the new additions to your portfolio, could significantly improve your financial position in retirement.
Pay off debt
Debt adds risk and reduces cash flow. Those things are especially troublesome to someone in retirement. By retiring debt free, you can greatly reduce the amount of savings necessary to fund your retirement. Assuming a 4 percent withdrawal rate, it takes $25,000 in savings to generate $1,000 in income each year (25 to 1).
That means if you’re mortgage is $1,300 per month and you’re able to pay it off before you retire, you could slash $390,000 from the amount you need to save for retirement.
Working longer may not sound fun, but neither is running out of money. If you haven’t saved enough, one option is to keep working and earning a paycheck. This strategy has multiple benefits: it allows you to save more, it gives your portfolio more years to recover and grow, it could help boost your potential Social Security benefits and it decreases the overall amount of income you need to draw over the years.
If the amount you need to make up is smaller, you also could consider working part-time. This could mean doing a phased retirement with your current employer or choosing something else entirely. Either way, it could give you increased freedom to begin following your retirement dreams while still providing some income.
Cut retirement expenses
If the idea of working longer doesn’t appeal to you, consider retiring on schedule and make up for any shortfall by reducing your retirement expenses. Examine your retirement budget for items you can reduce or eliminate.
Housing and transportation are often major expenses. Consider downsizing to a smaller home or sharing a car with your spouse. Staying active and healthy can save on health care co-pays and prescription costs. Substituting planned hobbies or activities with less expensive alternatives also can trim costs without significantly changing the quality of your retirement.
Taken cumulatively, these adjustments to your retirement budget can help reduce the strain on your nest egg and still provide a meaningful retirement.
Delay Social Security
If you delay collecting Social Security until after your full retirement age, you will get a permanent increase in your benefits. The increase is based on the year you were born. For example, those born after 1943 will get an 8 percent credit for each year they wait. The increase caps out at age 70, so a person waiting until then could see an increase of 24 percent to their benefits.
Review your asset allocation
The market upheaval of the last several years and investors’ response to that upheaval has wreaked havoc on many people’s asset allocations. Rather than having a balanced, diversified portfolio, many have sought safety by moving everything to cash or bonds. That could cause serious problems in the future if inflation picks up or the bond market stumbles. To protect your assets and maximize your returns over time you should meet with a trusted adviser and make sure the investments you hold are appropriate based on your risk tolerance, goals and time frame.
Protect against sequence risk
Stock and bond returns can be volatile. Sequence risk is simply the risk that you will retire and begin withdrawing money during a period of low (or negative) investment returns. Those early negative returns greatly increase your odds of running out of money.
One way to minimize sequence risk is to have a year or two of withdrawals sitting in cash. If you retire just prior to a bull market, you can pull income from your growing investments. If you retire on the cusp of a bear market, you can take withdrawals from your cash. That way you won’t be forced to sell investments in a down market in order to fund retirement and you will be less likely to run out of money.
Draw a greater percentage from your nest egg
Deciding how much to take from your portfolio each year during retirement is one of the most important decisions you will make. You don’t want to run out of money, but you don’t want to live like Scrooge either. Most experts peg the “safe” withdrawal rate at around 4 percent per year. If 4 percent of your nest egg isn’t enough to meet your needs, you can always take more. Keep in mind, however, that the more you take, the greater the chance that you will outlive your assets.
As you can see, by focusing on those things that you can control, you can minimize anxiety and maximize security as you approach retirement. Statistically speaking, the world doesn’t come to an end very often. Rather than worrying about all the things that make headlines, focus instead on giving your very best to those areas that you can do something about.
Thanks for reading. If you enjoyed this article, use the share buttons on our site to share it with your friends. Touch base if I can ever help.
I originally published this article at www.fpanet.org.
Every year, the Social Security Board of Trustees reports to Congress on the fiscal health of the Social Security program. Not surprisingly, high unemployment and a wave of retiring baby boomers have put a heavy strain on the program. Benefits being paid already exceed tax revenues collected and in their 2011 report, the board estimated that the program will only be able to pay promised benefits through 2036 (one year earlier than previously estimated). At that point the Social Security trust fund will be exhausted and revenue from workers will only be able to pay about 75 percent of promised benefits.
As grim as that sounds, the problems with Medicare are worse. Thanks to higher health care costs and lower payroll taxes, the Medicare Board of Trustees now expects the Medicare trust fund to run dry in 2024 (five years earlier than previously thought). The difference between promised benefits and estimated funds available is roughly $37 trillion.
What does this mean for you?
In all likelihood, your taxes will be going up and your benefits will be going down. Those close to (or in) retirement, will see fewer changes than those with a decade or more to go, but in my opinion, no one will be immune. The problems are just too big. If you’re in your sixties you will probably receive most of what was promised to you. If you’re in your forties, you won’t be so lucky. Plan accordingly.