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Too many Americans don’t have enough money saved for retirement. This makes understanding how to stretch limited retirement resources of paramount importance.
To illustrate how you can maximize a modest nest egg, I’d like you to meet Steve. He’s an entirely hypothetical retiree, but we’ll use Steve’s case to outline a workable strategy for planning for retirement when you don’t have enough set money aside.
Steve is a relatively healthy 60-year-old. Between a few kids, a divorce and several years of part-time work as he supported his aging parents—not to mention the multiple recessions that dented his paychecks over the years—Steve’s had a hard enough time remaining in the middle class without worrying about retirement.
Plenty of experts reiterate ad nauseum that Americans need to save at least 10% of their pay in a tax-advantaged retirement plan. It’s fine advice, but it offers little comfort to people like Steve, who are closer to the end of their working years than the beginning, with only a modest amount put away.
All Steve’s got is $100,000 in an individual retirement account (IRA), his Social Security benefits and the roof over his head. Steve’s situation should sound familiar: Nearly half of Americans are trapped in a retirement crisis where they’ll have less income as seniors than they earned when they were working.
Social Security is the most important part of Steve’s retirement plan, but choosing when to claim Social Security benefits poses something of a dilemma. He can opt to begin receiving checks at any time from the moment he turns 62 until age 70, when he must start taking benefits.
The longer Steve waits to begin Social Security, the more he’ll get each month. In fact, his monthly income will be 76% higher if he waits until age 70 to claim Social Security benefits.
Let’s say Steve has earned about the median wage from 1982 until now. If he started collecting Social Security at age 62, he could count on a monthly check of $1,500, according to this handy Social Security calculator—that adds up to about $18,000 a year.
But if he waited until 70, his check would jump to nearly $2,510, or more than $30,000 a year. Your specific outcomes will be different depending on how much you made over your career and just when you decide to retire, but the difference is significant.
In any case, putting off Social Security even until 68 can help many Americans go from crisis to security in retirement.
Life happens. That’s why the most popular age to claim Social Security benefits is 62. Only about a third of Americans wait until their full retirement age, let alone to age 70. You get laid off, you just get tired of the grind, perhaps your spouse, parent or children need a caregiver. Sometimes a global pandemic strikes.
When life happens, people need a bridge to help them continue delaying Social Security as long as possible, especially when they leave the workforce earlier than planned. A research paper from the Boston College Center for Retirement Research identifies a great candidate: annuitizing your retirement savings.
“The proposal…would introduce a default into 401(k) plans that would use 401(k) assets to pay retiring individuals ages 60-69 an amount equal to…the monthly amount an individual would receive from Social Security if he claimed at his full retirement age,” write the authors of the paper.
These annuitized payments would build a bridge to get you from the day you stopped working to your Social Security full retirement age—or even to age 70—before starting benefits. Besides helping you maximize your monthly Social Security checks, it would break the association ost people have between retiring and immediately starting Social Security.
Boston College compared this bridge approach to buying different types of annuities, such as a single premium immediate annuity (SPIA) or a qualified longevity annuity contract (QLAC) that kicks in at 85. They found that the Social Security bridge option works best. Which is good because fixed annuities aren’t terribly popular, and don’t come with many of the benefits of Social Security, such as no adverse selection or high administrative costs.
“The bottom line is that, for the median household, the Social Security bridge option is the clear winner,” per the study’s authors. The problem is that many employer plans don’t offer this option and, if they do, it’s not automatic.
Still, the report found that annuities deliver more wealth than no annuitization at all. The SECURE Act, passed in late 2019, makes it easier for qualified retirement plans to offer annuities, which may help their popularity.
Under Vernon’s plan, people would draw down their retirement savings while holding off on claiming Social Security as long as possible. Any remaining retirement savings would be withdrawn using required minimum distributions (RMDs) as a guide. You’d work until 65, then spend down your 401(k) to age 70, when you’d take Social Security plus RMDs.
Let’s return to our friend Steve. If he started Social Security at age 62 and 10 months, his monthly benefit would be $1,500. If he waited until his full retirement age of 66 years and 10 months, his monthly check would be $2,000 (both figures are in today’s dollars). Steve would lock in nearly an additional $6,000 annually by holding off on taking Social Security for 48 months.
That money could really add up. Steve’s an ex-smoker who drinks a few times a week and works out once a week or so—all in all, he’s expected to live to 88. That extra $500 a month he’d get by waiting to his full Social Security retirement age would add up to more than $130,000 over the course of his expected life span (again, in today’s dollars). That doesn’t even include cost-of-living adjustments.
Here’s where the annuity bridge comes in. Steve would draw payments for that 48-month period between retirement and Social Security by drawing down $2,000 a month from his retirement savings, for a total cost of $96,000.
According to St. Louis-based CPA Mike Piper, someone like Steve would do best to roll their IRA or 401(k) into certificates of deposit (CDs), a bond ladder or a fixed annuity to build the bridge, depending on their circumstances. This would free Steve from any risk of being forced to make withdrawals of risk assets like stocks or funds during a market downturn.
By building the bridge and annuitizing his scarce retirement funds, Steve would be buying bigger Social Security payments. For people like Steve, the trade-off works because they end up with a guaranteed retirement paycheck. And since you receive Social Security until you die, Steve has eliminated the biggest risk in retirement: outliving your savings.
“There’s an art and science to financial planning,” said Ken Van Leeuwen, chief executive of Princeton-based wealth manager Van Leeuwen & Company. “The science tells you that this is a pretty good idea. But the art is to convince people who will have a hard time making too many permanent decisions when they’re at an age that they view as early in their life.”
Some people worry that they’ll die before they reap the full benefits of an annuity—aka get more out than they paid in. Others may want to preserve some savings in case they ring up huge healthcare bills at the end of their lives. Some, says PricewaterhouseCoopers asset and wealth management leader Bernadette Geis, don’t want to rely on Social Security because they don’t believe the program will actually be around for them.
Finally, there are those who’ve worked hard and just want to claim their Social Security checks as quickly as they can get them. “Some people just want to take the money as soon as they can, regardless of what the math shows,” said Piper.
All of these are valid concerns, and you’d do well to powwow with a fee-only financial planner before making a final decision. But you can’t have everything in retirement, and Steve is no different.
While he may want to leave something to his kids, does he have that luxury when actuarial tables say he’ll likely live into his late 80s? What if, heaven forbid, he evades Father Time for even longer? Is there maybe something else, such as his home, that he might pass down?
Yes, Steve may also miss out on some capital gains. But he’s got bigger fish to fry. There’s no perfect solution to these painful decisions. The more money you have, the more options you have. One of the features of Steve’s retirement crisis is that his small 401(k) means he has less freedom.
But if he’s willing to spend down what money he does have in order to ensure a bigger Social Security check for the rest of his life, he’ll be better off. Follow his lead, and you might be, too.