WHAT WILL RETIREMENT cost? One solution to this riddle is to save as much as we can and hope it’ll cover our expected expenses. Finding the right answer—the exact amount of savings required—can involve hours of calculation, and even then there’s a fair amount of uncertainty.
At my financial planning firm, we help clients with this calculation. Our starting point: We believe the foundation of most retirement plans should be Social Security. Many Americans choose to take Social Security earlier than their full retirement age (FRA). There are downsides to taking Social Security early, of course, the greatest of which is a permanently reduced benefit.
Waiting to file until age 70 is in most people’s best interest, I believe. Their eventual benefit will grow 8% for each year they defer filing beyond their FRA, yet many people feel they can’t afford to wait. At our firm, we help build an income bridge so clients can more easily defer Social Security until 70.
We use a portion of their portfolio to make up for the missing Social Security benefit. Our clients get the same income they would have received had they filed early. The bridge tends to take away feelings of loss and provides them with needed income.
By effectively swapping risk assets like stocks for a larger guaranteed Social Security benefit, we hedge the risk that folks will outlive their other savings—and, for many, move retirement from a possibility to a reality. Now I hear what you’re saying—that I’m removing a piece of their portfolio to annuitize it. Yes and no. Unless they die early in retirement, they’ll get back the money in the form of a larger stream of guaranteed income, and that income will be delivered when it’s truly needed.
Many of my clients worry that Social Security won’t go the distance. Yes, the Social Security trust fund will be depleted by 2034, according to the latest estimate from the system’s trustees. Benefits may eventually be means tested, meaning they’re trimmed for those with higher incomes. But for those already collecting Social Security, I believe the likelihood of a benefits reduction is low.
For married couples, the longer the higher-earning spouse defers, the greater the survivor benefit that the lower-earning spouse will potentially receive. One objection I hear: Lower-earning spouses lose their entire benefit when they inherit the higher benefit of their spouse. This is true. But the surviving spouse’s cost of living should be lower for items such as food, health care and certain utilities. A financial planner can put a pencil to these expenses to calculate how your budget might change.
It can feel strange to no longer have a paycheck once you retire. To replace it, you’ll need to liquidate savings to sustain your lifestyle. The traditional approach is to withdraw 4% annually—in addition to guaranteed income from pensions and Social Security.
For instance, if you need $100,000 a year in retirement, you and your spouse might receive $50,000 from Social Security and $20,000 from pension income. That means you need to draw another $30,000 from savings. A quick calculation suggests you’d need savings of $750,000, assuming a 4% withdrawal rate.
Many clients say that once they have $1 million saved, they should be fine. Is this true? That depends on living costs and goals. Do you have legacy aspirations, including leaving money to charity or to family? Do you want to see the world, play golf five times a week or join a country club? You need to think about more than just a big round number.
Digging deep into what your life might look like tells us how much money you could need. Of course, it’s not just about the amount of assets. It’s also about how they’re invested. For individuals with a large nest egg but little guaranteed income, sequence-of-return risk comes into play. This is the risk of encountering down years at the start of retirement.
It’s human nature not to want to take money out of a depreciated asset. When the market is down, however, you may be forced to sell investments to cover living expenses. Once you’re forced to sell that asset, you may never recover your portfolio’s value when the market goes back up. How do you offset this risk?
Adding in guaranteed income sources, such as single premium immediate annuities and deferred income annuities, including qualified longevity annuity contracts, is one way to do it. Some of these can be purchased with a cost-of-living adjustment rider, where annual payments increase by, say, 2% or 3% each year. Having 60% to 70% of your expenses covered by guaranteed income—whether Social Security, pension or annuities—greatly reduces longevity risk.
Some people aren’t comfortable annuitizing, which is fine. We can help them ladder Treasurys or other bonds to produce the income they need. There’s limited risk of principal loss—provided they hold the bonds to maturity.
Finally, we’ll stress test a retirement plan, factoring in such things as higher inflation rates and tax rates to see how the plan stands up to such challenges. We can even factor in a 25% cut to Social Security benefits.
People often get “to” retirement haphazardly. They gather assets through their career, hoping to have enough wealth to get them over the finish line. I help them start planning “for” retirement, which involves discussing what your day-to-day will look like and stress-testing the possibilities that may derail your new life.
Kevin Thompson is a former Major League Baseball player and now CEO of 9Innings Capital Group LLC. He is a Certified Financial Planner® and Retirement Income Certified Professional®. Kevin graduated from the University of Texas at Arlington in 2011 with a degree in finance. His previous articles were Home Sweet Whatever and Big League Lessons.