by Suze Orman
But that’s not all. Let’s say you reach age 67 and you are still happy to be working, or you have enough retirement savings you can rely on, so you don’t need to begin receiving your Social Security payout. The Social Security Administration will pay you an 8% bonus for every year between the ages of 67 and 70 that you continue to defer your start date. That is, if you wait until age 70 to begin receiving your Social Security benefit it will be 124% of the benefit you would be eligible to receive if you started at age 67 and about 80% more than the benefit you would be entitled to at age 62.
There is indeed talk of “reforming” Social Security to help address our fiscal shortfalls, but there is no proposal being discussed that would alter the benefit formula for Americans who are already in their 50s; any changes would be slowly phased in over many years; they may impact your kids and their kids, but not you. And as I explained in the previous retirement class, Social Security is not going belly-up. The reality is that beginning in 2037, Social Security will not have enough money to pay 100% of the current benefits; it would be able to pay out at about 75% of its current promised benefit level. I am not suggesting that a 25% reduction is “nothing,” but it is also far different than no payment at all. And in fact, if and when Washington chooses to look seriously at fixes, there are some reasonable ways to tweak the system that would keep the program on solid footing well past 2037.
How Your Start Date Affects Your Social Security Payout
• Benefit at age 62: 70%
• Benefit at FRA*: 100%
• Benefit at age 70: 124%
*Assumes FRA of 67
It is also important to understand that Social Security benefits are indexed to inflation; every year there is inflation, your benefit will be adjusted higher.
So how come the Social Security Administration is so generous if you delay? Well, it’s nothing more than some actuarial math at work; the older you start, the less time, on average, you will collect that benefit. So the program can afford to pay you more.
That raises an important question I imagine you’re pondering right now: If you die before you reach age 67 or age 70, won’t you have “wasted” all that money you didn’t ever get because you waited? Or what if you don’t start to draw your benefit until age 70 and then you die at age 73? Won’t you have left a lot of money on the table?
Given the changes in the economy, that’s the wrong way to think about Social Security. If you have an illness or disability that makes it difficult or impossible to work past age 62, then of course it makes sense to draw your Social Security benefit at an earlier age if your other sources of income aren’t sufficient. If you need to draw a reduced benefit starting before your FRA, that is always the right move. But for those of you who can in fact delay when you start receiving your benefit, it is hands down one of the best ways to improve your retirement finances.
That’s especially true given our longer life spans. Remember, half of today’s 65-year-olds will still be alive in their 80s. If your health and your family history suggest you might be in that pool of people who enjoy a long life, then it makes tremendous sense to consider delaying your start date; you are essentially buying yourself a higher payout during those later years.
MY SOCIAL SECURITY STRATEGY
• Between Age 62 and Your FRA
Make it a priority to hold off on starting your Social Security benefit. Of course, if you are unable to work, and you have no other assets to support you, then drawing a reduced early benefit is what you must do. But if you can afford to wait, you should.
I know that many of you simply do not want to keep working full-time once you hit age 62. If that is your truth, that is what you must follow. But I am still going to tell you that you should not start your Social Security payout. My recommendation is to work part-time at a job that will pay you the equivalent of what you would be entitled to receive from Social Security. Let’s consider someone who is age 62 in 2011 and is eligible for a $1,500 a month benefit. Rather than collect that benefit, how about a part-time job for a few more years that brings in $1,500 a month? Not a 50-hour-a-week high-powered job, but something that provides the income you would otherwise be receiving from Social Security.
Note: If you decide you need to take your benefit before you reach your FRA, and you will still be working, you need to understand how your Social Security benefit may be impacted. In 2011, if you have not yet hit your FRA, you can earn $14,160 without any impact on your Social Security benefit. Your benefits will be reduced $1 for every $2 you earn above this amount. If you reach your FRA in 2011, you can earn up to $37,680 without any reduction in your benefit. Above $37,680 your benefits will be reduced $1 for every $3 above that limit. Luckily, once you reach your FRA the amount of any reduction you had because of your earnings while you were drawing early benefits is added back to your benefit. However, I still think it’s best to put off taking your benefit—so you can qualify for a bigger payout at a later age—particularly if you have other income coming in.
• At Your FRA
Once you reach age 66–67 I am fine with you beginning to take your Social Security benefit. Your patience will give you a payout that is 30% more, and that’s a great achievement. But I also want you to consider if you can possibly delay further, all the way until age 70. If you can and want to keep working, then delaying your benefit makes tremendous sense. But even if you are ready to stop working, that doesn’t automatically mean you must start your Social Security payout. I’d rather you live off other assets; remember that between age 67 and 70, for every year you delay starting your Social Security payout, you earn a guaranteed 8% increase in your eventual benefit. And that benefit could also be adjusted annually for inflation. That’s a risk-free return you can’t earn anywhere else given where interest rates are as I write this in early 2011.
• Special Strategy for Married Couples
If you and your spouse are both eligible for a Social Security benefit you can create a best-of-both-worlds strategy that gives you some Social Security income before age 70 while also allowing you to earn the maximum age-70 benefit as well.
The way Social Security works, when both spouses are eligible for a Social Security benefit they have the option of claiming a benefit based on their individual earnings, or they are entitled to a benefit that is 50% of their spouse’s benefit. When one spouse dies and the surviving spouse has reached her FRA, she can choose between her benefit or receiving 100% of her spouse’s benefit, whichever is more.
Let’s use an example where a husband is the primary earner. I would recommend he delay drawing his benefit at least until his FRA, but ideally wait until he reaches age 70. Given that women on average outlive men, that will leave his wife with the highest possible payout if she is widowed.
But if the couple wants to start receiving some Social Security income prior to the husband turning age 70, the wife can begin to claim a benefit. If she has paid into Social Security and is eligible for a benefit based on her own record she can collect a benefit as early as age 62. Or, once her husband reaches his FRA, she can claim a benefit that is 50% of his. (The husband does not need to collect his benefit; he can opt to “file and suspend,” which entitles his wife to claim a benefit based on his earnings record while his own benefit continues to grow until he decides to start receiving a payment, ideally at age 70.)
Now let’s say that the wife starts claiming a benefit based on her own earnings record, and her husband is indeed waiting until age 70 to collect on his own earnings record. Once the husband reaches his FRA, say at age 67, he can start to pocket some Social Security income by claiming a 50% spousal benefit based on his wife’s earnings record. So from age 67 to 70 he and his wife are collecting 150% of her benefit.
Then when the husband turns 70 he can suspend his spousal benefit and start claiming on his own maximum age-70 benefit. Depending on the wife’s own benefit at that juncture, it can also make sense for the wife to stop claiming her own benefit and start to receiv
e 50% of her husband’s benefit. If the wife survives the husband she would then be eligible to receive 100% of his benefit. Because he waited to start claiming his benefit until age 70 he has ensured his wife will receive the highest possible payout.
I realize that is a lot to absorb. The most important point to focus on is that married couples should aim to have the higher-earning spouse delay drawing a benefit on his or her earnings for as long as possible, preferably until age 70. You can learn more about spousal claiming strategies at www.ssa.gov.
LESSON 4. ESTIMATE YOUR RETIREMENT INCOME: HOW ARE YOU DOING?
Early in your career you would need a powerful zoom lens to look far into the future and see what your retirement savings and income might be. But now that picture can be viewed in a more refined close-up. With just a decade or so to go until retirement we can get a clear sense of what your savings and other retirement income sources might be worth in retirement. Perhaps you have a plan to pay off your mortgage early; perhaps you have found a way to save more and reduce your expenses; and you now know when you can expect to draw a Social Security benefit. So let’s see how it all falls into place.
In this lesson I want you to actually calculate what you might realistically expect your income sources to be in retirement. For those of you familiar with my CNBC show, this exercise is your personal “How Am I Doing?” segment.
In retirement most of you will have two primary sources of income:
Your Social Security benefit
Your personal savings, be it in 401(k)s, IRAs, or regular taxable savings
Some of you will also have:
Income from a traditional pension
If you work for the government or in the public sector this is probably your situation. And while private-sector firms rarely offer pensions to new employees these days, older workers may have been grandfathered into an old plan.
Let’s walk through how to get a rough estimate of what your various sources of retirement income may be worth when you retire:
1. Estimate your Social Security benefit. If you have been paying into the Social Security system, you should receive an annual benefits statement; it’s typically mailed out a few months before your birthday. Please pull that out to find your estimated benefit. Or you can get the information at the Social Security Administration website: www.ssa.gov/estimator.
Your estimated monthly Social Security benefit at your FRA:
$____________________
2. Estimate the value of all of your retirement accounts at your FRA. Next, we want to know what all your current retirement savings might be worth when you reach your FRA, and from there we can estimate how much monthly income you might be able to generate from those savings.
One of the hardest challenges you face that your parents and grandparents didn’t have to stress over is how to spend your 401(k) and IRA money at a pace that won’t put you at risk of running out of money later in life. All your parents and grandparents had to do was mosey on down to the mailbox and collect their pension and Social Security checks. You need to calculate a sustainable withdrawal rate from your personal retirement accounts that won’t put you at risk of outliving your money. Talk about a changed retirement dream!
I am going to suggest that if you plan to start making withdrawals in your late 60s, you aim to withdraw no more than 4% in the first year. So, for example, if you have $250,000 in your 401(k), your withdrawal in the first year would be $10,000. Then you can adjust the amount you withdraw each year in line with inflation. If you wait until you are 70 to start your withdrawals, you might consider starting your withdrawals at a 5% initial annual rate.
Okay, did that news just give you a minor heart attack? Why am I telling you to start with only a 4% or 5% annual withdrawal rate? Well, it’s that same old good news/bad news problem: your life expectancy. Because we are living longer than past generations we need to set a conservative withdrawal pace that would give us a high probability that we would not run out of money in 25 or 30 years. Of course, this is just a rule of thumb. If you have other assets you can tap—maybe you expect an inheritance—or your family history suggests you may not live into your late 80s and 90s, then you might consider a slightly higher withdrawal rate. But please stand in the truth that your biggest retirement risk is also a blessing: the fact that you could live a very, very long time. A conservative withdrawal rate is your best strategy for making sure that long life will not come with financial stress.
My recommendation is to use a free online retirement calculator to help you estimate what the monthly income from your 401(k) and IRA investments may be. There are many variables that go into the calculation, including how much you will continue to save between now and retirement and the return you may earn. T. Rowe Price and Vanguard have calculators that use solid assumptions, including an initial 4% withdrawal rate.
Go to The Classroom at www.suzeorman.com:
There you will find links to the T. Rowe Price and Vanguard retirement income calculators.
Calculator tips:
Exclude Social Security from your calculation, as we have already figured that out.
Exclude your pension information as well; we will gather this in the next step.
Your Estimated Monthly Income from Your 401(k) and IRAs:
$____________________
3. Your pension. If you are eligible for a traditional pension your plan will be able to provide you an estimate of your expected monthly benefit. But here too you must make some choices as to how you want to receive your benefit. Many pension plans allow you to choose between taking a lump sum payout when you retire or opting for an ongoing payment—typically monthly—once you retire. The ongoing payment is called an annuity.
I highly recommend working with a trusted financial advisor to decide whether a lump sum or monthly annuity makes sense for you; there are many variables to consider. An advisor can offer expert guidance, but this decision will have a significant impact on your retirement security. That is why you must take responsibility and ownership of the decision.
Factors to consider if you opt for a lump sum payout:
• If you take a lump sum payment, I strongly recommend you do an IRA rollover that will transfer the money from your pension into your own retirement IRA at a discount brokerage. If you take the lump sum in a check, all that money will be considered income paid to you for the year and you will owe tax on all of it. That could be a huge bill. It is far better to do the rollover; you owe no tax until you start to make withdrawals from the IRA.
• If you do not need to live off your pension and you want to leave this money to your heirs, you would be better off taking the lump sum and doing a rollover rather than opting for the annuity payment. But please understand that you will be in charge of deciding how to invest that money once it is in the rollover IRA. And I want you to be extra careful here. The sad truth is that some unscrupulous advisors recommend inappropriate investments for the lump sum that generate big commissions for the advisor. If you want professional advice on how to invest your money, please work with a fee-only financial advisor. That means you pay a flat fee. This is a much better setup than working with a commission-based advisor, who will be paid based on what products he sells to you. Recommendations from friends and colleagues are always a smart way to find a trusted advisor; you can also locate fee-only advisors at the napfa.org website. (I also offer investing advice for retirees in the next chapter.)
Factors to consider if you take an annuity:
• If you want an ongoing monthly payment from the pension your employer will ask you to choose from a variety of payment options. The two most common types of pension options are:
Single life only. This will provide the payout to the retired worker. When that retiree dies, no beneficiary will receive a payout.
Joint and survivor. The monthly annuity will be paid to the retired worker, and a surviving spouse as well. You can typically choose a joint-and-survivor benefit that pays the surviving spous
e 50%, 75%, or 100% of the employee’s benefit. The lower the survivor benefit, the larger your monthly check. So if you opt for a 50% survivor benefit, your current monthly check will be larger than if you opt for the 100% survivor benefit.
• If you are married and you decide to opt for the annuity payout, I strongly recommend you choose the 100% joint-and-survivor benefit. This always elicits howls from couples who want the higher payout that comes from a 50% or 75% survivor benefit. But carefully think this through with me: If the pension will be a large part of your retirement income, could the surviving spouse live comfortably if the pension payment were cut by 25% or 50%? Remember, your spouse will also likely have less Social Security income at that time; if both of you were drawing Social Security checks, when one spouse died the survivor would be entitled to the higher of the two checks, but not both. If at that time they also lost 50% of the pension that you were getting that would make it very very rough unless you had serious sums of money. Choosing the 100% joint and survivor is a smart way to ensure the surviving spouse will have as much income as possible.
• If you decide you want to receive a monthly income check, please take the annuity directly from your pension. Do not let a financial advisor convince you to take the lump sum in a rollover that he can then invest in an annuity for you. The annuity from your employer will be a fixed guaranteed payment. An advisor can sell you an annuity that does the same thing if you take a lump sum, but in my experience many of the annuities sold by advisors have high fees, and sometimes you are steered into an annuity where your payment will vary based on the performance of investments. I think it makes more sense to go with the known rather than the unknown: Stick with the guaranteed fixed annuity from your employer.
