Monday, April 28, 2014

Deferring Commencement of Social Security Benefit is OK, Deferring Retirement is Better

There have been a number of articles recently touting the benefits of deferring commencement of one's Social Security benefit.  For example, in my post of December 8 of last year, I quoted the author of one such article who said, "Rather than annuitizing retirement wealth, participants can get a much better deal by spending down retirement assets and deferring Social Security."  This post will examine a hypothetical situation in an attempt to quantify how much more retirement income a person could have by deferring commencement of his Social Security benefits.

Let's look at a 65 year old male with accumulated savings of $800,000 in 2014.  His Social Security Normal Retirement Age is 66.  He is eligible for a Social Security benefit of $2,000 per month (plus an inflation adjustment) if he retires at age 65 and commences his Social Security benefit at age 66, or $1,867 per month (.9333 X $2,000) commencing immediately if he retires at age 65 and commences at age 65.  Assuming annual inflation increases of 3% per annum, retirement at age 65 and deferral of his Social Security benefit until age 70, he would receive a benefit of about $3,060 per month (1.32 X $2,000 plus 5 years of assumed 3% per annum inflation increases).

The table below shows total spendable income available to the individual from accumulated savings, Social Security and, in the third scenario from a life annuity developed by using the simple spending spreadsheets found in this website and the assumptions recommended for use with the spreadsheets.  Readers are reminded that the spreadsheets provided in this website are designed to provide level real dollar total spendable retirement income from year to year over the expected payout period.

(click to enlarge)

Under Scenario 1, the individual retires at age 65 and commences Social Security immediately.  He uses the actuarial approach in this website (Excluding Social Security 2.0 spreadsheet) to determine his annual withdrawals from accumulated savings.

Under Scenario 2, the individual retires at age 65 but defers commencement of his Social Security benefit until age 70.  He uses the Social Security Bridge spreadsheet to determine the extra withdrawals from his accumulated savings that will, when combined with deferred Social Security benefit, provide level real dollar spendable income from year to year.  In this instance, the present value at 5% interest of those extra "bridge" payments is $152,480.

Under Scenario 3, the individual retires at age 65 and commences Social Security immediately.  He takes $152,480 of his $800,000 retirement nest egg and buys a life annuity.   I used a purchase rate of $14.03 per each dollar of annual income obtained from to determine the immediate life annuity payable at age 65.

As the table shows, total retirement income is comparable for the first three scenarios with the deferral strategy (Scenario 2) being somewhat better than the immediate commencement and no annuity purchase strategy (Scenario 1) but only slightly better than using the same amount of money to purchase a life annuity (Scenario 3) at current annuity purchase rates.

But, if this person really wants to get a significant increase in retirement income, he needs to work another five years.  Scenario 4 assumes that he continues to work until age 70 and retires at that point.  His accumulated nest egg in 2014 is assumed to earn 5% per annum and he is assumed to contribute $10,000 each year and his employer is assumed to contribute $2,000 each year.  While his Social Security benefit should increase somewhat as a result of five additional years of earnings and tax payments, we have assumed it would remain the same.  Under these assumptions, his benefit at age 70 is at least 35% higher than the benefits payable at age 70 under the other strategies.

Take Away:  Deferring receipt of Social Security may be able to get you a little more retirement income (depending on assumptions employed and actual experience), but if you really want more retirement income, you need to defer both your retirement and Social Security benefit commencement date.  This strategy works for you in two ways--it should increase your accumulated retirement nest egg and it reduces the expected payout period. 

Thursday, April 24, 2014

Back to How Much Savings is Needed

The primary focus of my posts is on how much accumulated savings can be spent each year in retirement.  But since that amount is generally linked with how much accumulated savings one has, readers will forward me articles aimed at pre-retirees looking for advice on how much they need to have saved at retirement. 

I have addressed this issue somewhat in this article and most recently in my post of May 31 of last year where I concluded that if you don't have sources of retirement income other than Social Security, you probably shouldn't be too worried about over-saving until you have accumulated at least 10 times your annual salary. 

This past week, I read "Have You Saved Enough to Retire?" and "Why not even $1 million may not be enough for retirement".

The first article references Fidelity's very optimistic "8 times" rule, which claims that if you are an "average worker", retire at age 67, die at age 92 and accumulate savings of 8 times your pay at retirement, you can enjoy total retirement income (Social Security and withdrawals from accumulated savings) of approximately 85% of your gross pre-retirement pay.  Based on the recommended assumptions in this website (5% investment return, 3% inflation and payments until age 95), I come up closer to a 70% replacement rate.  Of course, Fidelity assumes that you will earn an average nominal rate of return of 7.5% per annum with 2% inflation (a real rate of return of 5.5% per annum).  If I input Fidelity's assumptions in the "Excluding Social Security 2.0" spreadsheet on this website, I do get a replacement rate of 88%, so, at a minimum, I can confirm Fidelity's calculations, if not the reasonableness of their assumptions.

The second article argues that $1 million in accumulated savings at retirement may not be enough.  Whether it is enough will depend on many things, but I can provide some spending numbers associated with having $1 million in accumulated savings and you can make up your own mind.  If Social Security income is around $30,000 per year (about the maximum in 2014) and no other retirement income sources exist, then total annual gross retirement income (Social Security and withdrawals according to the approach outlined in this website) for an individual retiring at age 67 with $1 million of accumulated savings will be about $75,000 to $80,000 depending on how much of the $1 million is used to purchase an immediate annuity (based on current annuity purchase rates) and/or whether the retiree delays receipt of Social Security benefits.  This level of retirement income will probably be enough for many individuals who retire in the near future.  Keep in mind, however, that it assumes retirement occurs at age 67 with $30,000 in annual Social Security income.   

As an actuary, I tend to be fairly conservative.  I wish I could tell pre-retirees that you don't need to accumulate all that much to afford to retire, but in all good consciousness, I just can't.  If you want, you can certainly plan your retirement by assuming that you will earn a 5.5% real rate of return on your retirement assets, there will be no reductions in Social Security benefits, or you will retire later than age 67, etc.  Or, you can follow the more conservative path and save more now for your retirement. 

Friday, April 4, 2014

Delaying Commencement of Social Security--Internal Annual Real Rate of Return Calculations

Dr. Wade Pfau has produced another fine article of interest to individuals who are in a position to delay commencement of their Social Security benefits.   As discussed in several of our previous posts (most recently December 8, 2013), there are at least two ways to delay commencement of Social Security benefits.  One can keep working, or one can retire prior to age 70 and use their accumulated savings to "bridge" the period of delay by paying themselves what they would have received had benefits commenced earlier than age 70.  We have a spreadsheet to enable individuals to see how such a bridging approach could affect their total retirement spending budget.

In Dr. Pfau's article, he has determined internal annual real rates of return assuming death occurs at various ages for individuals with a Social Security Normal Retirement Age of 66 assuming commencement at age 62 vs. delaying commencement until age 70 and subsequent death at a later age.  He also assumes no changes in current Social Security law.  So, for example, he has determined a 3.2% internal annual real rate of return for an individual who dies the day before his 85th birthday (at age 84) resulting from his decision to delay commencement until age 70.  So, if inflation is 3% per annum, this example individual who elects to delay commencement of Social Security until age 70 and use his accumulated savings to bridge the payments he would have received will be financially better off provided he does not earn more than approximately 6.2% per annum (3.2% real) on his accumulated savings and the Social Security benefits he receives.

As shown in the article, internal annual real rates of return are lower than 3.2% if the individual dies earlier than age 84 and higher for deaths occurring after 84.  So, if you definitely know that you are going to live past your mid-80s, the delay strategy appears to be a good one unless you anticipate earning relatively high real rates of returns on your investments or changes in the Social Security law.