Monday, December 11, 2017

When Can I Afford to Retire and When Should I Commence my Social Security Benefits?

This post will address two of the more difficult financial questions confronting individuals who are considering retirement:
  • When can I afford to retire, and 
  • When should I commence my Social Security benefits?
Many factors enter into the decision of when to retire.  Our focus in this post will be strictly limited to the considerations of when retirement may be financially feasible.  We will not be covering the many non-financial questions/issues associated with ceasing employment and joining the ranks of the retired population.

To help you answer these questions and plan for the future, we encourage you to use the Basic Actuarial Equation or our Actuarial Budget Calculator (ABC) workbooks and our recommended assumptions to develop hypothetical spending budget decision “data points” based on alternative assumed retirement ages and assumed Social Security benefit commencement ages.  We will use these workbooks and a hypothetical worker named John to illustrate the calculations.

Before we dive into John’s numbers, we want to talk about the general impact on expected retirement income of continuing to work vs. retiring and deferring commencement of your Social Security benefit (the Social Security deferral strategy).  While it is common for retirement experts to tout the benefits of the Social Security deferral strategy as a way to maximize retirement income, we find that continuing to work (and at the same time deferring commencement of Social Security benefits) produces much larger increases in expected retirement income than retiring and employing the Social Security deferral strategy.

John’s calculations will show that if he retires and defers commencement of his Social Security benefit, he can expect his real dollar spending budget to increase by about 1% for each year of deferral (or slightly less if John is not in “excellent” health), whereas it increases by about 8% for each year that he continues to work.  Therefore, while we agree that the deferral of Social Security commencement strategy is probably “better than a poke in the eye with a sharp stick”, your decision of when to stop working is generally going to be a more significant driver of the amount of your spending budget in retirement than your decision of when to commence your Social Security benefit.

When can I afford to retire?  How much is enough?

Determining when you can afford to retire is a personal decision based on many factors, including:

  • Your tolerance for risk 
  • Your personal financial situation 
  • Your retirement goals
Common rule of thumb (ROT) suggestions for when you can afford to retire include when you have accumulated 10 or 11 times your annual compensation or when your retirement income replaces 70%-80% of your pre-retirement annual compensation.  We have even read that you should determine your “retirement number” using one of these ROT approaches and then double it.

Unfortunately, we cannot tell you exactly how much you will need in order to feel financially prepared to retire.  We can, however, provide you with a process to follow, workbooks to help crunch the numbers and a benchmark against which you can measure your progress at meeting your retirement age goal.

In order to replace about the same level of your spending after retirement as before, we recommend that you target about an 85% replacement level of spending.  After retirement, you will no longer be subject to work-related expenses such as FICA (Social Security and Medicare) taxes, and your federal income taxes should be lower than before retirement.   It is important to note that the target we recommend is 85% of your pre-retirement spending and not 85% of your pre-retirement pay.  So, if on average, you are saving about 10% of your pay just prior to retirement, your target would be 77% (.90 X .85) of your pre-retirement pay, and if you are saving 25% of your pay just prior to retirement, your target would be 64% (.75 X .85) of your pre-retirement pay.  So, if you want a lower retirement spending budget target, all you need to do is save more prior to retirement.  Also note that the 85% target is an average that might be a little low for higher compensated individuals and a little high for lower compensated individuals.

Of course, if you plan to spend more after retirement than before, for example by traveling more, or you just want to be more conservative in your planning, you will want to target a higher spending replacement level.  While research generally shows decreased levels of spending both at and after retirement, your situation may be different and you should plan accordingly.


Facts:  John was born on January 15, 1954 and is divorced.  He believes that he is in excellent health.  He is making $50,000 per year and is currently saving about 15% of his pay for retirement.  He has $400,000 in accumulated savings and if he retired and commenced his benefit in January, 2018, his Social Security benefit (estimated from the Social Security Online Quick Calculator) starting at age 64 would be $1,212 per month.  His employer matches his 401(k) contributions $.50 on the dollar up to six percent of his pay.  He has about $200,000 of equity in his home.  He has no mortgage and no longer pays alimony.

Retirement Goals:  While John enjoys his job, he is starting to think about retirement.  He does not want to become a financial burden on his son and wants to leave $50,000 in today’s dollars to his son upon his death to cover funeral and other miscellaneous expenses.  John believes that his spending after retirement will be about the same (in real dollars) as his non-work-related spending prior to retirement.  And while he may travel more early in his retirement, and he expects his health-related expenses will increase faster than inflation in the future, he believes that his other spending may decrease in real dollars as he ages.  Therefore, he is comfortable targeting constant real dollar recurring annual spending during his entire period of retirement.   Using the 85% recommendation, he determines his initial real dollar spending target in retirement to be of about $36,125 (.85 (1 minus John’s savings rate of 15%) X .85 X John’s pay of $50,000).

Assumptions: As a first step, John uses our recommended assumptions and our Actuarial Budget Calculator (ABC) for Single Retiree workbook to determine his Actuarial Budget Benchmark (ABB), assuming he retires on December 31, 2017 and commences his Social Security benefit at age 64.  He assumes that his home equity will cover his expected long-term care costs and he budgets $25,000 as the present value of his unexpected expenses.  He also assumes that he will retire completely and not take a part-time job.  After going to the Actuaries Longevity Illustrator, John selects a lifetime planning period (LPP) of 30 years based on his assumption of excellent health and the 25% survival probability level.

Initial Calculation

Based on the facts and assumptions discussed above, John calculates an ABB for 2018 of $29,661.  The screenshot below shows the details of this calculation. 

(click to enlarge)

Retire but defer Social Security commencement:  Based on his initial calculation, John decides to explores other planning options that will get him closer to his annual spending replacement target of $36,125.  He has heard that he can increase his retirement income after retirement by deferring commencement of his Social Security benefit.  So, he looks at the impact on his 2018 spending budget of retiring and deferring commencement of his Social Security benefit until age 70.  If he defers commencement of his benefit until age 70, it will be $1,846 per month before cost of living increases, which is equal to his $1,212 benefit divided by his early retirement factor of .8667 and further increased by 8% per each year of deferral after his normal retirement age of 66.  With six years of assumed cost of living increases of 2% per annum, his expected age 70 Social Security benefit is $2,079 per month.

He inputs $2,079 in cell E (11) as a monthly benefit and “6” in F (11) in the Input and Results tab of the ABC for single retiree workbook.  The resulting annual spending budget for 2018 increases to $31,752, an increase of about 7% over the initial calculation of $29,661.  This works out to be about 1% for each year of deferral, but the result is still less than John’s target of $36,125.

Note that if John were in “average” health (with an LPP at the same 25% survival probability level of 28 years), the six-year deferral strategy would be expected to increase his current spending budget by about 6% and if he were in “poor” health (with an LPP at the 25% survival probability level of 26 years), by about 5%.

John likes the fact that he can increase his annual spending budget by deferring commencement of his Social Security benefit, but when he goes to the Runout tab of the workbook, he notices that his accumulated savings will be much more depleted under the Social Security deferral strategy than under the immediate commencement strategy.  In fact, if all his assumptions are realized, he would have $120,373 less in accumulated savings under the Social Security deferral strategy at the end of year 5 of his retirement. He is also somewhat concerned that future changes in the Social Security program to address the system’s financial condition may make the Social Security deferral strategy less attractive than it appears to be today.

In any event, his calculations show that the Social Security deferral strategy won’t get him up to his target spending budget, so he decides to look at more options.

Keep working:  John now looks at options which require him to keep working.  So, he decides to look at the impact on his retirement spending budget of working one more year.  He switches to the ABC for single pre-retiree workbook and enters pay of $50,000 and “1” for the desired number of years until retirement in cell B (11).  He goes to the Social Security Online Quick Calculator which tells him his benefit would be $1,325 per month in today’s dollars if he retired at age 65 and commenced his benefit at that age.  With one year assumed inflation increase, this benefit would be $1,352 per month, or $16,224 per annum.   He enters this amount in cell E (15) and “1” in cell E (17).  He enters the same 30-year LPP, 15% annual savings, 2% per annum pay increases and $1,500 for the annual 401(k) employer matching contributions.  Instead of entering $50,000 as the desired amount remaining at death in today’s dollars as he did with the ABC for Single Retirees workbook, he enters $90,568 in this workbook as the desired amount remaining at death (in future dollars) which produces the same $50,000 amount in today’s dollars.

The resulting first year of retirement real dollar spending budget based on these entries is $32,121, or about 8% higher than John’s initial real dollar retirement spending budget.

John goes through this same exercise assuming retirement in three years and develops a first year of retirement real dollar spending budget of $37,563 (or about 27% higher than his initial budget estimate) and a little higher than his target.  Another option that John explores is to work two additional years and defer commencement of his expected Social Security benefit payable at age 66 until age 70.  He develops a first-year real dollar spending budget of $36,127 under this option, which is just about equal to his real dollar spending target.


There are many options that John, or you, can explore when determining the appropriate time to retire.  For example, you can consider:

  • Increasing your savings rate 
  • Working part-time in retirement 
  • Reducing your spending target 
  • Tapping some or all of your home equity 
  • Front-loading your real-dollar spending budget in retirement, etc.
Or, you can hope that your (or your financial advisor’s) investment strategies will generate the returns you will need to support your desired lifestyle in retirement.

The important “when-can-I-afford-to-retire” take-aways are:

  • How much you need to accumulate to feel financially secure with your decision of when to retire is a personal decision that should be based on your financial situation and goals, and shouldn’t be based on rules of thumb. 
  • You should probably do some number crunching before you decide to retire. 
  • We have workbooks that can help you do this number crunching.  These workbooks consider your total assets and your total spending liabilities. 
  • If you want to have about the same level of non-work-related spending after retirement as before, your first year of retirement real dollar spending budget should be somewhere in the neighborhood of 85% of your expected real-dollar spending just prior to your retirement. 
  • Continuing to work is generally going to be the most effective way of increasing your retirement spending budget.