“John’s calculations [using our Actuarial Budget Calculators] 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.’
In their recent research paper, “The Power of Working Longer,” the authors reach the same conclusion, stating, “Roughly speaking, deferring retirement by one year allows for an 8 percent higher standard of living for a couple and the subsequent survivor.” And while it is nice to have esteemed academic scholars support the same annuity-based pricing of spending liabilities that we recommend and confirm our calculations, we have some concerns about the authors’ assumptions and methodology, which cause them to conclude that working longer may be a more attractive option for individuals and couples than increasing their savings. While we agree that working longer is a powerful tool for increasing an individual’s or couple’s spending budget in retirement, we think it is probably a financial planning mistake to believe that you don’t have to save for retirement because you will simply work longer and rely on increased Social Security benefits, especially if you are relatively highly paid.
Authors’ Assumptions and Calculations for Stylized Household
The authors look at a “stylized household” which consists of a 36-year-old primary earner and his or her same age spouse. It is not clear from the example whether the spouse has the same earnings or has no earnings. The following assumptions are made by the authors:
- Whatever wage is being received by the household (either approximately the economy-wide average wage index by the primary earner and nothing for the spouse or two times that amount assuming they are both paid the same amount), it is assumed to remain constant until the assumed retirement age of 66
- Contributions of 6% of annual wage are made to their respective 401(k) plans and these contributions receive a 50% match (assuming here that the spouse actually has earnings) for a total of 9% of wage annual contributions.
- The assumed rate of return on accumulated savings in the 401(k) plans is 0%. This assumption is inconsistent with the assumptions used by the authors to convert accumulated savings to lifetime income and significantly inconsistent with the approximate 6% return assumption used in Social Security law to develop actuarially equivalent adjustment factors for early and deferred retirements.
- Social Security benefits for the husband and wife at age 66 are assumed to be 42% of their assumed to be constant wage at age 65. Note that the authors state that this is an average benefit payable at Social Security’s full normal retirement age, but under current law, age 66 would not be the full normal retirement age for these individuals. No Social Security spousal or survivor benefits are considered.
- Social Security law is assumed to remain unchanged in the future. This assumption includes continuation of actuarial increases of 8% per annum for each year of deferred commencement (even though increases in wages and real investment returns are assumed to be nil, and no changes in program benefits in light of significant future expected deficits.
- Accumulated savings are converted to an annuity at assumed retirement using fairly conservative assumptions and also assuming payment in the form of a joint and survivor annuity with 100% to be paid to the last survivor (even though the effect of survivor benefits in Social Security is to pay in the form of a joint and survivor annuity with 66.67% paid to the surviving spouse.
Comparison with Our Calculations
Somewhat surprising to us, given the assumptions made by the authors, the authors’ approximate 80%/20% distribution of expected real retirement income between Social Security and accumulated savings for this stylized couple is not terribly different from the distribution obtained by using the Actuarial Budget Calculator (Pre-Retired Couple) for a 36-year-old couple currently both earning $50,000 per year and contributing 9% of pay. For our calculations, we assumed:
- 3% future pay increases,
- Economic and longevity assumptions we recommend for determining the Actuarial Budget Benchmark,
- a 33 1/3% reduction in desired retirement income upon the first death within the couple.
- Social Security benefits from The Social Security Online Quick Estimator (with adjusted future pays to be consistent with our 3% pay increase assumption) of about 47% of final year’s pay (about $55,092 per annum in future dollars).
- Consistent with the author’s calculations, we assumed no other non-recurring expenses or other sources of income.
- We also ignored the present value of expected spousal benefits from Social Security upon the first death within the couple.
Using these assumptions, we developed projected total real first year retirement (age 66) spending of $74,957 of which $60,829 was expected to come from Social Security and $14,128 from accumulated savings. Thus, our calculations produced a 77% Social Security/ 23% accumulated savings lifetime income split for the authors’ stylized couple.
This total first year of retirement projected spending of $74,957 represented 62.07% of projected real dollar spending for the final year of working (age 65). Since it is less than the 85% rate that we recommend as a benchmark target, and further, since no reserves are contemplated for long-term care, unexpected expenses, rainy-day reserves, etc., we would encourage this stylized couple to consider alternatives such as increasing savings, continuing to work, taking on part-time employment, investing more aggressively, cutting back current expenses and/or not committing to funding education costs, tapping home equity, finding a rich person who will leave them an inheritance, etc.
Should You Give Up on Increasing Your Savings?
If you haven’t saved enough to date, we don’t think you should give up in your efforts to save for retirement and assume that you will just keep working and rely on Social Security. Here are some reasons why we believe you should increase your savings if our ABC tells you that you are falling behind:
- One very nice aspect of increasing your savings, from our point of view, is that it lowers your current spending budget and gives you a smaller spending target to replace in retirement. If you are saving 25% of your pay and you spend 15% of your pay on work-related expenses, your replacement spending target in retirement is only going to be 64% of your pay (.75 X .85). By comparison, if you don’t save, your replacement target will be 85% of your pay.
- The years just prior to your desired retirement will, in many cases, be your best opportunity to save. You may be eligible to make “catch-up” contributions and expenses such as education costs may be reduced,
- Given Social Security’s financial condition, there is a non-zero probability that Social Security benefits will be reduced in the future. These reductions may take many forms, including the possibility that Social Security’s actuarial increase factors for delayed commencement will be reduced to be more consistent with today’s low interest rates. We call this “Social Security Reduction Risk”
- You (or your spouse) may not be able (or want) to continue to work at a job that will pay you the same level of earnings (or more) as you age. Poor health, the need to take care of a family member, corporate downsizing initiatives/mergers, etc. may reduce employment opportunities. We call this “Continued Employment Risk”
- If you are highly compensated, Social Security represents a smaller percentage of your overall total retirement income, so you need to save more, all things being equal.
Conclusion
Working longer is a great solution to solving the problem of not having enough income in retirement, if you can make it work. As the old saying goes, “Nice work if you can get it” (pun intended). Therefore, unless you:
- really love your job,
- you are quite happy with the idea of working until age 70 or longer,
- you believe your boss thinks you are absolutely irreplaceable and/or there is almost no chance you (or your spouse) will lose your jobs (e.g., you are a tenured college professor),
