Chapter 18: Money in Retirement
Shelby Eatenton Latcherie: “The money is real nice and all. But l just like the idea of growing old with somebody. My dream is to get old, and sit on the back porch, covered with grandchildren, and I'll say: ‘No!’ and ‘Stop that!’”
– Steel Magnolias (1989)
When you’re in your twenties and thirties you may not be dreaming of porches. But we saw in the chapter on compounding returns how powerful an ally time is when it comes to saving money. And time you only get once.
That’s why there is one overarching piece of advice about retirement: start putting away as big a chunk of money every month as early as you can. Find an asset allocation that will let you sleep at night, and then leave it alone.
Retirement used to be a three-legged stool for many workers: Social Security, a pension, and savings. Things are wobblier today. More people have to rely on Social Security and savings alone. Pensions—also known as defined benefit plans—are becoming less common. Instead, 401(k) and other defined contribution plans have shifted the burden of saving and the risk of investing to workers. Even where pensions still exist there often is a big gap between the benefits that were promised and the money set aside to pay them. This problem of “underfunded pensions” has many people worried that the promised payments are in jeopardy.
Social Security
As we saw in Chapter 3, if you work you pay Social Security tax. Paying this tax entitles you to receive benefits when you retire. You can work on and off, but you need at least ten years under your belt to get any benefits. How much you get will be based on your average earnings over thirty-five years. Say you average $60,000 of income a year over that period; then you can expect to receive a yearly benefit of about $26,000. If you’re married, your spouse gets at least another $13,000 even if they didn’t work at all. Also, Social Security benefits are at least partially tax-free, so they go a bit further than regular earnings.
There are two major advantages of Social Security. One is that benefits increase with inflation. The dollar figures here are for 2020, but they will increase with future inflation. The second is that benefits last for life. You’ll get monthly checks even if you live to be 100 or more.
When do you start getting benefits? Full retirement age for anyone born after 1960 is sixty-seven. You can start collecting as early as sixty-two, but you’ll get much less. You can also opt to delay benefits until you are seventy and get significantly more. For most healthy people, planning to delay is a smart move. Of course, that means working longer or having other money to live on until age seventy.
Will Social Security be there when you are ready to retire? Right now, the cushion (“trust fund”) built up in the past is being used up and expected to run out by 2034. At that point, FICA taxes paid by workers are expected to only cover about 76% of promised benefits. No one knows how Congress will deal with this. Either benefits will be reduced, or the government needs to raise taxes or borrow more. Most likely it will be some combination of the three. But it is unlikely that benefits will disappear entirely.
It's not too early to set up a my Social Security account, which will let you check your earnings history for accuracy, estimate your future benefits, get a replacement Social Security card, and more.
Savings
With Social Security alone, you probably won’t be able to maintain your pre-retirement standard of living. That’s why taking advantage of retirement saving incentives (see Chapter 10) should be part of your plan.
How much do you need to save? It obviously depends upon what kind of a beach you want to retire on. Here is an important perspective. Focus on how much extra income you want in retirement and work backwards. The table below gives a rough rule of thumb for how big a pile of money will give you that income. [46]
Desired Annual Income | Savings Target | ||
Conservative (pretty likely to be enough) | Moderate (should suffice) | Aggressive (can last with a little luck) | |
$10,000 | $330,000 | $250,000 | $220,000 |
$25,000 | $830,000 | $625,000 | $550,000 |
$40,000 | $1,330,000 | $1,000,000 | $890,000 |
$75,000 | $2,500,000 | $1,875,000 | $1,665,000 |
These numbers should be an eye opener and reinforce the message at the beginning of the chapter: Let time work for you and start saving for retirement right away.
Annuities
As you get older, you may become a target for annuity salespeople. Annuities are bewildering financial products. They are often rightfully slammed for being too complicated and expensive. Unfortunately, they are also often pushed onto unsuspecting seniors.
There are two types of annuities to keep on your radar: immediate annuities and deferred income annuities. They protect you against longevity risk, which is the risk of living so long that you run out of savings. It may make sense to buy one of these with some of your retirement savings to ensure that you have at least some money coming in for the rest of your life.
Immediate Annuities
With an immediate annuity you hand over a chunk of money to an insurance company and in return you get a guaranteed monthly payment for the rest of your life starting immediately. Think of this as a permanent, irreversible deal. If you die early, you will have bought insurance against living too long that you didn't need. But if you live super long, the annuity has you covered. [47]
Deferred Income or Longevity Annuities (DIAs)
DIAs work like immediate annuities, but you give the insurance company money today and payments start sometime in the future—usually ten to twenty years later. The payments from a DIA are proportionately much higher than from an immediate annuity. DIAs are intended to make sure you have money coming in if you grow really old. Don't confuse DIAs with various deferred annuities such as fixed annuities, fixed indexed annuities, or variable annuities, which are the complicated, expensive ones. With a DIA you know today the size of the payment you will receive starting at a predetermined, advanced age.
Buying Annuities
The insurance company you get the annuity from should be financially strong. Even though there are some state protections for consumers, you want this company to be around for decades. There are several rating agencies that analyze the financial strength of insurance companies; the main ones are Standard and Poor’s, Moody’s, and A.M. Best. Buy annuities only from a company that has very strong ratings from Standard and Poor’s (AA or better) or Moody’s (Aa2 or better). You can usually find financial strength ratings on the insurance company’s website. New York Life is one of the highest rated companies and often has competitive quotes. Other strong annuity companies are Mass Mutual and Guardian Life.
It’s also usually best to get a so-called “life” annuity. This is one that pays you until you (and your spouse, if it is a “joint life”) die and then stops. You might see options such as a “period certain” or “refund at death” which guarantee some further payments if you die relatively early. But usually they are not worth the lower regular payments.
Annuities can give you some peace of mind in retirement. Be aware, though, that unlike Social Security, the payments aren’t guaranteed to keep up with inflation.
You buy annuities through an insurance agent. One source for quotes is online insurance agency Blueprint Income. Schwab and Fidelity have affiliated insurance agencies that can also provide quotes. Note though, that regardless of the agency you buy from, it’s the insurance company that makes and guarantees the payments.
Resources
Government and Regulatory Agencies
Social Security Administration | All things Social Security, with information and calculators | |
Overview brochure on Social Security and Medicare |
Businesses
Open Social Security | Good free calculator by a CPA and long-time financial blogger to figure out when to claim Social Security |
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