What’s Your Retirement Number? Higher than You Might Think!

7 09 2011

by Michelle Ash,  CFP®, CDFA™

As I start to write this article, I feel like maybe I should give readers a caution like you see at the start of some TV shows:  “The program you are about to watch contains disturbing images. Viewer discretion advised.”  This message is important!!!, but the telling of it isn’t necessarily going to be pretty.

Recently I have had the opportunity to experience a new phenomena in my career.  In the past couple of months, much by happenstance, our firm has had a number of younger individuals engage our services.  By younger, I mean they are generally of or near my own age demographic:  late 30’s to mid-40’s.  These individuals have generally been contemplating their future retirement, among other financial goals, and have hired us to put together a retirement plan to see how they’re progressing on that path.

Previously, our firm has primarily worked only with individuals ages 50 and above, who are often in what I call the “final chute” towards reaching retirement.

I have long observed the unpleasant circumstances that loom ahead for individuals who have not planned and saved well for retirement.  But since I was usually seeing those individuals at or near the age at which they had hoped to retire, I wasn’t necessarily able to understand what decisions might have led to their current status.

Having the opportunity to work with individuals who are twenty or even more years away from retirement, I can see the habits that cause success, or prevent one from achieving it.  In the process of that observation, I am also noticing an extremely disturbing trend.

The issue is thisI notice a general assumption that contributing the maximum funding to one’s 401(k) plan is all that really needs to be done to fund a retirement.

Now, I realize and agree that for some people, getting to the point where they can actually save $15,500 per year of their salary, the current maximum funding allowed for an employee under age 50, is a fabulous goal in and of itself.

But what bothers me is when I see individuals or couples making $150,000 per year, $200,000 per year, sometimes even more than that, and they think that just maxing their 401(k) is all they really need to do in order to be able to retire at age 60, live a long retirement, and have a lifestyle largely commensurate with that they currently live.

I guess I just have one thing to say to these people:  WAKE UP.  You are living in a fantasy, and if you stay there, the reality you are faced with once you get to retirement is NOT going to be a pleasant one.

Let’s run what I’ll call an “average” desired retirement.  It’s a standard many clients describe to me as “comfortable” but is certainly not lavish by most accounts.

• Retire at age 60
• Have $48,000 per year for expenses and budget needs (in today’s dollars)
• Have their house paid off by retirement
• Dollars for Property taxes, homeowner’s insurance, health insurance, and Medicare supplements are extra expenses above the base $48K
• Spend an extra $5,000 per year on travels or other hobbies while healthy
• Upgrade their vehicle every 7 years or so
• Have enough money to cover emergencies, home repairs, and medical emergencies
• Have enough money to last the rest of life no matter how long that lasts

After factoring in inflation, this scenario results in retirement costing approximately $96,000 in year one and $346,000 in the final year (assuming death at the age of 95).  Imagine if, just like going out to eat where your waiter hands you a final bill at the end of the meal for all of the different courses you ate, someone were to hand you the bill for your retirement at the very end of it.  If someone were to add up year by year the total cost of this retirement, the “number” that would result would be $8,905,800. **(Assumptions are listed below.)

Have you ever seen that commercial where people are walking around carrying their retirement “number”?  I have heard many people say they’ve been frightened by the size of some of the numbers.  Guess what – unfortunately those numbers can be very real!

Fortunately, there is a potential income source to help offset that need:  social security.  (As a sidebar, the cynical Gen X’er in me wants to say “yeah right, like we can count on that!)  We’ll assume there is no pension income, since a majority of Americans today, particularly younger ones, are no longer eligible for corporate pensions.  Using current rules, social security would account for approximately 39% of the overall need mentioned above. **

But that still leaves us over $5 Million dollars of future money needed in retirement that is unaccounted for.  This is not, of course – the “number” that needs to be accumulated prior to retirement, since accumulated dollars will likely earn a return during retirement.  However, it does accurately reflect the total likely cost of retirement – and can give insight to the size of the number which would need to be accumulated prior to retiring.

Let’s assume our hypothetical family has already saved $100,000 in 401(k)’s, which is the average amount we tend to see amongst individuals around age 40.  Solving this equation to determine how much money this family needs to save from this point forward, from age 40 until retirement at age 60, results in needing to fully fund each of their 401(k)’s at $15,500 per year each, PLUS save an additional $1,445 per month, or $17,340 per year.

Is this possible?  Especially if this requires them to save a good bit more than the maximum contribution allowed for most employer plans, it requires getting serious about their financial goals – and doing something about them – or… accepting something less.  Many people don’t like to hear advice like that, but please understand that it is not a judgment – it is just math.

I realize that at this point, some people reading this article might just want to throw in the towel and give up altogether.  As I said earlier, for many people, just getting to the point of contributing the maximum amount to a 401(k) can be a great goal.  I do not mean to diminish that accomplishment.  Ultimately, any savings you do will be better than nothing.  But what I do hope to do is cause people to realize that it takes a lot of hard work and a lot of saving to get to the point of a comfortable retirement.

With that in mind, my general suggestion to people working towards retirement, regardless of age, would be to save, save, and then save a little more.  That, or work with a CERTIFIED FINANCIAL PLANNER™ professional who can help you determine what your actual “number” is, and then make sure you’re doing everything you can to achieve it.

Expense Assumptions: 

  • House is assumed to be paid off prior to retirement.
  • Property taxes and homeowner’s insurance = $5,000 per year, inflating from today at 3.71%
  • Travel/Other Hobbies Budget of $5,000 per year inflates from today at 3.71% and ends at “advanced age” of 82 when many seniors no longer travel or pursue other hobbies as much.
  • Car upgrades begin in year 3 of retirement, occur every 7 years, and cost the equivalent of $20,000 today inflated at 3.71%.
  • Age at death = 95 for both spouses
  • Emergency savings, home repairs, and medical emergencies not accounted for since they are not quantifiable in this fact pattern.

Income Assumptions:

  • Social Security income is drawn at age 62 for both spouses.
  • Benefit amount = $18,960 per spouse, based on earnings that equal or exceed the current earnings cap of $106,800 throughout both spouses’ entire working history for 38 years (age 22 to 60).  (Source:  http://www.ssa.gov)
  • Inflation rate of 2.5% assumed on social security benefits, since Social Security benefits have not historically kept up with the rate of inflation.
  • Both spouses are assumed to live until the age of 95, meaning the family receives both social security incomes throughout retirement.

 Additional Savings Needed Assumptions:

  • Rate of Return = 7% annually.  This 7% is a mathematical figure, is hypothetical, and does not represent the returns of any particular investment or product.  Rate of return is applied to both existing accumulated dollars and future invested dollars.
  • Starting investment assets accumulated equal $100,000 in 401(k) plans.
  • Need reflected ($17,340 per year) is a total additional savings need , above 401(k) contributions of $15,500 per spouse ($31,000 total combined).  Total annual savings needed is therefore $48,340.
  • Investment time horizon:  Age 40 (current age) to age 95 (age at death).
  • Assets accumulated are assumed to be fully invested for the full lifespan of our hypothetical couple.  Both income and principal are consumed to meet retirement needs.

This blog article does not constitute legal, tax, or personal financial advice.  Please consult your own financial professional for personal, specific information.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.


Should I wait to retire for bigger Social Security benefits?

2 06 2011

by Michelle Ash, CFP®, CDFA™

Along the road of life there are many milestone ages – age 16 to drive, age 18 to vote, age 21 to drink, and so on.  When it comes to thinking about retirement specifically, there are a number of milestone ages there too – at age 50 you get your AARP card (usually without requesting it), at age 55 you can take penalty-free withdrawals from an employer plan like a 401(k) if you are retired or separated from service, and at age 59-1/2 you can take penalty-free withdrawals from an IRA.  The BIG milestone that causes many people to stop and think, though, is the age of 62.  What happens then?  Well, under current laws, age 62 is the first time in which a worker or spouse can draw social security retirement benefits.

However, age 62 is sort of like the minimum entry point to social security retirement benefits.  Think of it in the same way as if you were buying tickets to a sporting event or concert:  you’ve got the base tickets that cost the least and get you in the door but you might be in the nosebleed seating section; and then you’ve got better seats which cost more.  With social security, if you want a “better seat” – meaning a bigger social security check each month – then your additional “cost” is waiting until a later age to draw the benefits.

In fact, for individuals reaching the age of 62 today, their Full Retirement Age (FRA) is age 66.  As it’s name implies, that’s the age at which full benefits have been earned.  For individuals born in years 1955 or later, the FRA age is even higher than 66.  Under current law, the maximum FRA age is presently 67.

You’re not limited to the choices of age 62 or your Full Retirement Age as your only two options, however.  You can choose to draw benefits anytime in between those ages.  There is a sliding scale of reduced benefits that applies.  If you’re mathematically-minded and want to figure it out for yourself, you deduct 5/9th’s of one percent for every month you draw the benefits early.  I’ll give an example of how to calculate it in just a moment, however if you’re not inclined to do the math yourself, you may want to visit the Social Security Administration’s website at www.ssa.gov.  There you will find charts based on your year of birth that give you the exact percentage of benefit you would draw based on your age when you retire.  They break it down by month, so the data is very precise and helpful.

Here’s an example of how to calculate your social security benefit between ages 62 and FRA:

Jane wants to retire now at the age of 63.  Her Full Retirement Age is 66.  Her social security statement tells her that her FRA benefit is $2,000 per month.  If Jane wants to retire now at 63, she will multiply 5/9th’s, or 0.5555, times the number of months she’s retiring early.  In her case, it’s an even 36 months she’s retiring early.  So, Jane multiplies 0.5555 x 36 months = 20% (by rounding).  Jane multiplies that 20% times her FRA benefit of $2,000 and gets a reduction of $400/month.  So, her age 63 benefit will be $1,600 per month.

Factors to Consider

The numbers can give us a very monetarily-based answer, but like many things in life, the decision is often not quite so simple.  Consequently, very frequently we hear the question:  “Should I wait to retire for those bigger social security benefits?”

If Jane in our example knows her exact monthly budget and how much money she needs for her expenses every month, it might be very simple for her to decide whether the $1,600 per month benefit will be enough and whether to go ahead and retire.  But Jane might also look at things and feel like $400 per month of additional dollars, which she could have just by waiting three more years to retire, is an awful lot to sacrifice.  However, she also has to weigh in the fact that, during the three years between age 63 and 66 that she’s not receiving social security, that’s $1,600 per month that she’s not getting.  The question this often leads to is – “What’s my breakeven?”

Your Social Security “Breakeven”

Your breakeven is essentially the age at which the cumulative amount of extra money you got by drawing the benefit at an earlier age is equal to the cumulative amount of money you would have by waiting and getting a bigger benefit.  Generally, the breakeven is between 12 and 14 years after you began drawing early benefits.  What this means is that, if you believe you will live longer than 12-14 years in retirement, then you’ll have received more social security money by waiting to draw your benefit.  If you do NOT believe you’ll live that long and are planning to retire and no longer work, then you are better off drawing the benefit before your Full Retirement Age.

Continuing our example from before, Jane’s breakeven is exactly fourteen years.  At her age of 77, if she draws social security at age 62 and receives $1,600 per month, she will have received a total of $288,000 in benefits.  By comparison, if she were to wait until age 66 to draw her FRA benefits at $2,000 per month, she will have also received a total of $288,000 in benefits.  The real question then becomes – does Jane believe she’ll live beyond age 77?  If so, and if she wants a bigger paycheck, then she may want to wait.  If not, it may make sense to go ahead and draw benefits.

The Crystal Ball of How Long You’ll Live

I always find it interesting to discuss longevity, or how long you’ll live, with people.  Actually, the first hurdle is sometimes discussing it at all, since some people don’t even want to think about it.  But in my world of financial planning, at least in terms of social security benefits, it often becomes the critical question.  If we all knew exactly how long we’d live, it would be very easy to then figure out when to draw benefits to get the most amount of money from the program.  Most of us, though, don’t really have that crystal ball, or at least not one that’s real accurate.  How can you estimate?  Here are the factors I’d suggest considering:

1. Family Longevity – how long do the people in your family tend to live?  Are their health and circumstances similar to yours?  If so, this might be a good indicator.  If circumstances are substantially different, however, they might not be a good comparison.

2. Statistics – what do the mortality tables say?  Statistically today, according to data from the US Census Bureau (1), a man who is age 60 today can expect to live to the age of 80.9, and a woman to the age of 83.9.  Sadly, younger individuals today actually have a LOWER life expectancy, likely due to childhood obesity and other problems facing our nation.  That’s a topic for a different blog, however.

3.  Personal Circumstances – how’s your own health?  Do you take care of yourself by being physically fit and eating healthfully?  Do you control your stress levels?  Do you have balance to your life?  “Yes” answers to these questions may tend to lead to a longer life.  “No” answers may, though not always, detract from it.

Factoring in Social Security Rule Changes

Everything discussed so far is predicated on the current rules of the social security program.  Whether those rules will remain the same, however, is anyone’s guess at this point.  Certainly we hear about the program needing to change because it’s going broke.  Will it change?  Your guess is as good as mine.  Without knowing the future of social security, all you can do is decide what YOU think will happen, and take action accordingly.

Do you believe benefits may no longer be offered between age 62 and your Full Retirement Age?

Do you think your Full Retirement Age might be raised?

Do you think benefit payouts will be reduced?

If you’ve answered “yes” to any of these questions, then you may want to give serious consideration to drawing early.  On the other hand, if you are not bothered by these possibilities, and prefer to make the decision on your own terms instead of succumbing to fears, then you may prefer to wait and draw social security when you otherwise would.

Two Important Social Security Rules to Be Aware Of Before You Decide

Another factor that is extremely important to consider if you are thinking about taking social security benefits prior to your FRA is this:  are you completely finished working, or are you just retiring from one career and may start working another?  The reason this is important is because, if you draw social security between age 62 and your FRA, then any wages you make over about $14,160 per year cause your social security earnings to have to be given back.  The general rule of thumb is that you lose $1 of benefit for every $2 you earn.  In general, if you earn more than $55,000 in annual wages, you’ll have given back your whole social security benefit.  Since by drawing it early  you’ve already locked in a lower benefit, it makes very little sense to draw it and then give it back.  Don’t think you can hide the information from the Social Security Administration (SSA) either, as they and the IRS do share data.  If the SSA finds out money is owed back to them, they will deduct it from your benefits – in a hurry.

There are caveats to these statements:  you can proactively suspend your social security benefits  if you see this issue coming.  You should also know that social security gives you credit on your earnings record for the continued wages you’re drawing so that it benefits your social security amount.  All of those items are beyond the scope of this particular article.  Generally, it’s easier to avoid the whole issue up front.  However, if you’re already in the middle of such a situation, it may be a good idea to either do some online research on www.ssa.gov, or make an appointment with the folks at the Social Security Administration for individual guidance.

Another important factor to be aware of is that the benefit you draw at your Full Retirement Age is NOT the maximum benefit possible.  Under present laws, if you were to defer your benefits until after your FRA, they could continue to increase until age 70.  Here’s the lucrative part:  the benefit increase is currently a guaranteed 8% per year.  If you’re going to retire late, don’t need the money right away, or think you’ll have really long life span, this may be a great way to grow your benefit with absolutely no market risk.  Age 70 is the maximum age, though.  Beyond age 70 the benefits do not increase by waiting, so it does not make sense to defer benefits beyond that age.

Other Considerations and Where To Go From Here

There are MANY other strategies that financial planners such as myself have discovered and can apply to individual situations.  If you are married, there are factors regarding the age and work status for both you and your spouse that may be important to factor into your situation.  Unfortunately, many of those get too complex to go into here.

What’s my best advice if you’re still uncertain about when to draw benefits after everything you’ve read here?  Seek the help of a qualified retirement specialist like a CERTIFIED FINANCIAL PLANNER™ professional to help you figure it out.  You can research professionals in your area by visiting the CFP Board’s website at www.letsmakeaplan.org.

Footnote (1):  Table 103. Life Expectancy, by Sex, Age, and Race: 2007.  Source: U.S. National Center for Health Statistics, National Vital Statistics Reports (NVSR), Deaths: Final Data for 2007, Vol. 58, No. 19, May 2010. See also http://cdc.gov/NCHS/products/nvsr.htm#vol58/.


Disclaimer:  This blog article is not personal financial advice.  Please consult your a financial professional for personal, specific information.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.