Calculating the financial impact of working longer

Often clients and friends who are baby boomers ask me: “How much longer do I have to keep working?”

This is a familiar question, as baby boomers who once thought retirement was right around the corner now see it as way down the block or entirely out of the neighborhood. Whether their lack of preparedness arises from insufficient savings or recent portfolio losses, many boomers are coming to terms with the fact that they will have to work longer than previously planned.

The question is: how much longer will they need to work, and what impact will those extra paychecks have on their retirement income plan?

In laying the groundwork for this discussion, typically there are four big decisions you control when it comes to retirement income planning:

1. When to stop working?

2. When to start taking Social Security?

3. How to manage withdrawals from your savings?

4. How to allocate your assets?

Working longer

By working three years longer — from age 62 to 65 — and saving 15 percent of annual salary could raise your annual income from investments by 22 percent. Working five years longer could raise annual income from investments by 39 percent. Working five years longer and increasing annual savings from 15 percent to 25 percent could provide 50 percent more retirement income than if the client had retired at age 62. These results assume the client earns $100,000 per year and already has $500,000 in savings.

Delaying Social Security

Working longer also allows clients to delay taking Social Security. Delaying benefits three years — from age 62 to 65 — results in a 27 percent increase in the purchasing power of a retiree’s Social Security benefits, from $17,772 per year to $22,644. Delaying to age 70 nearly doubles the purchasing power of benefits to $33,408. And this does not take into account annual cost-of-living adjustments.

Taking all three steps — working longer, saving more, and delaying Social Security from age 62 to 70 — would almost double total retirement income from investments and Social Security in today’s dollars. So a client who had been looking at retirement income of, say, $37,772 ($17,772 Social Security plus $20,000 from the investment portfolio) could actually enjoy a retirement income (in today’s dollars) of around $75,000 starting at age 70.

For you who aren’t willing (or able) to keep working to age 70 and who do not need to double their retirement income, the following options would each raise retirement income by about 30 percent:

Retire in three years, at 65, by saving 25 percent of annual salary.

Retire in three and a half years, at 65½, by saving 15 percent of annual salary.

Retire in four years, at 66, by spending rather than saving additional earnings.

Taking withdrawals - The “4 percent Golden Rule”

For 30 years, the standard practice was to start withdrawals at 4 percent of the account value and increasing the amount by the inflation rate each year. This would provide an 89 percent probability that assets would remain at the end of a 30-year retirement. Raising the initial withdrawal rate to 5 percent would reduce the odds to 40-65 percent, depending on the asset allocation strategy used. This is referred to as the “4 percent Golden Rule.” The only problem is what if you are in the other 11 percent at the end of 30 years.

While the “4 percent rule” was confirmed, it is important that retirement withdrawals should be carefully monitored and adjusted if necessary. If retirees suffer poor portfolio returns in the first few years of retirement, they should consider lowering their withdrawal amounts temporarily or at least holding their annual withdrawals flat for a while instead of increasing them for inflation. There have been recent studies recommending 2.8 percent.

Asset allocation

The asset allocation decision was said to be less important than the other three decisions, but the study cautioned retirees against holding too few equities. Instead, “moderate exposure to equities is recommended for diversification, growth potential, sustaining real income, and providing a ‘cushion’ to cover unexpected expenses during a 30-year retirement.” As we know, real life can turn out to be different. To allow an equity base, it would be a wise plan to include a guaranteed, inflation adjusted lifetime income stream as a foundation.

Putting the four decisions in perspective

The bottom line is that all four of these decisions — when to stop working, when to take Social Security, how much to withdraw in retirement, and how to allocate assets — will determine, independently and together, your financial success in retirement. The best results come from working longer, although delaying Social Security, taking minimal withdrawals, incorporating guaranteed income products, and holding more equities also contribute to retirement security.

But no one wants to work forever, deprive themselves of needed income, or subject themselves to excessive market risk. With planning, you can retire comfortably and be relatively assured of having enough inflation-adjusted income to last their life expectancy. It’s a tall order and may require you to accept some unwelcome news (“I have to work how many more years?”), but having all the numbers and decision points laid out for them is vastly superior to not knowing.

Performing a Social Security analysis may be one of the most important strategies both individuals and couples can use to increase future income. Knowledgeable financial advisors and accountants can also be excellent resources for helping navigate the Social Security maze. Should you like to discuss, or have more questions, please feel free to give me a call.