You don’t need fancy financial products to stretch your retirement savings. In fact, most Americans have access to the best retirement income generator around: Social Security, according to a recent report.
Researchers at the Stanford Center on Longevity, in collaboration with the Society of Actuaries, analyzed 292 different retirement income strategies and found that Social Security meets most planning goals. The authors created a retirement income strategy around Social Security, called Spend Safely in Retirement, targeted to middle-income workers with between $100,000 and $1 million in savings who don’t have significant help from a financial advisor.
Spend Safely in Retirement is designed to help wring the most from existing savings, while maximizing the guaranteed income of Social Security, writes Steve Vernon, research scholar at the Stanford Center on Longevity and lead author. Among other benefits, this strategy protects against inflation and the risk of outliving savings while minimizing income taxes and complexity.
In order to maximize Social Security, beneficiaries should delay claiming until age 70, the report says. Financial advisors have long urged clients to wait as long as possible to claim Social Security, since doing so guarantees an annual return of between 6.5% to 8.3% from age 62 to 70, according to Bruce Wolfe, executive director of the BlackRock Retirement Institute. Yet only 4% of those who started taking Social Security in 2016 waited until that age, according to the Social Security Administration.
The report suggests several strategies to bridge the income gap until age 70:
- If possible, continue working, at least enough to cover your basic living expenses, and slash your discretionary spending to live frugally within your means.
- If work isn’t possible, consider using a reverse mortgage line of credit as a pool of funds to help cover living expenses.
- If outside sources of income aren’t adequate, consider building a “retirement transition bucket” with a portion of retirement savings equal to the total amount of Social Security that you’d forgo by waiting until age 70 to claim. Say you retire at 65 and would have received the average monthly benefit of $1,369 if you claimed at that age. Put roughly $95,000 into the transition bucket to cover the amount you would have received in benefits from 65 to 70, indexed for inflation. This pot should be invested in a liquid fund with minimum volatility, such as a money market fund or a short-term bond fund.
Once you reach age 70 ½, the Internal Revenue Service requires you to withdraw a minimum amount from your tax-advantaged 401(k) or IRA each year and pay ordinary income taxes on it. Think of these required minimum distributions (RMDs) as your “retirement bonus,” the report says. Just like the bonus that you might have received on the job, the amount fluctuates—in this case, with your age and the market performance of your retirement account. Your Social Security check, on the other hand, is your “retirement paycheck,” a fixed amount adjusted annually for inflation that covers basic living expenses.
Keep a hefty portion of your RMD accounts in stocks, the report recommends. If you can stomach the volatility, you can go as high as 100% equities, as this provides the most potential upside. Yet if that allocation would keep you up at night, sweating fluctuations in the market, then stick to 50% or 60% in stocks, the authors advise.
In addition to your retirement account, the report recommends that you maintain an emergency fund that wouldn’t be tapped for regular retirement income. Also, if you want to spend more money in your early years of retirement, say to travel, then set those funds aside. For example, if you budget an extra $5,000 for fun for the first five years of retirement, put $25,000 in an account that isn’t used to generate retirement income.
To be sure, this approach won’t make up for inadequate savings, Vernon cautions. And it also won’t protect retirees from catastrophic long-term care expenses, which can quickly drain savings. But other retirement income strategies would also fall short on those counts. Spend Safely in Retirement offers multiple advantages, including a simple design that most retirees can execute on their own.