An academic center studying longevity and a professional body dedicated to managing the risks of aging think they have a solution to what economist and Nobel laureate William Sharpe has called the “nastiest, hardest problem in finance”: turning retirement savings into a predictable stream of income over a period that could span years or decades.
The issue of creating lasting retirement income is particularly onerous for Americans who have less than $1 million in savings—that is, most—and don’t pay for professional financial advice. Left to their own devices, these savers often go to one of two extremes, says Steve Vernon, a research scholar at the Stanford Center on Longevity. They either live too frugally for fear of running out, or they choose to be oblivious, spending freely until they reach a point of no return.
When to collect Social Security
It is hard to strike a balance, he says, because there are so many variables such as years in retirement, inflation, and market performance, and so little room for error.
Meanwhile, the primary resource for retirement saving today—employer-sponsored retirement plans like 401(k)s—have only recently started to look at how to help employees safely spend down their savings. “For the first time, the vast majority of plan sponsors see their objective to generate retirement income,” says Bob Melia, executive director of the Institutional Retirement Income Council.
So what’s a retiree to do? The Stanford Center on Longevity and Society of Actuaries recently outlined a strategy that could be the answer for middle-income Americans seeking a straightforward plan they can execute without an advisor or annuity. The Spend Safely in Retirement Strategy, as they call it, involves two basic components.
Wait to claim
The first is to maximize Social Security income by claiming benefits as late as possible, ideally until age 70, when recipients receive 132% of their full monthly benefits for delaying 48 months.
“Social Security is probably the best retirement income source for most middle-income people because it addresses every common financial risk,” says Vernon. “It’s indexed for inflation, it protects against longevity risk, and if the stock market crashes, it doesn’t go down.” It also protects against cognitive risk, he says, since recipients don’t need to worry about making complicated investment decisions or turning their assets over to a scam artist. And there are tax advantages to boot: A portion of the benefit is exempt from federal tax, and most states don’t tax Social Security income.
The easiest way to delay claiming Social Security is to keep working, he says, even if it means working just enough to cover living expenses. “This is what I’m doing,” says 66-year-old Vernon, who “downshifted” from an intense job as a consulting actuary to his current role with the Stanford Center on Longevity.
The alternative is to retire before 70 but delay claiming benefits by carving out a portion of retirement savings to cover expenses until Social Security kicks in. A 65-year-old single woman with a current salary of $50,000 and savings of $250,000 who claims Social Security at age 70 would increase her annual benefit to $27,646 versus claiming at 65 for $19,476. Doing so would require that she use a significant chunk of her savings to bridge the gap—but in the long run it could increase her total retirement income 14% and reduce the percentage of her total income that is subject to market, inflation, and longevity risk.
Invest like your younger self
The second component of the Spend Safely in Retirement Strategy is to invest retirement assets more aggressively than had traditionally been prescribed by experts while withdrawing as little as possible.
The thinking here is that retirees who adopt the first part of the strategy to rely more heavily on Social Security for income needs can afford to take more market risk. The researchers concluded that a 100% allocation to stocks might even be acceptable. “But I’ll be the first to admit that not many people in retirement are going to want to invest 100% in stocks,” says Vernon, who as a compromise recommends a balanced fund with stocks and bonds or a target-date fund with an investment mix geared toward someone younger.
This phase of the strategy calls for retirees to withdraw no more than the Internal Revenue Service’s required minimum distribution. (For people younger than 70½—the age at which retirees must begin withdrawing a percentage of their savings in tax-deferred accounts—the researchers used IRS methodology to map out equivalent percentages.) To take the guesswork out of withdrawals, retirees can set up automatic withdrawals in monthly or quarterly increments.
“It’s hard to argue with this strategy,” says Melia of the Institutional Retirement Income Council, though he says it may be harder to pull off if employees have retirement funds in multiple accounts.
Vernon acknowledges this strategy isn’t for everyone, namely retirees who have amassed larger savings. For retirees with at least $1 million in assets, he says, investment returns carry more weight and annuities can start to look more appealing.
Still, for Americans who count their retirement savings in tens and hundreds of thousands, a simple approach may be the best. “Once you optimize Social Security for a middle-income retiree, that might be all the annuity income you need,” says Vernon.
What about the risk that Social Security benefits could be cut? Vernon has run the numbers with various scenarios, including a 20% reduction in benefits in 2035—when the program is expected to deplete its reserves. “The answer is delaying is still the right strategy,” he says.
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