Saving for retirement can be difficult. It is more difficult to plan how the nest egg is to be spent – while ensuring that the money does not run out.
But there is good news: According to experts, Americans can create a simple, inexpensive pension plan that consists only of social security and savings.
From an academic perspective, the "optimal" retirement strategy combines two concepts, said Wade Pfau, professor of retirement income at the American College of Financial Services.
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On the one hand, pensioners with guaranteed payments such as social security have created an "income ceiling" to cover all recurring fixed costs in retirement (e.g. insurance premiums and mortgage payments).
The second pen uses an investment portfolio for discretionary expenses (e.g. travel and leisure activities). Pensioners would choose this expenditure up or down based on life expectancy to ensure that their money did not run out.
"This is an easy way to develop a retirement strategy that is close to the (ideal) academic strategy," said Pfau.
Maximizing social security benefits is perhaps the most important aspect of the strategy.
Social security is the "foundation" of retirement for most middle-income retirees, providing about half to three-quarters of their total retirement income, Pfau and other researchers wrote in an article published in 2017 by the Stanford Center on Longevity.
The researchers define "median income" as having a retirement savings between $ 100,000 and $ 1 million.
Pensioners should at least determine what their fixed costs will be in their retirement years. This is the "floor" income, which includes all essential monthly and annual payments such as living, eating, utilities and transport.
The goal is to "get as much social security as possible," said David Blanchett, director of pension research at Morningstar Investment Management.
It would be even better to exceed the minimum income, he said.
Social security is a unique benefit for retirees for several reasons.
Payments are guaranteed for life, which means that they cannot be survived. They are tied to inflation, so a pensioner's purchasing power will not decrease as much over time. They are partially shielded from federal income tax and are not exposed to the volatility of the stock market. In many states, this income is also exempt from state taxes.
And because payments are made in regular monthly installments like a paycheck, they help overcome a common behavioral hurdle for retirees – the fear of spending the money, Blanchett said.
"It's just the best," said Blanchett.
It's like the cookie cutter pension plan you can start with.
CPA and author of the Oblivious Investor Finance blog
Americans can start social security from the age of 62. However, waiting until the age of 70 is one of the most important financial decisions that a pensioner can make.
This is because social security checks increase by 8% each year when a pensioner waits for benefits.
Imagine someone turning 62 this year and getting around $ 1,000 a month from social security at age 67. This person would receive $ 716 per month at the age of 62, but a much larger monthly amount – $ 1,266 – if the Social Security Administration is waiting until the age of 70.
A guaranteed return of 8% is particularly lucrative in the current low interest rate environment, which means that retirees with traditionally secure investments such as cash and bonds will get much less returns.
The second focus of the retirement savings strategy is the investment portfolio. The goal is to use those liquid savings to fund all of the fun things in retirement.
This money can be invested aggressively – for example in a mutual fund that replicates the stock market, like an S&P 500 index fund, according to the Stanford paper.
This is because a pensioner's overall investment risk would be watered down by the fact that so much of his total retirement income comes from a safe source (social security and / or a traditional pension).
However, more risk-averse retirees can still get "reasonable results" by investing in a more conservative mutual fund, such as a balanced fund that invests about half in stocks and half in bonds.
How much has to be withdrawn?
Pensioners can switch payouts from their investment portfolio each year based on their life expectancy to ensure they don't run out of money.
Retirees can follow the directions in a "Minimum Distribution Requirement Worksheet" published by the IRS as a guide.
The simple exercise is to divide the account balance by a "distribution period" given for the appropriate age. The output is the amount that a pensioner can safely withdraw from his investment portfolio this year.
Photo by Supoj Buranaprapapong
For example, a 70-year-old retiree with a $ 1 million retirement account would divide $ 1 million by $ 27.4. This is the distribution period given for a 70 year old. This person can withdraw approximately $ 36,500.
Pensioners repeated the exercise each year based on their new account balance.
Withdrawing accounts in this way tends to be more conservative, said Peacock.
"This is fairly easy to implement," said Mike Piper, CPA and inventor of Oblivious Investor's personal finance blog, about the overall strategy. "It's like the cookie cutter pension plan you can start with."
There are differences in strategy that retirees might implement depending on their specific situation. This would of course complicate the two-pronged strategy outlined above.
The ideal pension scenario is to work until the age of 70 and to cover the cost of living with a paycheck before claiming social security.
Of course, not everyone can wait until the age of 70 to retire.
Those who retire earlier should cut out part of their investment portfolio as a transitional fund to cover expenses in the years before social insurance was used.
Now is the wrong time to guess retirement. If you are not sure and do not have to do it, I would consider working a little more.
Head of Retirement Research at Morningstar Investment Management
This would be conservatively invested in a money market fund, a short-term bond fund or for 401 (k) investors in a stable fund.
It is ideal to have a bridge fund up to the age of 70, but taking advantage of social security at the ages of 67, 68 and 69 "still offers significant benefits," the Stanford newspaper says.
"Now is the wrong time to guess retirement (age)," said Blanchett, referring to the country's high unemployment. "If you're not sure and don't have to, I would consider working a little bit more."
Some pensioners, especially those with higher incomes, may not be able to get all of their floor income from social security.
If they have the money, retirees can buy a simple or deferred simple vanilla pension to fill that gap. Retirees should generally avoid more complex versions of annuities such as variable or fixed indexed annuities for this exercise.
Income from a traditional pension plan can also complement social security.
However, this planning strategy is not without risks.
First, it can be difficult for this plan to consider large unexpected expenses such as healthcare costs or long-term care.
Retirees can potentially use their home equity, such as through a reverse mortgage or home loan line, to supplement retirement income and fix certain unexpected costs, Pfau said.
However, a reverse mortgage has some limitations that could hinder this strategy.
For example, while it could cover the cost of long-term care related to home care, it would likely not cover care outside the home (e.g. in a nursing home) because the home must remain the borrower's primary residence.