Unlike Jack Nicholson's character in A Few Good Men, we trust that
you can handle the truth. No matter your age, securing a comfortable
retirement is a huge concern. Folks want the whole truth about their
financial outlook, but straight answers are hard to come by.
Both sides of the mainstream media habitually present opinion-tainted
partial facts. Case in point: the unemployment numbers announced earlier this
month. One side is cheering because unemployment dropped to a six-year low,
while the other side is calling it pure fraud.
I found author and libertarian-about-town Wayne Root's remarks in a recent
article for The Blaze particularly telling:
The middle class isn't getting richer, it's getting poorer.
The only people being hired are your grandparents. 230,000 of the new jobs
went to those in the 55-to-69-year-old age group. In the prime working age
group of 24 to 54 years old, 10,000 jobs were lost.
It means grandma and grandpa are desperate and willing to take grandson's
low wage job to survive until Social Security kicks in. The US workforce is
now the oldest in history. And if grandpa has to work (out of desperation)
until the day he dies, there will never be any decent jobs for the grandkids.
Here's the part Root gets wrong: Baby boomers are not working until
Social Security kicks in. They're working well past that point, because they
feel they must. Smart boomers know they can't afford to wait until robust
interest rates return; they're taking action to protect themselves now, lest
their circumstances become truly dire.
You're 65-Now What?
The Employee Benefit Research Institute surveys workers each year
concerning their retirement confidence. Despite an uptrend, the latest report
shows that 82% of workers feel less than "very confident" about
having enough money to retire comfortably.
With that statistic in mind, we looked at three different 40-year
retirement scenarios. Note that the numbers and charts in this overview are
meant to illustrate several scenarios, not provide individual guidance. Every
person's situation differs in terms of taxes, time horizons, and other
parameters, and we encourage you to work with a financial planner to manage your
savings.
The data exclude other sources of retirement income you may have, such as
Social Security or a pension. All of the amounts, including annuity incomes,
are pre-tax.
·
Scenario 1. At age 65, you decide to retire with
$500,000 in personal savings. You anticipate your expenses will rise
approximately 3% annually. Thus, with each subsequent year, you will need to
withdraw 3% more than the previous year. You estimate that your savings will
grow by 5% annually. You are planning for a 40-year retirement, meaning your
savings must last until age 105.
How much money can you withdraw each year,
using those assumptions?
·
Scenario 2. At age 65 you have the same $500,000 in
personal savings that you did in Scenario 1; however, you take $100,000 from
your account and buy an annuity. Our go-to source for annuity information, Stan
The Annuity Man, says that currently, this annuity would pay $527 for the
rest of your life. You use the remaining $400,000 as principal for the next
40 years in the same fashion as in the first case: assuming the same 5% rate
of return and an annual 3% withdrawal increase.
·
Scenario 3. Instead of retiring at age 65, you work for
five extra years and buy a 100,000 annuity at age 70. We will assume you did
not add to your savings during that time (though it did earn interest). Many
boomers use extra working years to eliminate any lingering debt, so they can
retire 100% debt-free. (However, note that we encourage a different approach:
using extra working years to save as much as possible, including maximizing
catch-up contributions to your 401(k) or IRA.)
If your nest egg grew at a 5% compound rate, it
will total $638,141 when you are age 70. So, excluding the $100,000 spent on
an annuity, you have $538,141 to draw from. As with Scenarios 1 and 2, we'll
assume the withdrawals last for 40 years here, stretching the retirement
period until age 110. Buying the annuity at age 70 instead of age 65 raises
your monthly annuity payout to $582 per month.
Now, let's take a closer look at each of these cases.
Scenario 1: He Who Takes It All Is Not the Winner
For your nest egg to last 40 years, in year one, you can withdraw $17,747,
or $1,479 per month, from your $500,000 nest egg. Each year you take out 3%
more to keep up with rising expenses.
Follow the yellow line representing your nest egg in the chart above. As
you can see, after 40 years your $500,000 is gone.
What happens if you stay within your monthly allowance and live past age
105? Here's hoping you have generous grandchildren. If not, you might be at
the mercy of a Social Security system that may or may not be around in its
current form.
There's good reason the Bureau of Labor Statistics projects that workforce
participation for people age 75 and over will rise to 10.5% by 2022, up from
7.6% in 2012. For the 65-74 age group, it projects that the rate will jump to
31.9%, up from 26.8% in 2012 and 20.4% in 2002. Better health and a sustained
desire to work may be one reason more seniors are working longer, but another
is fear.
61% of older Americans fear outliving their money more than they fear
death. This is a fear we hope no one encounters as they near the end of the
line. Other than the late George Burns, I doubt many centenarians are holding
down a job.
Running out of money and having Social Security as your final safety net
is a legitimate concern. Every politician, regardless of party, acknowledges
the US government cannot make good on all of its promises. No one knows what
the future will bring.
With that in mind, let's move on to Scenario 2.
Scenario 2: Spreading Out Risk
Insurance companies have a range of annuities that will pay you for the
rest of your life, which our team covered in detail in Annuities De-Mystified.
In essence, holding an annuity as part of your overall retirement plan
is one way to reduce the risk of running out of money. Since going back to
work at 105 is both unappealing and impractical, let's look at how Scenario
2-the same $500,000 nest egg with $100,000 used to purchase an annuity at age
65-plays out.
Your annuity will provide monthly payouts of $527. Using the same 40-year
time frame, your monthly income from the remaining $400,000 will be
approximately $1,183 per month in first year, or a total of $1,710.
You start out with a bit more money; however, the annuity payment will
remain constant, with no adjustment for inflation. At the end of 40 years,
your nest egg will be gone, but you will still receive the annuity payments.
There is no way to know how long you will live. Today, a man who reaches
age 65 can expect, on average, to live to age 84.3; a woman, 86.6. One in ten
65-year-olds, however, can expect to live past age 95. Medical advancements
are pushing those numbers up, making life after age 105 seem not too far
fetched. An annuity is just one way to hedge against running out of money too
soon.
One big disadvantage of an annuity is that it doesn't offer real inflation
protection. Even annuities with inflation riders usually yield marginal
results.
If you receive Social Security, you can hope the annual inflation
adjustments make up some of the difference, but it's unlikely to be enough to
maintain your current lifestyle. That brings us to Scenario 3.
Scenario 3: Delayed Gratification
Congratulations! You made it to age 70. The $500,000 in savings you had at
age 65 has grown to $638,141 (at an annual rate of 5%). You buy an annuity
for $100,000 that will pay you $582 every month until death and draw down the
remaining $538,141 over the next 40 years-again assuming 5% growth rate and
3% annual withdrawal increase.
The lump sum of $538,141 will provide approximately $1,592 per month
during the first year. Add the annuity payouts and your total monthly income
comes to $2,174, before taxes.
In the first year, your total income, including withdrawals and annuity
income, will be $26,085 compared to $17,747 in Scenario 1 and $20,516 in
Scenario 2.
And although your savings will still run out after 40 years, you will be
110. By working an additional 5 years and deferring the start date you get an
additional five years before you have to rely on the annuity only.
The Takeaways
This is all a reminder that the best way to enjoy retirement is to build a
portfolio that can generate enough capital gains and dividend income to
satisfy your spending needs, while leaving the principal intact as long as
possible. If you want to end up in the 18% of people who are very confident
about having enough money to retire, you may want to keep working after age
65, if possible, and invest part of your savings in an annuity to
ensure you have at least some income if you outlive the rest of your nest
egg.
