This is a guest post from Robert Brokamp of The Motley Fool. Robert is a Certified Financial Planner and the adviser for The Motley Fool's Rule Your Retirement service. He also has a blog, Twittering thing, and a wife who has written a clever little children's book, The Picky Little Witch.
Looking for an effective way to improve the chances that you won't run out of money in retirement? It's easy: Just delay retirement.
That may not be the solution you wanted to hear. But by working just a few years more, you can greatly enhance your portfolio's longevity, as well as have a higher Social Security benefit to rely on in the event that your money runs out. To illustrate these benefits, consider a 62-year-old who has saved $250,000 for retirement. In the past year, she earned $75,000 at her job, and contributed 15% of her salary, or $11,250, to her 401(k). She figures she could live on 75% of her pre-retirement income.
How long would her money last if she retired today as compared to later ages? We fired up the “Am I saving enough? What can I change?” calculator (found among the retirement calculators at The Motley Fool) to analyze her situation. Here are the results.
|Number of Years Portfolio Will Last||5.2||6.3||7.8||9.8||12.8|
|Portfolio Will Last Until Age…||67.2||70.3||73.8||77.8||82.8|
|% of Expenses Covered by Social Security||34.2%||39.5%||45.5%||52.8%||59.9%|
With all those pretty numbers in mind, let's discuss the benefits of working a few years longer.
Your portfolio will have more years to grow
Our hypothetical retiree's portfolio will last an estimated 5.2 years if she retires today, but its longevity increases with every year she puts off retirement, thanks to a combination of additional contributions and delaying the point at which assets are sold to pay for retirement. In fact, her $250,000 could almost double to $483,087 by age 70, assuming a 5% investment return and continued annual contributions of $11,250.
You'll get a larger Social Security benefit
A bigger portfolio isn't the only reason our retiree's prospects improve the longer she works. Her portfolio will also last longer because of bigger Social Security checks, which means she'll need to withdraw less from her portfolio to cover expenses. According to the benefits calculator on the Social Security website, our retiree will receive $16,032 in her first year of retirement if she applies for benefits at age 62. However, the calculator estimates that her benefit would more than double to $36,096 if she can wait until age 70.
That increased benefit is due to two factors. First, for every year you delay taking Social Security, the benefit increases approximately 8% plus inflation. Secondly, the benefit is calculated using the 35 years in which you earned the most money (adjusted for average wage inflation); if you are earning a high income in your 60s relative to what you earned previously in your career, then the more years you work, the more the higher-income years replace the lower-income years in the benefits calculation, resulting in a bigger monthly check.
Finally, delaying Social Security benefits also provides a larger safety net in case your portfolio does get fully depleted. If our retiree stopped working at age 62 and later ran out of money, Social Security would cover just 34.2% of her expenses. However, had she waited until age 70 and her portfolio went kaput, Social Security would cover 59.9% of her bills. Not ideal, of course, but better than 34.2%.
Your portfolio's potential expiration will be closer to your own
The length of your retirement is the number of years between the day you quit work and the day life quits you. The older you are when you retire, the fewer number of years your money needs to last.
Of course, you don't know exactly when you'll exceed life's mortal debt ceiling, but according to the Social Security Administration, the average 62-year-old male will live another 19.4 years and the average 62-year-old female will live another 22.3 years (apparently, pulling fingers reduces longevity). As you can see from the above table, if our retiree quits work at age 62, the calculator estimates she'll run out of money at age 67. If she retires at age 70, her money is estimated to last into her 80s. This is still not ideal; most financial advisors recommend that retirees plan to reach age 90 to 95. But retiring later does result in her portfolio running out at an age closer to the average life expectancy.
The Bottom Line
There several ways to improve the chances that you won't run out of money in retirement, such as save more while you're working, earn higher investment returns (though never guaranteed, of course), downsize your home, reduce your expenses (as exemplified by Akaisha and Billy Kaderli, whom I interviewed a few weeks ago), or marry Warren Buffett.
Delaying retirement is not the only option, but it's likely the most impactful option for those approaching their 60s with insufficient savings. It can also benefit those who have already retired but are willing and able to return to work, even part-time. (If it's been less than 12 months since you received your first Social Security check, you can withdraw your application for benefits, return any money you received, and then take a larger benefit later.) Whatever you do, run your own numbers to determine what will best improve your retirement security. Many people retire too early, only to figure that out too late.