STRATEGIES RETIREES AND PRE-RETIREES CAN USE SAFEGUARD THEIR RETIREMENT INCOME
By Steve Vernon
As a result of the recent downturn in the economy and stock market due to the coronavirus epidemic, many pre-retirees and retirees might be understandably anxious and worried about their financial security in retirement. During these scary economic times, older middle-income workers and retirees can address their fears by deploying a careful strategy to balance the goals of protecting and maximizing their retirement income.
Recent Stanford Center on Longevity (SCL) research can help older workers and retirees make critical retirement decisions, such as:
- When can they afford to retire?
- When should they claim Social Security benefits?
- How can they best deploy their retirement savings to survive financial downturns?
These complex and high-stakes decisions can cause a lot of anxiety for older workers in normal times, and the current financial crisis only makes matter worse.
For retirements that can last 25 years or more, it’s important to develop a retirement income strategy that can not only survive today’s crisis, but can also last through future crises that might be inevitable during such a long retirement.
To help pre-retirees and retirees make these decisions, the recent SCL research analyzed a straightforward retirement income strategy that can be implemented using virtually any IRA or 401(k) plan. The strategy’s target market is older, middle-income workers and retirees who have accumulated less than $1 million in retirement savings and typically don’t work with financial advisers, which describes the vast majority of older American workers.
SCL researchers designed this strategy to help retirees withstand economic downturns. The researchers note that it’s holding up well during this latest crisis, due to the inherent level of risk protection that is built into the strategy.
The strategy, known as the Spend Safely in Retirement Strategy, or Spend Safely Strategy for short, has two steps:
Step 1: Optimize Social Security benefits by delaying the start of benefits as long as possible, but not beyond age 70. Middle-income retirees who optimize their Social Security income will risk-protect two-thirds to three-quarters or more of their total retirement income.
That’s because Social Security provides the most protection against common retirement risks compared to any other retirement income generator, including these three critical risks:
- Longevity risk, since it’s paid no matter how long a retiree lives
- Investment risk, since Social Security benefits won’t decrease if the stock market crashes
- Inflation risk, since benefits receive an annual cost-of-living adjustment
Because of these advantages, it makes sense for most middle-income retirees to increase their Social Security benefits through a careful delay strategy. Older workers can delay the start of their benefits in one of two ways:
- Retire from full-time work, and if possible, work part time just enough to enable delaying the start of Social Security benefits.
- Use a portion of retirement savings to fund a Social Security bridge payment, which tides over retirees until their actual Social Security benefits start.
When pre-retirees and retirees risk protect most of their total retirement income, it enables them up to adopt straightforward strategies for deploying the remainder of their retirement savings and possibly invest it for the potential to grow their retirement income, as described below in Step 2.
Step 2: Invest retirement savings to generate regular retirement income to supplement Social Security checks. The baseline Spend Safely Strategy calls for investing in low-cost balanced, target date, or stock index mutual funds that are commonly offered in most IRA platforms and 401(k) plans. Pre-retirees and retirees can decide the degree of risk protection they desire for this portion of their retirement income by choosing the allocation to stocks in the funds they select.
Retirees can use the IRS required minimum distribution (RMD) to calculate the amount that they can withdraw from savings each year. Many financial institutions and 401(k) administrators can calculate and pay out the RMD to their customers and plan participants.
Retirees who desire more risk protection and simplicity could also consider buying a cost-effective annuity from an insurance company.
To help determine the feasibility of the Spend Safely Strategy, SCL researchers used powerful analytical techniques to compare the Spend Safely Strategy to 292 different retirement income strategies. The Spend Safely Strategy compared favorably to these strategies using eight different metrics, including the total amount of income that’s projected to be delivered throughout a retiree’s lifetime and the degree of potential losses in retirement income due to stock market fluctuations.
To help their older, middle-income customers and participants make the critical decisions described in this article, and to enable them to implement the Spend Safely Strategy, financial institutions and sponsors of 401(k) plans can offer retirement income options and educational information to their customers and plan participants. In the process, financial institutions and 401(k) plan sponsors can do their part to help older workers and retirees weather the financial storms they are currently facing. This help could go a long way to earning both their gratitude and their loyalty.
For more details on these ideas, including the analyses that support the conclusions and discussions of implementation issues and refinements, please see the following resources:
- Viability of the Spend Safely in Retirement Strategy, by Wade Pfau, Ph.D., Joe Tomlinson, FSA, and Steve Vernon, FSA. Society of Actuaries, May 2019.
- How to “Pensionize” Any IRA or 401(k) Plan, by Steve Vernon, FSA. Stanford Center on Longevity, March 2018.
- Optimizing Retirement Income by Integrating Retirement Plans, IRAs, and Home Equity: A Framework for Evaluating Retirement Income Decisions, by Wade Pfau, Ph.D., Joe Tomlinson, FSA, and Steve Vernon, FSA. Society of Actuaries, November 2017.
Steve Vernon, FSA., is a research scholar in financial security at the Stanford Center on Longevity.