“Spend Safely in Retirement Strategy” by Steve Vernon
Takeaway #1: How Does the “Spend Safely in Retirement Strategy” Work?
I always thought it was not a good idea to ask individual workers to be their own actuary and investment manager. However, I feel like we are making progress on adequate savings now through default options.
Retirement planning involves tradeoffs.
There is not a single perfect income retirement solution. The tradeoffs are what is the amount of income you expect to get throughout the rest of your life, how much wealth or liquidity you have — some people want to have bequests they can offer at the end of their lives — and implementation, simplicity, and costs. All of these involve tradeoffs.
Right up front I am giving away the solution, but then we will go into details. I acknowledge that there are many other viable retirement income strategies. I am not representing this as the perfect solution, which, by the way, does not exist. What we are proposing is that this is a straightforward solution that can work with many, many people, particularly middle-income retirees with less than a million dollars in savings, which describes lots of people. We are not saying that there is a one-size-fits-all solution here. We are just acknowledging that there are many tradeoffs. For example:
- If you want to maximize the amount of income, that might be at the expense of reducing your accessible wealth or liquidity or reducing your bequests.
- Making sure the money lasts for the rest of your life — inflation, investment risk, also known as sequence of return risk, and death of a spouse — you want to make sure the money keeps going after one spouse dies.
- In later years cognitive decline or making mistakes or fraud — those are always problems.
- You want to minimize income taxes.
In my research role at Stanford, I have been focusing on de-cumulation, or how you can deploy savings in retirement. We may have found one solution out of the 292 different strategies that we looked at that is straightforward for many people to implement.
These are all the common risks that people might face. It is a lot to juggle, but I think that people are resilient. Moreover, if we can get simple solutions that address many of these risks and get people close to financial security, then it is reasonable they can adjust their living expenses budget from there. That is really the point of this strategy.
You start by optimizing Social Security.
If necessary, you might need a portion of your savings as a retirement transition bucket, so that if you retired before you start Social Security, you could replace that Social Security benefit that you are delaying with savings. For middle-income people to do this strategy, Social Security might be all the annuity income that you need. The remaining savings, if you use the IRS required minimum distribution, can be in either a target date fund or a balanced fund which are quite common in 401(k) plans. This strategy actually compares favorably to more complex strategies.
In a very simple example, suppose your Social Security benefit would have been $20,000 per year at age 65. You want to delay Social Security to age 70, so you put $20,000 times five years, $100,000, aside and that is what you are going to draw down between age 65 and 70 that allows you to draw down Social Security at age 70. You would invest this retirement transition bucket in funds that are common in 401(k) plans, such as stable value funds, short-term bond funds, money market funds. Because of your short investing horizon, you do not want to invest this money in the stock market.
Most of the time you optimize by delaying retirement for the primary wage earner as long as possible but no later than age 70.
The best way to implement this is to work just enough in your 60s to enable delaying Social Security. However, we acknowledge that many people do not want to delay retirement until age 70. If you are retiring before and you are starting your Social Security benefit, you might want to set up a retirement transition bucket to replace the Social Security benefit that you are delaying. We think a short-term retirement transition bucket is a good way to protect your income in the period leading up to retirement and as you are transitioning from full-time to part-time to full retirement.
This Key Retirement Takeaway is excerpted from a recent webinar presented by Steve Vernon, FSA, MAAA, Research Scholar, Stanford Center on Longevity, President of Rest-of-Life Communications.
In both of his roles as Research Scholar at the Stanford Center on Longevity and as the President of Rest-of-Life Communications, Steve is active with research, writing, and speaking on the most challenging issues facing retirees today, including finance, health, and lifestyle.
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©2018, Steve Vernon. All rights reserved. Used with permission.