Written By: Michelle Budzien
Retirement can be an exciting time, however it can also be stressful. Even with proper financial planning, determining how much money is needed to last you until your final days is nearly impossible with so many unknowns. There are steps that clients can take to make the process easier, by eliminating future fixed expenses and determining the best time to begin drawing Social Security benefits given their unique situation.
Eliminate Fixed Expenses
More and more people are entering retirement with mortgages. In order to reduce the unexpected financial stressors present in retirement, paying off a mortgage, car loans, and other fixed expenses prior to retiring may be a wise choice. That way the individual has more freedom with their limited income.
When helping someone with retirement planning, it is important to remind them that their budget will change. Even if they can survive on less than $2,000 per month now, it is difficult to determine what might happen in the coming years. Do they have dependents? Are their dependents (primarily children) self-supporting? What is their family health history? How much will health care costs increase? Will they need to move into assisted living or a nursing home? How many years will they live? If they deplete their personal retirement accounts, will they be able to live off Social Security and/or a pension? Upon death, do the surviving spouse or dependents have sufficient means to support themselves?
How Much Money Is Needed?
There is no right answer. The amount of money needed to retire depends on the individual’s health, lifestyle, and expectations. Do they want to travel or own a sailboat, vacation house, or a fancy car? Will they receive a pension? It is important to create a budget with your client that includes all of the annual expenses during retirement as well as the potential for increasied healthcare costs, insurance, (Survivor Benefit Plan, Medicare supplement health insurance, long-term care insurance, etc.) and living arrangements. Also consider creating a reduced budget to see if it is possible to live off of Social Security and a pension if the individual lives longer than their estimated life expectancy.
Help clients make an informed choice as to when to claim Social Security. Social Security benefits increase by 8 percent per year if claiming is delayed until age 70. While that sounds attractive, especially compared to the current returns in many investment accounts, it may not be the best choice for the clients given their individual situation.
Deciding between claiming early Social Security or delaying benefits requires tradeoffs. If Social Security is collected at age 62, the monthly check is permanently reduced, however five to eight more years of Social Security income will be received. If Social Security benefits are delayed until age 70, the monthly payout will be higher, however the individual may not live long enough to recoup the money that could have been collected for the previous eight years.
The Social Security Administration website is an excellent resource to help estimate Social Security benefits. After creating an account, individuals can verify the credits they have earned to qualify for Social Security (typically 40 credits, or 10 years of work earning a certain income, $1,220 in 2015, is necessary to qualify). The website also has many calculators and provides individuals a customized review of their estimated benefits at full retirement age (between age 65–67 depending on the year you were born), at age 70, or at early retirement or age 62.
Let us look at an example. In this hypothetical scenario (Table 1), the primary earner’s average income of $64,983 is comparable to many averages for United States military officers, and according to the Center for Disease Control and Prevention’s National Center for Health Statistics, the average American male lives to nearly age 77 and the average American female lives to nearly age 82. (Note: it is important to adjust this figure up or down for each client to show them how their income impacts their total Social Security benefits received. The Social Security Administration website provides a great starting point to help clients analyze their situation.)
What about married couples? The Social Security spousal benefit allows a husband or wife to receive up to 50 percent of their spouse’s Social Security benefits, even if he or she never worked!
- Spouses who qualify for their own benefit will be paid that amount first. If the benefit on their spouses’ record is higher, they will get the additional amount on their spouses’ record so that the combination equals the higher amount.
- Between age 62 and full retirement age, the spouse benefit is reduced by a percentage based on the number of months until full retirement age.
- At full retirement age, the spouse benefit cannot exceed 50 percent of their spouse’s full retirement amount.(If born before January 2, 1954, there are other options. Check the Social Security personalized account to determine which is best!)
- There is a family maximum, typically150 to 180 percent of the worker’s full retirement benefit.
Note: If divorced, an ex-spouse may qualify for benefits on their ex-spouse’s record, if the marriage lasted at least 10 years. Read the “If You Are Divorced” section on the Social Security Administration website.
Early retirement may look like the best option, but remember the assumptions made in this hypothetical scenario: life expectancy of 77 for a male earner and 82 for a female and an average indexed monthly earnings of $5,415.25 ($64,983). If life expectancy is longer, having a guaranteed annuity payment until death reduces stress related to the unknowns and how many years of income are needed. Consider the following:
- Social Security benefits are calculated using the average indexed monthly earnings during the 35 years of highest earnings. If your client earns a high salary in their later years, the average indexed salary may boost the Social Security payout amount.
- If your client is working and claiming early Social Security, $1 in benefits is lost for every $2 earned over the Social Security Administration’s earnings limit ($15,720 in 2016). Once at full retirement age, there are no longer deductions. Lower income earners may consider claiming Social Security early, but should typically only consider this if planning to continue to work and do not earn more than the annual limit.
- Low income earners should consider increased expenses during retirement as they likely do not have other assets to contribute to unexpected bills. Working longer and delaying Social Security in order to maximize their benefit could act as a guaranteed investment, especially since many cannot afford to invest their own salary.
- How is your health? If life expectancy is shorter than average, it may not make much sense to delay retirement benefits.
- Calculate the break-even point. When claiming Social Security, at what age is it worthwhile in order to take advantage of the guaranteed increased benefit?
Social Security benefits are reduced by as much as 30 percent if collected early at age 62. Delaying benefits until age 70 can increase benefits by as much as 8 percent per year. Run the numbers for each unique situation to determine what is most advantageous.
As a part of the Bipartisan Budget Act of 2015, Congress approved major changes to Social Security which may impact benefits. The two major changes were designed to eliminate the well-known “file and suspend” and “restricted application” loopholes. The “file and suspend” strategy allowed an individual to file for benefits at full retirement age and then immediately suspend payments; however, their spouse could file and receive a spousal benefit immediately. Under the new law, spousal or dependent benefits can only be received once the filer has started collecting their Social Security benefits. The other eliminated loophole was the “restricted application” strategy, where dual-earners could essentially double claim. It is essential to research on the Social Security Administration website before making any decisions.
Deciding to retire and when to claim Social Security are complex decisions unique for each client.There is no “right” dollar amount to signify you have enough money to retire. If immediate income is not necessary, delaying Social Security benefits could be advantageous because life expectancy continues to increase, and a larger guaranteed paycheck is extremely valuable. Calculate the breakeven point for your specific situation. Always consider health, family obligations, lifestyle expectations, financial need and other retirement income sources in order to make an informed decision.
Michelle Budzien, AFC®, is a graduate of Marquette University with a Bachelor of Science degree in Business Administration. She is currently the Director of Navy-Marine Corps Relief Society in Okinawa, Japan, a non-profit military relief society dedicated to providing financial education and need-based assistance to Sailors, Marines, and their families. Michelle serves on the advisory boards for the American Red Cross, Marine Corps Base Butler, and the Marine Thrift Shop Okinawa.