Delaying Social Security and using RMD rules to draw down your nest egg is a winning combination for middle-income retirees.
Retirement-income strategies are big business. Financial advisers and online advice services will help you transform your savings into a steady retirement paycheck—for a fee. Some mutual funds also promise to deliver a stream of retirement income—for a fee. And all manner of annuities will guarantee you lifetime income—for fees, fees and more fees. But what if the best retirement-income strategy didn’t require you to pay anyone for advice or fancy financial products, and you could actually implement it yourself while channel-surfing and ordering pizza?
New research concludes that the best way to produce a retirement paycheck really is that simple. The Stanford Center on Longevity, in collaboration with the Society of Actuaries, conducted a study comparing hundreds of retirement-income strategies, including various combinations of variable and fixed annuities, systematic portfolio withdrawals, reverse mortgages and delaying Social Security.
One approach, which the researchers dubbed the “Spend Safely in Retirement Strategy,” works well for a broad swath of middle-income retirees, the study finds. And it’s not exactly rocket science: It involves delaying Social Security and using the IRS required minimum distribution tables to draw down your nest egg.
Generating retirement income has become a major issue for retirees, says Steve Vernon, research scholar at the Stanford Center on Longevity and co-author of the study. Traditional pension plans that guaranteed lifetime income are disappearing, replaced by 401(k)s and other defined-contribution plans that rarely offer guaranteed-income options.
All retirement-income strategies involve trade-offs. If you want to maximize your lifetime income, you’ll reduce the amount that will be left over for heirs. And if you want to boost your guaranteed income by buying an annuity, you lose the flexibility to access your savings in a pinch.
To help retirees make smarter trade-offs, the Stanford study looks at hypothetical retirees with varying amounts of savings and compares retirement-income strategies based on eight different measures. Those metrics include the change in inflation-adjusted income expected during retirement; liquidity, or the average amount of money that is accessible during retirement; and the average amount that is left over for heirs.
For middle-income retirees—those with $100,000 to $1 million in savings—the Spend Safely strategy stands out, the study found. The combination of delaying Social Security and using the RMD rules to draw down the nest egg ties together two highly efficient retirement-income strategies, says Jamie Hopkins, co-director of the New York Life Center for Retirement Income at the American College. Social Security offers some protection against major retirement risks—such as inflation, outliving your savings and the death of a spouse—and part or all of it is excluded from taxation. And the RMD strategy automatically adjusts your portfolio withdrawals to reflect your remaining life expectancy and investment gains and losses.
Although the Spend Safely strategy does not produce the highest level of initial retirement income, it generates inflation-adjusted income that grows moderately during retirement, whereas many other strategies that were studied didn’t keep up with inflation. And because Social Security provides such a solid foundation, the strategy has a relatively low level of downside risk, with potential future spending reductions generally well under 3%, the study found.
Putting the Spend Safely in Retirement Strategy to Work
The best way to implement the strategy, the researchers say, is to work enough to cover your living expenses until age 70. At age 70, claim your Social Security benefits and start drawing down your portfolio using the RMD tables in IRS Publication 590-B. (Use Table 3 in appendix B, or Table 2 if your spouse is more than 10 years younger than you.) Divide your total investment portfolio balance by the factor listed for your age in the IRS table to arrive at your annual withdrawal amount.
For married couples, the Social Security claiming decision is more complex. While the higher earner should generally delay benefits as long as possible, Vernon says, couples should consider using online software to help them find the optimal claiming strategy. Tools that can help you maximize benefits are available at financialengines.com (enter “Social Security” in the search box) and socialsecuritysolutions.com.
For people who can’t—or don’t want to—work until age 70, the next-best solution is to draw enough from your savings to enable you to delay Social Security as long as possible. A “retirement transition bucket” can help you accomplish that, the researchers say. Let’s say you plan to retire at 65 but want to delay Social Security until 70. Your Social Security benefit starting at age 65 would be about $20,000 a year. So you could set aside $100,000 from your savings in short-term bond funds or other conservative holdings, drawing $20,000 annually from that bucket between 65 and 70. For additional income, you can draw about 3.5% annually from your remaining investment portfolio, Vernon says.
The study also examined the best way for retirees to invest their nest egg. For many middle-income retirees who delay Social Security until age 70, that guaranteed bond-like benefit accounts for roughly 75% to 85% of total retirement income. That leaves retirees room to take considerable risks in their investment portfolio, investing up to 100% in stocks if they can stomach the volatility, the researchers say.
Vernon acknowledges, however, that most people won’t feel comfortable with 100% in stocks. A target-date fund that automatically adjusts its investment mix as you age or a balanced fund with 40% to 60% in stocks, he says, “could be a good compromise.” Spend Safely isn’t set in stone, Vernon says. If you can only wait until 67 or 68 to take Social Security, “you still get a lot of benefit,” he says.