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Playing Catch-Up with Retirement Savings

I sometimes receive emails from investors describing themselves as “behind schedule” with regard to retirement savings. They’re nearing the age at which they’d like to retire, but their portfolios just aren’t where they’d need to be to get the job done.

The truth is, if you’re in such a situation, there are things you can do to improve your chances of retiring comfortably, but they’re not magic bullets — they involve sacrifices and have imperfect success rates. Nor are they top secret tips — these are the same types of things we discuss here on the blog all the time.

Retire Later

Whether it’s sticking it out for an extra couple years at your current job or picking up part-time work in a more enjoyable field after leaving your job, retiring later is often the highest-impact thing you can do for your retirement finances. Each additional year of work is one more year to accumulate savings and one fewer year of spending from your savings.

Improve the Return from Your Investments

Many investors who find themselves behind schedule with their savings attempt to make up for lost time by ratcheting their stock allocation upward. Sometimes it works. Other times it backfires.

Rather than crossing your fingers and taking on more risk, my best suggestion for improving returns is to cut costs. While even this is not a sure thing, low-cost index funds (or ETFs) tend to outperform the majority of actively managed funds, and I have yet to hear of anyone finding a better predictor of mutual fund performance (within a given asset class) than fund expense ratios.

Annuitize Part of Your Portfolio (by Delaying Social Security)

Finally, the safest way to increase the amount you can spend from your portfolio per year is to annuitize a part of that portfolio via an immediate inflation-adjusted lifetime annuity. In exchange for giving up liquidity and the ability to leave the money to your heirs when you die, such annuities offer a higher level of income than you can safely take from a typical stock/bond portfolio.

Remember though, that delaying Social Security is akin to buying just such an annuity — one that’s a significantly better deal than what you could actually buy from an insurance company. So before using a part of your portfolio to purchase an actual annuity, it usually makes sense to use that part of your portfolio to satisfy your regular spending needs while you delay claiming Social Security benefits for as long as possible.

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  1. Sorry, but I don’t understand the final topic. Are you suggesting that people delay SS, delay buying an annuity, or both? And how is delaying SS akin to annuitizing part of the portfolio? Isn’t buying an annuity the way to annuitize?

  2. Larry,

    Each month that you delay claiming Social Security benefits is like buying a (small) lifetime inflation-adjusted annuity because you give up a sum now (a month of benefits) in exchange for an income stream for the rest of your life (in the form of increased benefits).

    The differences are that:

    1. The payout (per dollar invested) is significantly higher than what you could get from an actual annuity today,
    2. The credit risk is lower, but
    3. There is some degree of political risk (how significant this is depends on who you ask).

    So, what I’m saying is that before buying an actual annuity, it’s usually best to “buy” as much of this Social Security annuity as you can. If you’ve already done that (i.e., delayed benefits to 70) and still want to annuitize further, that’s typically when an actual annuity would come into play.

  3. OK. I’m 63. Let’s say that (assuming I can keep my present full-time job) I plan to retire no earlier than 66, which is my FRA for SS, or perhaps a year later. Already as a consequence I am delaying taking SS until that time, and my portfolio will still have perhaps 3-4 years to grow.

    Let’s say further that on retiring at 66-67, at a 4% withdrawal rate from my portfolio I might still be tight on money for expenses. In that case, would I be better off waiting until age 70 for SS and taking a higher withdrawal rate from the portfolio, or should I start SS immediately on retiring?

  4. If the goal is to maximize the amount you can safely spend per year (as opposed to the sometimes-conflicting goal of maximizing the amount you leave to heirs), delaying Social Security all the way to 70 usually makes sense.

    It’s all just mental accounting, but I find it easier to think of your withdrawal rate as the withdrawal rate you’ll need after you start taking Social Security. The additional amount you spend in the years prior to claiming (in order to make it possible to delay benefits) is the amount you’re effectively annuitizing.

  5. Thanks, Mike. I’m not too concerned about heirs, but my question rather was about the time span between starting retirement and age 70. If I retire at 66-67, I still have to fund those 3-4 years somehow, and I might not be able to do that at a 4% withdrawal rate if I delay taking SS. On the other hand the 4% SWR seems to be pegged to an expectation of a 25-year retirement, which I may or may not reach. Maybe I’m missing your point, but although I can understand delaying SS as long as possible, I’m still confused about how best to handle the period between retirement and age 70.

  6. Let’s use some made up numbers.

    Let’s assume a person has:
    $40,000 of annual expenses,
    $500,000 portfolio,
    $20,000 annual Social Security benefits if claimed at full retirement age of 66 (which would mean roughly $26,400 of benefits if waiting until age 70).

    If the person retires at 66 and claims SS right away, he’ll have $20,000 of annual expenses to satisfy with the $500,000 portfolio. That is, he’ll be using a 4% withdrawal rate starting at age 66.

    If the person retires at 66 and delays SS until 70, he’ll have $13,600 ($40,000 – $26,400) of expenses to satisfy every year, plus an additional $26,400 to satisfy for the 4 years until he claims Social Security.

    If we subtract $105,600 (or $26,400 x 4) from his $500,000 portfolio (in order to satisfy the additional expenses for those 4 years), that leaves him with $394,400. With $13,600 of expenses, he’s now only using a 3.45% withdrawal rate, starting at age 66.

    Effectively, he’s annuitizing $105,600 between ages 66 and 70. And, with the rest of his portfolio, he’s using a 3.45% withdrawal rate starting at age 66. This is as compared to annuitizing nothing and using a 4% withdrawal rate for the entire portfolio starting at age 66.

  7. Hope you don’t mind my monopolizing the conversation, but I have to get this straight. Agreed, “if the person retires at 66 and claims SS right away, he’ll have $20,000 of annual expenses to satisfy with the $500,000 portfolio. That is, he’ll be using a 4% withdrawal rate starting at age 66″ and the other $20K will come from SS.

    But if the person retires at 66 with $500K, needs $40K a year, and delays SS until 70, where is that $40K coming from if not the portfolio? As I see it, he’s now using an annual withdrawal rate of 8% (500,000 x .08) and reducing his portfolio to $340,000 (40,000 x 4 = 160,000; 500,000 – 160,000 = 340,000) by age 70.

    What am I missing?

  8. Correct: If he delays until 70, the $40,000 of expenses for the first 4 years are coming from the portfolio.

    But that’s not an 8% withdrawal rate in the typical retirement planning sense, because those studies are typically based on the assumption that the withdrawal rate will be used throughout retirement.

    In essence, what the investor who delays until 70 is doing is breaking down his $500,000 portfolio this way:

    • $394,400, which, at a ~3.45% withdrawal rate beginning at age 66, will satisfy $13,600 of expenses for the rest of his life (assuming the 3.45% rate is safe, that is), and
    • $105,600 which will be spent during the first 4 years to satisfy the additional $26,400 of expenses prior to SS kicking in.
  9. I see – I think. So is this what you’re saying? by holding off until 70, you’ll be drawing a larger percentage from the portfolio in the first 4 years, so that you can draw a smaller percentage in later years because SS will more than compensate to make up the difference?

  10. Yes.

  11. One of the best thing you can do is reduce expenses in your portfolio. I mainly use index mutual funds and ETFs in my portfolio. I do use some active funds and leveraged ETFs, but I use them sparingly, this keeps my expense ratio well below 1% (more like 45 bps). This is hugely important, because you will be hard pressed to find an active manager that consistently beats the performance of their benchmark, especially if you factor in an expense ratio of 1.5% and/or a mutual fund front-load fee that can be as high as 5%!! The problem I still see with actively managed mutual funds is that portfolio managers can play games to improve and protect their track record, which can cost you money. For example, a manager might sell a position near year-end at a big loss just so you don’t see it in the year-end report, even though this position may be on the upswing. They don’t want you to see their bad call in the year end report. They are willing to sacrifice the future upside and lock in a loss, just so you do not see it. Not good…

  12. Mike,

    I think I understand now what you’re saying. But it appears inconsistent with the advice you’ve given in print – in Chapter 2 of your Retirement book – to keep withdrawal rates low at the start of the retirement period due to volatility and sequence of returns risk.

  13. Larry,

    I don’t think it’s inconsistent at all. What this strategy does is reduce sequence of returns risk, because your long-term withdrawal rate is significantly lower than it is with claiming Social Security right away.

    Consider it this way: If instead of delaying Social Security, the investor in question claimed Social Security at age 66 and (also at age 66) used the $105,600 to buy an inflation-adjusted lifetime SPIA, would you say he was using a high withdrawal rate in that first year? That is, would you include the $105,600 as “money spent” when calculating the withdrawal rate he used for the year?

    Edited to add my own answer to the above question: I would not include money annuitized as money spent, because rather than just disappearing, it also increases the income the investor will receive per year for the rest of his life. And the same thing goes for money used to delay Social Security — it will increase the income the investor receives per year for the rest of his life. (The tricky part is that it feels like it was just spent, because it did in fact go to pay for groceries, utilities, etc. But it still has the same result as money annuitized: increased lifetime income.)

  14. “I don’t think it’s inconsistent at all. What this strategy does is reduce sequence of returns risk.”

    But I don’t see quite how. In the book, you write, “when you’re systematically taking money out of an investment portfolio, the early returns (i.e., the ones that occur while you still have a lot of money invested) are the ones that matter most. If you’re withdrawing more than a few percent of your portfolio per year, and you experience a severe or extended bear market early in retirement, there might not be enough of your portfolio left for your retirement to be saved when the market finally does rebound.”

    And yet in the example given above, you’re speaking of taking $40K for the first four years, or 8% annually from a $500K portfolio. I understand that starting at 70, you now might need only 3% or so going forward as the SS benefit will be correspondingly higher. And of course in a prolonged bull market none of this is an issue. But my concern is what happens in a prolonged bear market if, prior to age 70, you’re depleting such a large percentage of your assets for the first few years of retirement.

    Please forgive me if I’m missing something, but I think it’s an important question to get clear on.

  15. I’m sorry I wasn’t more clear in the book. When I wrote, “If you’re withdrawing more than a few percent of your portfolio per year…” I was talking about using a withdrawal rate of more than a few percent per year throughout retirement — because, if you get a bear market early, it will be difficult to continue funding that level of spending.

    In the case of the hypothetical investor above who delays Social Security to 70, the $105,600 of his portfolio that he’ll be spending/annuitizing over those first 4 years will just sit in savings/CDs until he spends/annuitizes it.

    So one part of his portfolio will be nearly risk-free, and the other part (the part with a typical stock/bond allocation) will be asked to fund a 3.45% withdrawal rate throughout retirement. This is as compared to the investor who claims Social Security right away, for whom the stock/bond portfolio would have to fund a 4% withdrawal rate throughout retirement.

    The end result is that the investor who doesn’t delay Social Security is the one who is significantly more exposed to a bear market early in retirement (or to a bear market at any point, really).

  16. OK. I don’t remember this approach being really developed in the book, and I wasn’t clear also that the $105.6K was to be put into savings/CDs. But the picture is starting to emerge: regardless of the market, draw more from the portfolio in the few early years of retirement if needed, and wait to claim SS as long as possible so that you can draw less from the portfolio for the remaining 10, 20, 25 or so years.

  17. Ah ha! There’s our hangup. Yes, it’s important that the money that will be annuitized over the next few years (or spent, in order to delay SS) be in something low-risk, otherwise, yes, there would be a (big!) additional risk to a bear market early.

    Sorry I didn’t make that clear sooner.

  18. OK, that’s good. So if one pursues an allocation strategy of putting a larger percentage into fixed income (and can I presume that very low-risk investments like short-term bonds also qualify?), then chances are one is safe using the strategy you describe.

    I was also thrown by the term “annuitize,” since I would have assumed that meant the active purchase of an annuity, whereas here you apparently are speaking of an annuity effect.

  19. “…whereas here you apparently are speaking of an annuity effect.”

    Correct. The effect is mostly the same (both would reduce exposure to market risk and longevity risk, though they expose you to different types of default risk). But as explained in the linked-to article, the payout you get from delaying Social Security is a better deal than what you can get from an actual annuity. So it doesn’t usually make sense to buy an actual annuity until you’ve delayed Social Security all the way to 70.

    “So if one pursues an allocation strategy of putting a larger percentage into fixed income (and can I presume that very low-risk investments like short-term bonds also qualify?), then chances are one is safe using the strategy you describe.”

    Cash, money market, short-term Treasuries, CDs, savings — anything along those lines would be OK. But the whole point is to reduce risk, and given that this money will be spent (either to delay Social Security or buy an actual annuity) in the next few years, you want something that you know isn’t going to lose money over a short period.

  20. How about adding a second stream of income for a few years? Freelancing, consulting, or Internet Marketing, for examples?

If you want to discuss this article, I recommend starting a conversation over at the Bogleheads investing forum.
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