What’s the number one concern of most retirees? Running out of money. It’s the natural consequence of our expanding life expectancy. Living longer simply costs more. Since I haven’t met anyone willing to volunteer to reverse this trend, that leaves only two options: a) increase your personal savings, or b) resign yourself to living on whatever help you might get from the government.
For decades the financial services community has implored us to “Save More!” The reality, however, is that whether you’re in your 20s or 40s, saving for retirement takes a back seat (“It’s years away!”) to more immediate priorities such as paying the mortgage, an unexpected medical issue, braces and college for your kids and, of course, more immediately gratifying expenses such as vacations, a new car and other “necessities.” And let’s not forget the economy. Lay-offs and down-sizing not only prevent you from saving but may also force you to draw down some of the nest egg you’ve managed to save.
The Default “Retirement” Plan
Then one day you realize you’re in your mid-fifties and “OMG! Retirement is just ten years away!” And you’ve got next-to-nothing saved to help pay for it.
That most Baby Boomers will tell you that their plan for retirement is “Keep working.” The reality is that many of us feel we simply cannot afford to retire. Unfortunately, despite your intentions, research by the Employee Benefits Retirement Institute (EBRI) consistently finds that only about one-third of those who expect to work “as long as I can” or well into their late 60s, are able to do so. The majority are forced to exit the workforce for a variety of reasons, such as deteriorating health or the need to care for a spouse.
The Benefits of Continuing to Work
Still, if you’re able to keep working in your 60s- even part-time and in a totally different field- there are a number of benefits. In fact, you can significantly make up for under-saving in your earlier years. First of all, since your salary is covering at least part of your living expenses, you may not have to withdraw money from your retirement account for this purpose. This gives the investments in your account more time to potentially grow.
Plus, since you have earned income and are over age 50, you can contribute up to $6,500 to an IRA this year.(1) Or defer up to $24,000 into a company-sponsored 401(k) or 403(b) plan.
Admittedly, the idea of continuing to add to your retirement plans sounds great – if that leaves you enough money left to live on. But what if your salary is less than $30,000? How are you supposed to survive if you take even $3,000 of that and put it into a retirement account?
The genius solution comes from George Fraser, a veteran financial advisor headquartered in Scottsdale, Arizona. Fraser specializes in helping small-to-mid-sized employers install retirement plans for their workers. But he doesn’t stop there. Part of his service is to provide personal financial advice to every single plan participant who wants it.
It Takes Discipline, Not Mega-Bucks
Most of the folks who work at the companies Frazer covers make very modest salaries- less than $40,000/year. “When you throw out numbers like, ‘We need everyone to save 15% of their salary,’ most of them figure there’s no way they can afford it,” says Fraser.
So he starts small, asking employees to contribute just 1% of their salary to their 401(k). Each year contributions go up by 1% until they top out at 6% in the 6th year of employment. “If you can get a 20-year old to do this,” says Fraser, “Even if they never make more than $25,000/year, they’ll have more than $290,000 in 45 years.”
In other words, in the first year the individual would contribute a total of $250/year spread out over 12 months. The next year, her contribution goes up to $500 or $60/month. In this example, by year six the employee is contributing $1500/year and does so for the next 39 years.
According to Fraser’s calculations, assuming this worker never gets a raise and the employer never makes a company contribution to her account (i.e. a rare and extreme case), by the time she is 65, her 401(k) will have grown to $290,378, provided the investments earn a relatively modest 6% per year.
It’s safe to say that most people who “only” make $25,000/year would never dream they could every build a nest egg that large. In fact, many people who earn far more than that have not managed to accumulate $300,000 in retirement assets.
Using Social Security to Your Advantage Fraser’s break-through involves harnessing the rules that govern Social Security to help lower-income employees who are willing and able to continue working to super-charge their retirement accounts.
Take two real clients we’ll call John and Jane. Both are 66 years old- full retirement age, or “FRA”- and each has earned a Social Security benefit. Although he never made more than $26,000/year, 40+ years of work translate into a FRA benefit of $1,864 for John. Jane’s is $848. John likes his job and figures he’ll work another three years.
There are a number of Social Security rules that come into play:
- Once you reach FRA(2) and continue to work, you will receive 100% of your benefit amount- no matter how much you earn. (3) - If you are FRA and choose to delay collecting your Social Security benefit, your benefit will increase by 8% for every 12 months that you postpone filing for it. (This “delayed retirement credit” stops once you reach age 70.) - If you wait until you are FRA to file for Social Security you have additional choices in terms of how you can take your benefit. - Your Social Security benefits may be subject to income tax if your “provisional” (a.k.a. your “combined”) income exceeds a certain amount.(4) If you file “married/joint” and your provisional income is less than $32,000, none of your Social Security is taxable. Although other variables such as health come into play, in most cases, someone who earns more than John and who wishes to continue working past FRA, would be advised to delay the start of Social Security and thereby reap the benefit of a substantially larger Social Security check. After all, delaying until 70 (48 months) results in a benefit that is at least 32% larger than at age 66.
Fraser turns this on its head.
The Social Security Shuffle Instead of waiting until age 70 to begin collecting Social Security, Fraser advised John to immediately file for his Social Security benefit of $1,864. Since she is also FRA, Jane can file for just her 50% spousal benefit of $932/month, allowing her own benefit to earn delayed retirement credits. Their combined income from Social Security will be $2,796/month. In other words, their annual income from Social Security will be $32,552- $7,000 more than what John will earn from his job!
The Triple Whammy
Because he is full retirement age, John’s Social Security benefit is no longer subject to reduction. Since their combined benefits exceed John’s salary, they can continue to afford their current lifestyle based upon their income from Social Security alone.
This enables John to use nearly all of his salary to make the maximum contribution to his company 401(k) plan- $24,000/year. If he does this for the three years he is planning to work, John’s account will be at least $72,000 larger- providing significantly greater financial security for both him and Jane, who is likely to outlive him.
What’s more, maxxing out his 401(k) contribution results in “a significant reduction in their income taxes immediately,” explains Fraser. Since only a small part of their Social Security will be taxable, on an after-tax basis, they actually will have more money to spend!
At age 70, Jane will switch from her spousal benefit to the Social Security benefit she herself earned. By then, after 4 years of delayed retirement credits, it will be roughly one-third larger.
No wonder when Fraser relayed the news “she got up and hugged me and he walked out like he’d just hit the lotto.”
While this approach isn’t right for everyone, it underscores the need to understand the rules that surround Social Security- or find a financial professional who can navigate them for you. “When you help someone who has lost hope, that’s better than winning a $20 million account,” says Fraser.