Retirement Mindset Series - 2 of 5
Hey, what's up, everyone, Henry here from Disruptive Money Management, and we are back with our continuation of the Retirement Mindset series. I have often said in the past that retirement is not an action but a journey. Yes, you may one day wake up and decide that you want to retire, but retirement is not a one-and-done process.
Retirement should be prepared for, not just financially but also mentally and emotionally. I've met far too many individuals who focus only on the financial aspect. They spend a lot of time wondering:
Do I have enough saved?
How much will my retirement nest egg generate?
Will I outlive my money?
And while pondering those questions are well and good, far too few think about life after retirement in terms of what they intend on doing. How I spend my free time as a retiree is just as important as how much retirement income I can expect. What will my life's passion be now that I just freed up 40+ hours from not having to work?
What's worst about the process of retirement is that you generally only get one shot at this. You get one shot at determining whether you have saved enough and one shot at pulling the trigger on retirement. You get that one shot at dropping the retirement announcement bomb, deciding on Social Security, your pensions, and you get one shot at laying the foundation so that your estate transfers to your loved ones in an appropriate manner.
For many of us, we have just one shot at retirement. How confident are you in taking that shot right now?
There are certain aspects that you might be able to re-work. If you're young and you've retired early in your late thirties or early forties like some of my clients, you can quickly go back to work if you find that retirement doesn't suit you or the numbers aren't added up. But what about when you're in your sixties? It might be more challenging, especially in the day and age when employers are hiring younger individuals at a lower pay structure.
While the process itself may seem daunting, foreign, and for some, scary, if undertaken accurately, you will be able to address your retirement concerns. At the very least, you will be able to determine whether retirement is even a viable option given your current state of financial affairs. And that's what I set out to do with this five-part series. To guide individuals like you who do not do this daily, the necessary framework to walk themselves through the retirement planning process. Every step I present to you is the time-tested steps that I have taken with my clients.
Part 1 of this 5 part series talked about Goals and setting goals for retirement, so if you're just joining us, I highly recommend you check out Retirement Mindset #1. Establishing your retirement goals is extremely important because you can't anticipate how much retirement income you need without knowing your goals. Without knowing how much retirement income you need, you cannot determine whether you have saved enough in your retirement nest egg, and isn't that ultimately what we're all just trying to figure out?
Retirement Mindset Part 2 is about appropriately selecting your guaranteed income vehicles. For many, that is Social Security, and for others, it is the pension. If you're an employee belonging to the Federal government, State government, or local municipality, you most likely have access to the respective pension and probably not have individual Social Security.
Deciding how to take your pensions and when the most appropriate time for turning on Social Security can impact your overall retirement income perspective.
For those that have access to pensions, you want to consider how the coverage is applied. While almost all pensions provide guaranteed coverage throughout your life, it typically also gives you the option to cover a secondary life, such as your spouse or significant other.
Covering for one life generally means more income every month, and if you are to cover two lives, you'll see that you have a reduced benefit during your lifetime. This shortfall is designed because the pension has to cover two lives, not just one.
Let us break down the two components so that we can better assess what makes more sense.
Single Life Annuity Option
A pension that only provides coverage for one individuals' life is otherwise known as a single-life annuity. The single life annuity payout offers the highest monthly payment to individuals for as long as they live. Still, that payment ceases upon the person's passing, and there is no death benefit to any survivors.
The single life annuity option is most beneficial towards individuals who are:
Unmarried;
In excellent health and has longevity in their family;
Has a spouse that is much older and not likely to survive them';
Or has a spouse that has their pension that would provide a suitable income.
Joint and Survivor Annuity Options
Joint and Survivor annuity options are designed to cover two individuals. Because it covers both lives, you will often see a much lower starting amount than single-life annuity payouts.
It's important to note that joint and survivor annuity options are intended to cover the participant's life and the participant's spouse if the participant dies first. If the spouse passes first, there is no take-back on the option; you are stuck with the lower amount.
You will usually see three different calculation methods for survivor annuity options. They are generally 100%, 75%, and 50%, with those numbers being how much your survivor receives upon your passing. It goes without saying that the higher the percentage is, the lower your initial starting number would be.
The joint and survivor annuity options make the most sense for individuals who are:
Married;
Has a spouse that is younger and is expected to outlive the pension participant;
Or, if the spouse would be unable to meet their retirement income needs without the pension benefits, the household has not saved up enough retirement money over their working years.
You must consider whether or not your pension provides for a cost of living adjustment and what that adjustment is calculated to be. While most private pensions no longer offer COLA adjustments, public sector employees will likely see the adjustment remain in place. However, what the COLA is and the genuine rise in consumer spending could be two different things.
For instance, many public sector pensions have historically provided a COLA of approximately 2.00%. The assumption is that the COLA will offset the general increase in consumer goods. However, the historical average of CPI has spiked as much as 4% over the past ten years.
How many of your essential grocery items have gone up in price over the past five years? And if they haven’t, how many of those packages have gotten smaller?
So while having a pension annuity payout in and within itself is of tremendous value, you have to keep in mind that cost of living adjustments may have to be made up in other areas, like external investment accounts. For instance, a $3,000 monthly pension is the equivalent of having approximately $900,000 in principal. This is, of course, assuming a 4% withdrawal rate.
However, that $3,000 may not increase year over year at the rate you need to keep up with gas, groceries, and necessities. It is essential that while you are working, you defer into qualified retirement plans to utilize that account as your own cost of living adjustment equalizer.
Social Security
When it comes to your Social Security options, it's easy to understand that waiting until FRA provides 100% of the eligible benefits. While Social Security is available at age 62, it comes at a reduced benefit of 74%. Each year you delay between age 62 and FRA will increase the benefit percentage to the complete 100%.
Delaying past FRA would give you an eight percent increase each year until age 70.
With these many options, how do you know what option works out to be the best? While the possibilities may seem to be endless, you can simplify it down to a few options based on your situation:
If you're planning to continue working past age 62, it doesn't make much sense to turn on Social Security early. Collecting Social Security before FRA while still working could cause your Social Security benefits to become taxable.
If you're working past FRA, you're in excellent health, and longevity is in your family history, it makes sense to delay to age seventy so that you can maximize benefits.
If you retired early, say in your fifties, waiting until FRA may not necessarily make sense. There are times when I have seen scenarios play out better by delaying no further than age 65 or 66. This is because the FRA benefits are expected based on an individual working up until FRA. If you retire at, say, age 55, your benefits could decrease because you're not paying into the system at what the SS benefits expected you to.
If you're married, the options that work out to be the best depend again on several factors:
If both individuals have earned a similar income over the years, it makes sense for each individual to file for their own individual Social Security instead of spousal benefits.
Suppose one individual has always had a higher income over the other, which is expected within households with a stay-at-home parent. In that case, it makes more sense for the primary income earner to delay until age 70. This strategy will allow the individual to have the highest possible benefit for themselves. It also protects the spouse in the primary individual's passing because the spouse automatically gets the higher amount.
Social Security in itself can be a very complex topic, and due to its importance in evaluating retirement income, I have an entire episode specific to that topic. Understanding and Maximizing Social Security Benefits can be found on my podcast channel, but I'll also drop a link in the show notes so that you can easily find it. I highly encourage you to give that a listen if you haven't yet because Social Security, like many things in life, doesn't make it easy for you to fix if you make a decision that you later come to regret.
It is crucial to figure out your Social Security and pension strategies early because that income is guaranteed for life. Well, let me put a caveat to that. It is guaranteed based on the strength of the provider of that annuity payment. For Social Security, that is the full strength and taxable power of the US government. For private pensions, it is the full strength and reserves of that said company. For States and local governments, it is the full strength of that municipalities' taxing power.
Always keep in mind that while guarantees may sound good, nothing could ever remain forever. In one of my recent episodes, What Does A Reduction in Social Security Look Like?, I go over in-depth how reliant we, as a society, are on Social Security and the potential decrease of Social Security. Thirteen years from now, in 2034, the Social Security Trust Fund is expected to be zeroed out, and we are looking at an approximate 25% reduction in Social Security benefits. If you were banking on Social Security as the primary source of retirement income, you best start planning lest you're comfortable brushing off your resume for Walmart.
The same can be said for private pensions. Nothing is forever, and this goes the same for the corporate world. Private pensions, as well as public pensions, can become underfunded. We see this with numerous states and private sector companies. Private companies, will over time, become overburdened with their pension benefits and can become insolvent.
What happens when a company or state becomes unable to pay its pension benefits? Many individuals are disillusioned that they are protected by the PBGC, the Pension Bureau Guarantee Corporation, a Federally chartered entity designed to protect individuals whose pensions' have gone belly-up. The government intended the PBGC to step in when a pension fails and replace up to 90% of the individual's guaranteed pension income.
It sounds like it's all good and blue skies then, right? If your employer pension fails, the PBGC steps in, and you're made about almost whole. Well, before you sit back and relax, listen to this:
According to the PBGC's fiscal year 2017 report, the PBGC is expected to run out of money by 2025. Let me take that back; the PBGC has a 90% probability of running out of money by 2025. There is a 1% probability that it can still make payments to the over ten million individuals it currently covers.
I don't know about you, but 2025 is right around the corner, and the PBGC running out of money does not bode well.
So what do you do if you're an individual facing the option of taking your pension payout or a lump sum rollout? I suggest you take an in-depth look at the reports provided to you by the pension administration company. Pension administrators are obligated, under law, to provide written materials of the actual total health of the pensions they administer. In addition, they sometimes also can provide calculations on how long the pension itself will remain solvent. If those numbers don't look well, you might want to consider deeply what your options are.
The last thing you want to do is lock yourself into an annuity provided by a company that could potentially become insolvent when the PBGC is already expecting to be unable to provide additional coverage. Typically, this is more common in the private sector; the companies would provide a lump sum option in place of guaranteed payments. It might not hurt for you to consider what that lump sum amount can give instead of banking on the longevity of a pension that is quickly running out of money.
Whew, I know that seems like a lot to take in but figuring out your Social Security and pension income strategies is critical before you pull the trigger on retirement. I often review my clients' guaranteed income benefits at least a few before retirement. I do this because we know we have to shape it up on the retirement account balance if those guaranteed numbers do not provide enough coverage. Not having enough guaranteed income to cover your expenses means you will end up dipping more into your retirement nest egg.
If we know how much the guaranteed income can cover or what the gap is, we can determine whether the nest egg has a sufficient enough amount to provide enough of a withdrawal that you can live the lifestyle you deserve. If it doesn't, well, we get back to work.
Don't become discouraged if the numbers don't look like where you want them to be. The truth of the matter is that knowing the news, whether good or bad, should empower you to get it fixed. The last thing you want to do is live your final working years leading up to retirement with blinders on. With the average retiree living well past twenty years from the time they retire, don't just pray and hope that things will be fine. Take that financial house of yours and put your checks and balances in place so that you know exactly where you need to be and how to get there.
And that's it for today, my friends. I hope you enjoyed Retirement Mindset #2. Again, this is part two of the five-part series. Episode 3 will be on structuring your investment portfolio and figuring out your withdrawal ratio so that you do not run out of money in retirement. Be sure to subscribe, like, and tune back in.
For now, I wish you and your family the very best. I hope you all have a safe and wonderful Thanksgiving filled with joy, laughter, and love.