After years of working, many people face the challenge of converting their savings into a sustainable flow of income in retirement. Some researchers think they have a practical solution: Workers should take steps to “pensionize” their nest eggs.
The transition from saving to spending was once relatively simple, at least for retirees with traditional pensions offering predictable payments. But such plans are dwindling — in 2017, only 16 percent of Fortune 500 companies offered a defined benefit plan (traditional or hybrid) to new hires, down from 59 percent among the same employers in 1998, according to Willis Towers Watson — as employers have shifted to investment-based retirement accounts funded largely with worker savings.
While employers have taken steps to automate employee contributions to workplace plans, retirement experts say, few offer options for automatic payment plans in retirement. That means many retirees face a jigsaw puzzle of payments, requiring them to piece together an income from their workplace retirement stashes and individual retirement accounts to supplement Social Security.
One option is to use some of their savings to buy an annuity — an insurance contract that pays out income over time. But many of them are complex and larded with fees.
The complexity often pushes people to “wing it,” said Steve Vernon, a research scholar in the financial security division at Stanford University’s Center on Longevity. Retirees may then spend too much, jeopardizing their long-term financial security.
Mr. Vernon and two colleagues think they have a workable solution, developed in collaboration with the Society of Actuaries and outlined in a report in November: The “spend safely in retirement” strategy.
It focuses mainly on middle-income people — those who have saved perhaps $100,000 to as much as $1 million as they approach retirement — who generally lack traditional pensions, but have workplace 401(k)-type investment plans or I.R.As. Wealthier people with professional planners, however, can also use it.
The strategy helps older workers mimic a steady pension with their own retirement savings with three steps: Work longer; delay taking Social Security to maximize payments, and set a basic budget using an amount that you are required to withdraw from your retirement accounts anyway, effectively “pensionizing” your savings.
Working longer — at least part time — can help cover basic living expenses and preserve savings. That in turn helps enable the second step, the postponement of Social Security benefits, ideally until age 70, to maximize those payments. For each year past your “normal” retirement age that you delay claiming Social Security benefits, your payments increase by 8 percent, until age 70 (the automatic increases stop at that point, although adjustments for inflation continue).
Taking benefits sooner, in contrast — say, at 62, the earliest age for taking benefits — significantly reduces your check.
Robert Siwa, 74, of Findlay, Ohio, said he filed for Social Security benefits at age 62, then worked off and on for a few years before fully retiring. He didn’t have a pension, but he had received a payout earlier from a company profit-sharing plan, which he invested in an I.R.A.
Then, in 2011, the annual premium on a life insurance policy he held skyrocketed at renewal, because of a health problem. He felt it was important to keep the policy, so he returned to work part-time to pay for it. He works on call, driving cars between auto dealerships. “I really didn’t want to take it out of retirement savings,” he said. “It’s a balancing act.”
Cindy Hounsell, president of the nonprofit Women’s Institute for a Secure Retirement, said she often is asked what women should do if they lack retirement savings. “Keep working!” she said. “That’s your answer. Where else are you getting 8 percent?”
If 70 isn’t possible, working even an extra year or two can help.
The third step of the strategy (warning: retirement jargon ahead!) is to draw down a percentage of your retirement accounts each year as income, using the Internal Revenue Service’s “required minimum distribution” amount as a guideline. That’s the money retirees typically must withdraw from most types of retirement accounts each year, after age 70 1/2.
Called an “R.M.D.,” the amount is calculated each year as a percentage of your retirement savings, based on an I.R.S. formula that factors in your life expectancy. So if you have $400,000 in a retirement account at age 71, you must withdraw about $14,600, according to the I.R.S. work sheet. That translates to about $1,217 a month.
The R.M.D. wasn’t designed as a budgeting tool; rather it was created to make sure Uncle Sam collected his taxes, after letting retirement savings grow tax deferred for years. But it can work as an income plan too, Mr. Vernon said.
The withdrawal rate progresses from about 3.65 percent to 4.2 percent of assets for people in their early 70s, according to the I.R.S.’s chart, and continues to rise gradually over time. Although you don’t have to take a distribution before age 70 1/2, the approach can be used to calculate a safe withdrawal rate at younger ages — Mr. Vernon suggests 3.5 percent, to keep things simple.
If someone can’t work until age 70, Mr. Vernon says, it’s preferable to cut back on spending and dip into savings to meet basic needs for food, clothing and housing for a few years, in order to delay taking Social Security. That may mean less savings over all, but the trade off is higher “guaranteed” Social Security income.
Mr. Vernon and his co-authors, Wade Pfau and Joseph Tomlinson, analyzed about 300 variations of retirement income strategies, and found that the “safe spending” approach generally wrings the most out of available benefits for middle-income retirees, while avoiding excess complexity.
Mr. Vernon urges potential retirees to think of Social Security payments as their steady “paycheck,” to cover the basics, while the money from annual R.M.D.s, which may fluctuate based on investment returns, represents a “bonus.”
The approach isn’t perfect. For one, it assumes that Social Security will continue as it exists today, although the program is subject to political risk as the population ages. (Mr. Vernon also cautions that it’s important for married couples to plan carefully when claiming Social Security, so the surviving spouse gets the highest amount possible should one of them die.)
Some retirees are not even aware of R.M.D. rules, said David C. John, a senior strategic policy adviser at the AARP Public Policy Institute, despite hefty penalties for failing to take them (50 percent of the money not withdrawn), and may be uncomfortable calculating them.
Mr. John said he recently conducted a retirement seminar and some older people were in tears because they only learned they had missed a withdrawal when they received a tax bill reflecting the penalty.
In theory, he said, retirement plan sponsors alert account holders about required withdrawals, but it may not always happen.
Some financial planners say they doubt that basing a budget on Social Security plus an R.M.D. will support the lifestyle many people hope for in retirement, unless they have saved larger amounts of cash. “If the R.M.D. isn’t enough, you still have to cut expenses,” said Jennipher Lommen, a financial planner in Santa Cruz, Calif.
Retirees are dubious. “It wouldn’t be enough,” said Nancy Hall, 71, of Princeton, N.J., who retired as a researcher with the New Jersey State Health Department 15 years ago. (Her husband is also retired.)
Ms. Hall said she was fortunate to have a government pension, but worried that it won’t stretch as far as planned because the state had eliminated cost of living increases.
“We thought we were on easy street,” she said with a laugh. She claimed Social Security at 64, but wonders if she should have waited.
Mr. Vernon said retirees should consider the “spending safely” proposal a baseline, and modify it to fit their circumstances. Meanwhile, he is acting on his own proposal. Retired for a decade from his full-time career as a consulting actuary, he’s now 64 and “working just enough” in his encore career as a researcher, he said, to delay his Social Security benefits — hopefully until age 70.
“Age 70,” Mr. Vernon said, “is the new 65.”