MONEY Social Security

How Social Security Spousal Benefits Can Boost Your Tax Bill

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q: If my wife takes the “spousal benefit” on my Social Security, which I have suspended until age 70, do we have pay taxes on that income? – Ron

A: Yep, you do. Social Security benefits are taxable if they exceed certain levels, and this applies to spousal and other benefits as well as your own retirement benefits. The rules can be a bit tricky. If you file a joint tax return, and your “combined” income is less than $32,000, you will owe no federal income tax on your Social Security benefits. If it’s between $32,000 and $44,000 a year, you will owe taxes on 50% of your benefits. Above $44,000, you would owe taxes on 85% of your benefits. Under current rules, you will never owe federal taxes on more than 85% of your benefits. These income brackets are not adjusted for inflation each year, so over time more and more people will owe taxes on their Social Security benefits. To determine your combined income as defined by Social Security, take your adjusted gross income (AGI) from your tax return, add any nontaxable interest you receive (from, say, a municipal bond), and then add half of your household’s combined Social Security benefits.

Q: After reading your article in Money, I thought the Start-Stop-Start strategy might work for me. I have called Social Security and they have never heard of this. Can you tell me the part of their regs which allows this method of claiming benefits? Thanks. —Phil

A: Start-Stop-Start is not an official name but a short-hand reference to a way of using Social Security’s rules for Suspending Retirement Benefits. If you have begun receiving benefits (the first Start), these rules permit you to suspend them (the Stop part) when you’ve reached your Full Retirement Age. Then, they will increase due to Delayed Retirement Credits until you resume them (the second Start part). Your suspended benefits will reach their maximum amount at age 70.

Q: My wife and I are both high earners. I am 68 now and am not taking Social Security benefits. My wife will be 66 in June 2017. Can I file for benefits and suspend and if I do, can she then receive half of my benefits now, even though she is not yet 66? What effect will this have on her own benefits, which she would like to defer until age 70? — Rao

A: If your wife files for a spousal benefit before she reaches 66 (which is defined as Full Retirement Age) she will not be able to file just for her spousal benefit. Under Social Security’s “deeming” rules, she will not be able to suspend her own benefits but will be required to file for them and her spousal benefit at the same time. She will not get both benefits but an amount that is roughly equal to the greater of the two. Also, because she is filing before her FRA, her benefits will be hit with Early Claiming Reductions, meaning that she will get an amount that is roughly equal to the greater of two reduced benefits! Unless you are in dire financial straits or facing a health or other family emergency, she should wait to file for a spousal benefit until she is 66. At that time, and assuming you have filed for and suspended your own benefit, she can file what’s called a restricted application for just her own spousal benefit. She will receive the full value of this benefit, which will equal half of your benefit as of your FRA. And she will be able to let her own retirement benefits increase by 8 percent a year until up to age 70.

Philip Moeller is an expert on retirement, aging, and health. He is co-author of The New York Times bestseller, “Get What’s Yours: The Secrets to Maxing Out Your Social Security,” and is working on a companion book about Medicare. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

Read next: How to Time Medicare and Social Security Claims for 2016

MONEY retirement income

The New Way to Get IRA Income

Thanks to a government rule on annuities, retirees can be rewarded for their patience.

For years, financial planners have touted the benefits of longevity annuities for retirees. Now a new IRS rule has made these income generators an even better deal.

With a longevity annuity—also called a deferred income annuity or longevity insurance—you pay a lump sum in return for monthly income for life, starting at some future date. Because the issuer assumes that—let’s just say it—some buyers will die before they start receiving money, or soon after they do, your monthly check will be far more than you would receive from an immediate annuity costing the same (see the chart below). A longevity annuity’s larger, delayed payout helps hedge against the risk of outliving your money. It also frees you up to invest more aggressively in the rest of your portfolio, because you know you’ll have this income later on.

Under a rule passed last year, if you use IRA funds to buy a longevity annuity meeting certain IRS guidelines, its cost—up to $125,000 or 25% of your account, whichever is less—won’t be used in calculating the required minimum distributions you have to take from your retirement account starting at age 70½. Such a qualified longevity annuity contract, or QLAC, as it’s known, lets you leave more money to continue growing tax-free in your portfolio. To decide whether a longevity annuity is right for you, follow these steps:

Assess your cash situation. As useful as the annuity can be, you have to balance that future income stream with your need for money that you can tap for emergencies, either now or later. So commit only a small portion of your portfolio— no more than 20%—to a deferred annuity, suggests Michael Finke, financial planning professor at Texas Tech. “The sweet spot for buying a deferred annuity is $500,000 to $1 million or more in retirement assets,” he says. Less than that, and you won’t be able to purchase much income; more than that, and you can likely fund your future needs without annuitizing.

RIA_pays_delay_graphic

Make sure you can wait. Some buyers of longevity insurance are workers who plan to defer their annuity only until they retire, often within 10 years. But to maximize your benefit, defer 15 years or longer and wait until you’re in your seventies or eighties. Otherwise, you won’t get a big income bump from the issuer’s expectation that a certain number of buyers like you won’t collect. “If you can’t afford to wait more than a few years, there’s not much advantage over an immediate annuity,” says York University finance professor Moshe Milevsky.

Get ready to research. Several insurance companies have started selling QLACs, including Principal Financial and American General. You can get quotes for them at ImmediateAnnuities.com or through Vanguard and Fidelity.

So your money will be there when you need it, stick with insurers rated A+ or better by A.M. Best or Standard & Poor’s, says Coral Gables, Fla., financial planner Harold Evensky. After all, the whole point is to have fewer financial worries in retirement.

Read more about annuities:
What is an immediate annuity?
How do I know if buying an annuity is right for me?
What payout options do I have?

MONEY retirement planning

The 4 Questions You Must Get Right for a Secure Retirement

senior mature man on laptop in kitchen
Getty Images

To stay on track to a comfortable retirement, focus on these four essentials.

Given the flood of often confusing and conflicting information from financial services firms, market pundits and the media, it’s easy to lose sight of what really matters when it comes to retirement planning. No doubt that’s one reason only 32% of American workers surveyed by Personal Capital reported they are very or somewhat prepared for retirement. But there’s an easy way to improve your odds of a secure post-career life: Focus on the fundamentals, which can be boiled down to these four key questions:

1. Are you saving enough? How much is enough? Well, if you get started early in your career and experience no disruptions to your savings regimen, you may very well be able to build a nest egg well into six or even seven, figures by stashing away 10% of pay each year, especially if your employer is throwing some matching funds into your 401(k). But not everyone gets that early start and sticks to it. So I think a more appropriate target—and one cited in a Boston College Center for Retirement study—is 15% a year.

Of course, if for whatever reason you’re getting a late start on your retirement planning, you may have to resort to more draconian measures, such as ratcheting up your savings rate above 15%, putting in a few extra years on the job before retiring and scouting out innovative ways to cut expenses and save more. There are a number of free online calculators that can help you estimate on how much you should be saving to have a reasonable shot at a comfortable retirement. Don’t despair if the figure the calculator recommends is too high. You can always start with an amount you can handle and then increase it by a percentage point or so a year until you reach your target rate.

2. Do you have the right investing strategy? By the right strategy, I mean tuning out the incessant Wall Street chatter and the pitches for dubious investments and concentrating instead on building a well-balanced portfolio that jibes with your risk tolerance while also giving you a reasonable shot at the returns you need to achieve a comfortable retirement. Fortunately, that’s fairly easy to do. Start by gauging your true appetite for investment risk by completing this free 11-question risk tolerance-asset allocation questionnaire from Vanguard. Then, using the mix of stocks vs. bond funds the tool recommends as a guide, create a portfolio of broadly diversified low-cost index funds.

The portfolio doesn’t have to be complicated. Indeed, simpler is better: a straightforward blend of a total U.S. stock funds, total U.S. bond fund and total international stock fund will do. The idea is to keep costs down—ideally, below 0.5% a year in annual fund expenses—and avoid toying with your stocks-bonds mix except to rebalance every year or so (and perhaps to shift your mix more toward bonds as you near and then enter retirement).

3. Are you fine-tuning your plan as you go along? Retirement planning isn’t a task you can complete and then put on autopilot for 20 or 30 years. Too many things can change. The financial markets can take a dive, a job layoff might upset your savings regimen, a health or other emergency could force you to dip prematurely into your retirement stash. So to make sure that you’re still on track to retirement despite life’s inevitable curve balls, you need to periodically re-assess where you stand and determine whether you need to make some tweaks to your plan.

The best way to do that is to fire up a good retirement calculator that uses Monte Carlo simulations. For example, by plugging in such information as your current salary, retirement account balances, how your investments are divvied up between stocks and bonds and your projected retirement date, the calculator will estimate your chances that you’ll be able to retire in comfort if you continue on your current path. If your chance of success is uncomfortably low—say, below 80%—you can see how moves like saving more, investing differently or postponing retirement might improve your retirement outlook. Doing this sort of evaluation every year or so will allow you to make small adjustments as needed to stay on track, reducing the possibility of having to resort to more dramatic (and often more disruptive) moves down the road.

Read next: This Overlooked Strategy Can Boost Your Retirement Savings

4. Have you developed a retirement income strategy? If you’ve successfully dealt with the three questions above, you’re likely well on the path to a secure and comfortable retirement. But there’s one more thing you need to do to actually achieve it: Develop a plan for turning your retirement nest egg into reliable income that, along with Social Security and other resources, will provide you the spending dough you need to sustain you throughout a long retirement.

Typically, creating such a plan involves such steps as doing a retirement budget to estimate how much income you’ll actually need to maintain an acceptable standard of living in retirement; deciding when to take Social Security to maximize lifetime benefits; figure out how much of your retirement income you would like to come from guaranteed sources like Social Security, pensions and annuities vs. draws from savings; and, setting a reasonable withdrawal rate that will provide sufficient income without too high a risk of running through your nest egg too soon.

Clearly, you’ll also want to devote some time to non-financial, or lifestyle, issues, such as thinking seriously about how you’ll live and what you’ll do after retiring, whether you’ll stay in your current home or downsize or, for that matter, even relocate to an area with lower living costs to stretch your retirement budget. But if you want a realistic shot at a secure and comfortable retirement, you need to answer the four questions above.

Read next: Why Social Security Is More Crucial Than Ever for Your Retirement

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com. You can tweet Walter at @RealDealRetire.

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MONEY Social Security

Why Social Security Is More Crucial Than Ever for Your Retirement

Social Security card
Michael Burrell—Alamy

As the program turns 80, it's fast becoming the last source of guaranteed lifetime income for most retirees.

Social Security, the long-embattled entitlement that lifts 15 million seniors out of poverty and is the sole source of income for nearly one in four recipients, turns 80 on Aug. 14. Its future remains tenuous as ever. Yet the program has never served a more vital and widespread need.

Social Security isn’t just a lifeline for the less advantaged; it’s an increasingly rare source of guaranteed lifetime income for just about everyone. Four decades ago, traditional private pensions played much of that role by providing lifetime monthly payments to millions of retired Americans, giving them the ability to live well even if they had little savings. Today, most workers have a 401(k) plan and will have to rely on their own ability to draw down assets at a rate that won’t bankrupt them before they die.

That’s a tall order. Most folks have little ability to properly manage their life savings. Common strategies like the 4% withdrawal rule, while helpful, are oversimplified and do not always work. Efforts are under way to help savers seamlessly and inexpensively convert their nest eggs to a guaranteed lifetime income source. But such policy change takes years, so for many seniors Social Security will stand alone as a reliable means to cover inflation-adjusted fixed living costs until the day they pass.

Social Security benefits have been in peril since even before the first check was cut to Ida May Fuller on Jan. 31, 1940. When the program was enacted in 1935, during the first presidential term of Franklin Delano Roosevelt, critics charged it was redistributionist and should be ended. Those arguments failed to stop the program, but today many see the entitlement as unaffordable. Indeed, the Social Security trust fund is on track to run dry in 2034. At that time, the program would be able to meet only 79% of scheduled benefits; over the following 55 years, payouts would decline to just 73% of benefits.

And yet somehow the program survives. Today the Social Security Administration collects payroll taxes from 210 million workers. It pays out more than $800 billion in annual benefits to 60 million retired and disabled beneficiaries. Despite the fiscal problems, the largest percentage of American workers in 15 years say that Social Security benefits will be a major source of their retirement income.

That’s partly due to many Americans not saving enough. More than half of U.S. adults have not taken any steps to address the risk of outliving their savings, according to the Northwestern Mutual 2015 Planning and Progress study. A third believe there is at least a 50% chance they will outlive their savings, while 12% say they are certain their savings will run out.

Faith in Social Security as a backstop, however, is strongest among Americans 50 and older. More than 80% of those ages 20 to 49 are concerned the program will not be there for them, according to a study from Transamerica Center for Retirement Studies. Reflecting the shift away from traditional pensions, 68% in the study say their 401(k) or IRA will be a significant source of retirement income.

Only now is this shifting income source beginning to be felt on a broad scale. In 1982, 44% of retiree income came from traditional pensions and Social Security, Brookings Institution found. By 2009 that figure had barely changed, rising to 46%. This is because traditional pensions have been phased out slowly and millions of today’s retirees still receive them. But we’ve reached an inflection point—from here on, new retirees will receive increasingly less of a pension benefit. This will make Social Security an ever-larger component of the typical senior’s retirement income.

Even retirees with considerable savings depend to a surprising degree on this program. Payouts from Social Security and pensions account for 35% of income for the wealthiest seniors, according to Brookings researchers. The rest comes from savings withdrawals. If wealthier retirees do not manage their drawdowns well—and as traditional pensions fade away—Social Security will become a vital resource for them, as it is now and long has been for much of America.

Read next: How Reading Your Social Security Statement Can Make You Richer

MONEY retirement income

QUIZ: How Smart Are You About Retirement Income?

senior sitting in chair reading newspaper with beach view in background
Tom Merton—Getty Images

Only 4 in 10 Americans have seriously looked at their retirement income options.

Do you have a credible retirement income plan? A TIAA-CREF survey earlier this year found that only four in 10 Americans had seriously looked into how to convert their savings into post-career income. To see just how much you know about creating income that will support you throughout retirement, answer the 10 questions below—and see immediately if you got them right. You’ll find a full explanation of all the correct answers, plus a scoring guide, just below the quiz.

When $1.5 Million Isn’t Enough for Retirement

Scoring:

0-4: You really need to brush up on retirement income basics, preferably before you start collecting Social Security and drawing down your nest egg.

5-7: You understand the basics, but you’ll improve your retirement prospects immensely if you take a deeper dive into how to create a retirement income plan.

8-9: You clearly know your way around most retirement-income concepts. That doesn’t mean you couldn’t profit, however, from learning more about such topics as Social Security, different ways to get guaranteed income and how to set up a retirement income plan.

10: If the answers in this quiz weren’t so obvious, I’d say you’re a retirement income expert. Still, congratulations are in order if for no other reason than you actually read this story from top to bottom and got every answer right.

Explanation of Answers:

1. Based on projections in the Social Security trustees report released last week, the trust fund that helps pay Social Security retiree and disability benefits will run out of money in 2034. That means…
c. that payroll taxes coming into the system will still be able to pay about 79% of scheduled benefits.
d. that Congress needs to do something between now and 2034 to address this issue.

Both c and d are correct. Although the trust fund’s “exhaustion date”—2034 in the latest report—gets a lot of press attention, all it means is that we’ll have run through the surplus that accumulated over the years because more payroll taxes were collected than necessary to fund ongoing benefits. When that surplus is exhausted, enough payroll taxes will still flow in to pay about 79% of scheduled benefits. That said, I doubt the American public will stand for a system that eventually calls for them to take a 21% haircut on Social Security benefits. So at some point Congress will have to act—i.e., find some combination of new revenue and perhaps smaller or more targeted cuts—to deal with this looming shortfall, as it has addressed similar problems in the past.

2. Given the low investment returns expected in the future, what initial annual withdrawal rate subsequently increased by the inflation should you limit yourself to if you want your nest egg to last at least 30 years?
a. 3% to 4%

In eras of more generous stock and bond market returns, retirees who limited their initial withdrawal to 4% of savings and subsequently increased that draw for inflation had a roughly 90% or better chance of their nest egg lasting 30 or more years. Hence, the oft-cited “4% rule.” But later research that takes lower investment returns into account suggests that an initial withdrawal rate of 3% or so makes more sense if you want your money to last at least 30 years. Truth is, though, whatever initial withdrawal rate you start with, you should be prepared to adjust it in the future based on on market conditions and the size of your nest egg.

3. An immediate annuity can pay you a higher monthly income for life for a given sum of money than you could generate on your own by investing the same amount in very secure investments. That is due to…
c. mortality credits.

Some annuity owners will die sooner than others. The payments that would have gone to those who die early and that are essentially transferred to those who die later are called mortality credits. Thus, mortality credits are effectively an extra source of return an annuity offers that an individual investing on his own has no way of earning.

4. A Roth IRA or Roth 401(k) …
c. may or may not be a better deal depending on the particulars of your financial situation.

While it’s true in theory that a traditional 401(k) or IRA makes more sense if you expect to face a lower tax rate when you make withdrawals in retirement and you’re better off with a Roth 401(k) or Roth IRA if you expect to face a higher rate, in real life the decision is more complicated. The tax rate you pay during your career can vary significantly, which means sometimes it may go to go with a traditional account, other times the Roth may make more sense. It can also be difficult to predict what tax rate you’ll actually face in retirement, making it hard to know which is the better choice. Given the uncertainty due to these and other factors, I think it makes sense for most people to practice “tax diversification,” and try to have at least a bit of money in both types of accounts.

5. Starting at age 70 1/2, you must begin taking annual required minimum distributions (RMDs) from 401(k)s, IRAs and similar retirement accounts. If you miss taking your RMD in a given year, the IRS may charge a tax penalty equal to what percentage of the amount you should have withdrawn?
d. 50%

That’s right, there’s a 50% tax penalty for not taking your RMD—and that’s in addition to the regular tax you own on that RMD. (If you’re still working, you may be able to postpone RMDs from your current 401(k) until after you retire, if the plan allows). You can plead your case and ask the IRS to waive the penalty—and sometimes the IRS will. But clearly the better course is to make sure you take your RMD every year rather than putting yourself at the IRS’s mercy.

6. Many retirees focus heavily on dividend stocks to provide steady and secure income throughout retirement. How did the popular iShares Dividend Select ETF perform during the financial crisis year 2008?
d. It lost 33%.

Tilting your retirement portfolio heavily toward dividend-paying stocks and funds can leave you too concentrated in a few industries. The main reason iShares Dividend Select ETF lost 33% in 2008 was because of its heavy weighting in financial stocks, which got hammered in the financial crisis. If you want to include dividend stocks and funds in your portfolio, that’s fine. But don’t overdo it. A better way to invest for retirement income is to build a portfolio that mirrors the weightings of the broad stock and bond markets and supplement dividends and interest payments by selling stock or fund shares to get the income you need.

7. To avoid running through your savings too soon, you should spend down your nest egg so that it will last as long as the remaining life expectancy for someone your age.
b. False

Life expectancy represents the number of years on average that people of a given age are expected to live. (This life expectancy calculator can help you calculate yours.) But many people will live beyond their life expectancy; some well beyond. So if arrange your spending so that your nest egg will carry you only to life expectancy, you may find yourself forced to stint in your dotage. To avoid that possibility, I generally recommend that you plan as if you’ll live at least to your early to mid-90s.

8. If your Social Security benefit at your full retirement age of 66 is $1,000 a month, roughly how much per month will you receive if you begin collecting benefits at age 62? How about if you wait until age 70?
c. $750/$1,320

For each year you delay taking Social Security between the age of 62 and 70, your benefit increases by roughly 7% to 8% (and that’s before cost-of-living adjustments). If you also work during the time you postpone taking benefits, your payment could rise even more. To see how much delaying benefits and other strategies might boost the amount of Social Security you (and your spouse, if you’re married) collect over your lifetime, check out the Financial Engines Social Security calculator.

9. With yields so low these days, bonds and bond funds, no longer deserve a place in retirement portfolios.
b. False

There’s no doubt that if interest rates continue to rise as they already have since the beginning of the year, that bonds and bond funds could post losses. But as long as you stick to a diversified portfolio of investment-grade bonds with short- to intermediate-term maturities, those losses aren’t likely to come anywhere close to the 50% or more declines stocks have suffered in past meltdowns. Which means that while bonds at current yields may not provide as much of a cushion as they have in past years, a portfolio that includes bonds will be much more stable than an all-stocks portfolio. In short, for diversification reasons alone, it still makes sense to include short- to intermediate-term bonds or bond funds in your retirement portfolio.

10. A new type of longevity annuity called a Qualified Longevity Annuity Contract, or QLAC (pronounced “Cue Lack”), allows you to invest a relatively small sum today within your 401(k) or IRA in return for a relatively high guaranteed lifetime payout in the future. For example, a 65-year-old man who invests $25,000 in a QLAC might receive $550 a month starting at age 80, or $1,030 a month starting at 85. Putting a portion of your nest egg into a QLAC also allows you to…
b. Worry less that overspending early in retirement will exhaust your nest egg since you can count on your QLAC payments kicking in later on.
c. postpone taking RMDs on value of the QLAC (and avoid the income tax that would be due on those RMDs) until it actually begins making payments.

Both b and c are correct. The main reason to consider a QLAC is to hedge against the possibility of running through your savings and finding yourself short of the income you need late in retirement. But the fact that you can postpone RMDs and the tax that would be due on them is an added bonus. To qualify for this bonus, however, you must be sure that the longevity annuity you buy with your 401(k) or IRA funds meets the Treasury Department’s criteria to be designated as a QLAC and that the amount you put into the QLAC doesn’t exceed the lesser of $125,000 or 25% of your account balance.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

Read next: Why the Right Kind of Annuity Can Boost Your Retirement Income

MONEY Savings

This Is The Biggest Threat to Your Retirement Number

141467898
Image Source—Getty Images

The one thing that can suddenly derail your retirement strategy altogether.

The idea of coming up with an exact number for how much you need to save for retirement is an attractive one for savers. By drawing a visible finish line for your retirement savings, a retirement number can be the foundation of your financial planning throughout your career.

In coming up with a good estimate for a retirement number, it’s crucial to understand how having a bad market in early retirement can have a huge impact on the viability of your entire long-term retirement strategy. If you don’t take this risk into account, it could pose a threat to the accuracy of the retirement number you’ve spent a lifetime seeking to reach.

How a bad market early in retirement can snare you
In coming up with a viable retirement number, the ideal situation is one in which you can weather the worst future conditions the financial markets can throw at you. Much of the time, planning for the worst will leave you in far better shape than you expected, as worst-case scenarios don’t occur very often. Yet if you truly want a retirement number that maximizes the probability that your money will outlast you, you can’t afford to ignore realistic future scenarios, no matter how improbable they might be.

In doing research on the retirement-number question, many experts have noticed that the most difficult situations retirees face occur when a major market correction occurs soon after a person retires. Even when overall average annual returns over the long run are similar, a retiree who suffers poor performance early in retirement has a much harder time preserving his assets than one who’s fortunate enough to avoid bad markets until later on. Indeed, in some cases, even a retiree who has ahigher average annual return in retirement still ends up worse off if the worst years come early on.

Experts call this problem sequence-of-return risk, and the problem stems from the fact that retirees need to take withdrawals from their savings in order to cover their living expenses in retirement. In simplest terms, bad performance early in retirement forces you to “sell low” by liquidating investments at fire-sale prices to cover your required withdrawals. If poor initial returns last long enough, then you won’t have enough money to enjoy the full benefit of any future rebound in the financial markets.

2 ways to protect against this retirement-number risk
In response to sequence-of-returns risk, financial analysts have come up with conservative rules of thumb such as the well-known 4% rule to help savers build more secure retirement nest eggs. Using historical data that suggests a typical balanced portfolio with stocks and bonds can make it through tough market conditions for a 30-year period as long as you start out taking no more than 4% of your initial portfolio value, coming up with a retirement number is simple: Just multiply your expected annual income needs in retirement by 25.

However, there are several problems with that approach. First, many people have a hard time saving 25 times their expected net spending in retirement. Also, some believe the 4% rule could be problematic in a low-interest rate environment, because low initial bond yields leave the income-generating side of the portfolio weaker than usual.

An alternative approach uses a different way of thinking about retirement. The benefit of the 4% rule is that it aims to provide exact expectations for what you can safely spend. Yet in reality, most retirees aren’t terribly comfortable continuing to spend at heightened levels when the markets move against them, and they instead look at ways to economize and spend less. Adapting the 4% rule to allow for reductions in withdrawals during lean return years is an idea that has been floating around for years, and research suggests that if a retiree can handle volatile markets by cutting spending, it can reduce the needed multiple of annual expenses from 25 down to 20 or lower.

Stay safe
With markets at high levels now, those who have recently retired are understandably nervous about the potential fallout from sequence-of-returns risk. Your best defense against this risk is to find ways to be more flexible with your financial needs. If you can build in some resiliency to changing future conditions, you’ll be much more likely to aim at a retirement number that will get the job done.

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MONEY Pensions

The Trouble With Taking a Lump Sum Pension Payout

dropper squeezing out coins
Yasu+Junko

Tempted to trade your pension for a lump sum? Here's why you should think twice.

Congratulations! You’re one of the shrinking number of Americans who have earned the right to a pension—guaranteed income for life for you and maybe for your spouse as well. Just make sure you don’t give it up too easily.

That’s a real risk. Up to half of companies with pension plans, say experts, give workers the option of taking their pension as a lump sum. On top of that, 47% of corporate plans, including those from Boeing and Hewlett-Packard, either have just made or will soon make pension buyout offers to vested former employees, benefits firm Aon Hewitt reported earlier this year. Driving those offers are IRS rules expected to make buyouts less favorable for employers within a year or so.

Lump-sum checks, often in the hundreds of thousands of dollars, are tempting. Fifty-eight percent of employees take buyouts, and the share taking the lump-sum option at retirement is likely higher, says Aon Hewitt consultant Ari Jacobs.

Pension industry experts and consumer advocates, however, say that for most workers the traditional pension is a better deal. So before you decide, think this over:

When to Take Steady Payments

If you or your spouse is in good health and has a family history of longevity, lean toward taking the monthly pension. The advantages: The money lasts for life. If you make it to age 90—and 28% of 65-year-olds do—you’ll still be getting that check. And, in exchange for smaller benefits, your spouse can continue to receive half or often all of those monthly payments after your death. So if you’re a man and your wife survives you—on average, she will—she’ll get cash for life too. One downside: Unlike Social Security, most private pensions don’t adjust for inflation, so your purchasing power will diminish over time.

Now, you could invest the lump sum (set by a complex IRS formula) and use it to fund a monthly stipend. But even if you’re the next Warren Buffett, you’d likely get less each month than you would from a pension. Say you’re due $1,500 a month, or $1,295 if you opt for a 100% survivor’s benefit. If you took the roughly $240,000 you’d receive instead and sought to have it last a 65-year-old’s average life span of about 20 years (see chart), you’d pay yourself only $1,213, calculates David Blanchett, Morningstar’s director of retirement research. And this strategy would have only an 80% chance of success. To be safe, you’d have to cut your allowance to $1,000 a month—or $855 to last until you’re 90.

Why is the lump-sum income so low? Flying solo, you have to make sure your money lasts a full 20 or 25 years. But in a group plan, a lot of people will live shorter lives, so less money has to be reserved for them. The result is more generous monthly payouts for everyone, says Robert Goldbloom, a principal at pension consultant Penbridge Advisors. “People who don’t live as long subsidize those who live longer,” he says. That makes pensions a particularly good deal for women, given that they generally live longer than men.

When to Take the Lump Sum

If you’re in poor health and don’t have to provide for a spouse, the math favors the lump sum. Given a life expectancy of a decade or less, you’d have more than enough to duplicate a pension. In the above example, you could pay yourself $1,500 a month over 10 years, not invest a dime, and still have $60,000 left over.

A lump sum also makes sense if you have no cash in the bank or investments you can tap for emergencies. You could keep part of that money in the bank for urgent needs, and live off the rest.

Should you be lucky enough to live comfortably off other sources of income, you could take the money and invest it aggressively to maximize a possible inheritance for your beneficiaries.

Finally, take into account your pension plan’s health. Most private-sector plans with at least 26 workers are backstopped by the Pension Benefit Guaranty Corp.—up to about $5,000 a month for a single-employer plan, but far less for a multi-employer plan. Check on your plan’s “funded status”—a measure of its assets and liabilities. If the number, which the plan has to report to you annually, is falling toward 80%, that’s worrisome; you might take the bird in the hand if you’d lose much of your benefits from a failed plan.

In any case, your best bet is to roll the money into a traditional IRA; otherwise, you’ll get a big tax bill. Smaller withdrawals from the IRA, on the other hand, will likely be taxed at a lower rate.


 

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MONEY Social Security

How Reading Your Social Security Statement Can Make You Richer

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Making smart use of the information in your benefits statement can save your retirement.

The Social Security Administration is learning what financial educators have known for decades: good information is helpful but does not always lead to useful action. Now, in a bid to help individuals make smarter decisions about their benefits and retirement income overall, a push is on to broaden the regular Social Security statements that all taxpayers receive.

Social Security is the nation’s most important source of retirement security, providing half the monthly income of half of all retirees. Yet the system is so complicated that many puzzle over when to take monthly benefits, which may vary widely depending on the age at which you begin. You can start at age 62. But your check is about 8% higher for each year you delay until age 70.

As traditional pensions disappear, Social Security is the only source of guaranteed lifetime income that many future retirees will have. Making the most of it is critical—and it may be as simple as just reading your statement, now available online, in order to understand your options. (To find yours, go to ssa.gov/myaccount.)

The government began mailing a regular benefits statement in 1995, but stopped in 2011 as a cost-cutting measure and tried to direct people to the Social Security website instead. Last fall, however, the agency began mailing out paper statements again to recipients every few years.

This statement shows your expected monthly Social Security benefit at various retirement dates. Studies show that 40% of taxpayers use these calculations in their planning, according to a new study from the Center for Retirement Research at Boston College. But individuals do not use this information as a prod to change the date that they intend to start taking benefits, the CRR’s researchers found.

This is a familiar disconnect that lurks in money behavior at many levels. Proponents of financial education have had a difficult time proving that kids or adults who are taught about things like budgets and retirement saving put this knowledge to good use and make smarter money decisions because of the knowledge they have gained. They understand. They can pass a test. But does this knowledge change behavior for the better? Some encouraging signs are surfacing. But the lasting impact of financial education remains an open question.

Looking at a set of studies centered on awareness of the regular Social Security statements, researchers at CRR found that more Americans have been delaying benefits since the statements began arriving in mailboxes 20 years ago. But they attribute this entirely to outside forces, including a higher rate of college graduates, greater longevity and longer careers. “The information contained in the statement is not sufficient to improve their retirement behavior,” the authors note.

The upshot: a more “comprehensive” Social Security statement would lead more taxpayers to better optimize their benefit, CRR asserts. That might mean including instruction on how to place Social Security benefits in context with other assets and income sources, and how to determine the amount of monthly income you are likely to need.

Meanwhile, to make sure you are making the right claiming decision, gather the information in your statements and plug those numbers into one or more Social Security calculators; you can find several listed here. As a study last year by Financial Engines found, many individuals are leaving $100,000 or more in income on the table—as much as $250,000 for married couples—by choosing the wrong claiming strategy. That money could make your retirement a whole lot more comfortable.

Read next: This Is the Maximum Benefit You Can Get from Social Security

MONEY retirement income

This Is the Top Secret of Wealthy Retirees

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Barry Winiker—Getty Images

Successful retirees still save nearly a third of income from their pension and 401(k) distributions.

Individuals that have saved successfully for retirement evidently cannot kick the habit. Even after they have reached retirement age they continue to save, on average, 31% of income, new research shows.

In many cases this continued saving comes from income streams guaranteed for life, such as a traditional pension, certain annuities, or Social Security. So further saving may have little to do with financial security—and much to do with a routine that has served them well over the years. If you are looking for the top secret of affluent retirees, it may be just that simple.

Retiree income flows from five primary sources, according to the research from fund company Vanguard. Guaranteed lifetime income is the biggest cut at 42%. Withdrawals from tax-advantaged accounts like IRAs and 401(k) plans are the second biggest source (20%), followed by pay from a part-time job (12%), withdrawals from savings accounts (7%) and from specialty accounts like a cash-value life insurance policy (4%).

The income source matters. Those who mainly get by on withdrawals from a 401(k) or other financial accounts reinvest about a third of what they take out due, say, to required minimum distribution rules. Those collecting guaranteed monthly income save only 25%.

This makes perfect sense. Lifetime income, by definition, never runs out. Those who get most of their income this way are under far less pressure to save anything at all. Meanwhile, those living off withdrawals from financial accounts, which can run dry, show a predictable concern with that possibility.

These are findings worthy of some study in government and pension circles. In coming years, a greater share of retirees will rely more heavily on their own savings, which could undermine spending in general and take a bite out of economic growth. On the other hand, those who get most of their income from withdrawals from financial accounts are more likely to work longer or part-time in retirement, which contributes to the economy and probably the individual health of those doing so.

The Vanguard study looked at households where the head was 60 to 79 years old, had at least $100,000 of investable assets, and at least one member of the household was fully or partially retired. This is an affluent, though not rich, group that continues to save and, in some ways may be doing so inappropriately.

Two-thirds of the money saved from income that comes from financial accounts goes into low-yielding savings vehicles. That might be by design—a desire to lower risk or save for a big purchase. But it might also be the result of inertia—required distributions left unattended. If such distributions are not needed for spending they might be better reinvested in growth or higher income accounts.

It’s tempting to assume that affluent retirees keep saving simply because they have the means to live as they wish and still have income left over. But that probably sells them short. They had to save or work hard for their pension to get there. It’s the habit that made it happen—and once established it’s tough to kick.

Read next: How Being a Boring Investor Can Make You Rich

MONEY retirement income

Why the Right Kind of Annuity Can Boost Your Retirement Income

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The risks of longevity convinced this early retiree that guaranteed income has a place in his portfolio.

The ultimate in retirement security is guaranteed, lifetime, inflation-adjusted income. Most of us will get some of that—though not enough— in the form of Social Security. A few will get the balance of what they need from pensions. But the rest of us will see a shortfall between our fixed living expenses and our guaranteed income.

You can try to fill that gap by making systematic withdrawals from your investment portfolio throughout your retirement. A balanced portfolio is likely to outperform many other retirement income options, if the markets do average or well. But it’s not guaranteed. Even for experienced investors, there are serious risks in managing a retirement portfolio.

The insurance industry offers what sounds like a safer idea: an annuity. Annuities can provide peace of mind by removing longevity risk—the chance you’ll outlive your assets. And, they let you generate more safe income than you could from the same amount in a portfolio of stocks and bonds. That’s because, with an annuity, you’re consuming both principal and earnings, plus you’re pooling your lifetime risk with other buyers.

Unfortunately, many kinds of annuities, especially complex variable and indexed annuities, are a quagmire of pushy salespeople, hidden expenses, and dizzying complexity. Consequently, many careful retirees rule out any kind of annuity as a retirement income solution. I was once in that camp. Why would I need an annuity, when I had proven success growing my own diversified portfolio in excess of our retirement income needs?

But then the market crashed in 2009. Our portfolio did better than most, and we had no need for income at the time, but the huge drop demonstrated the potential downside of retiring at the wrong time. I knew that retirees who had purchased annuities were happy with the steady paychecks they received during the crisis. I realized that annuities had a place in retirement planning, at least for those without the investing skills and fortitude to endure a severe recession.

Once I retired, the decades ahead without a regular paycheck suddenly became very real. It didn’t matter that I had many years of investing under my belt, and was confident in my ability to manage our portfolio. It didn’t matter that we lived frugally, and could cut our living expenses even further if needed. Because there was one thing I realized I couldn’t control: how long I would live. Insurers, however, could control that variable and protect me from running out of money, by combining my lifetime with thousands of others via an annuity.

Finally, when I reviewed my estate plan, I realized that, even though I had accumulated enough money to provide for my family, I would not necessarily be around to manage those assets for the duration. I could see that my loved ones might need to put a portion of our assets on “autopilot,” so they could count on a steady lifetime income without worries.

Then along came research demonstrating that combining single-premium immediate annuities (SPIAs) with stocks may be the best way to generate retirement income for a wide set of circumstances.

Given all those factors, I’ve come to believe that you should plan for a guaranteed income “floor” in retirement. This assures a reliable income stream that meets your essential living expenses until the end of your life, however long that may be.

Annuities will be a key part of that equation for many. We’re talking here about simple single-premium immediate annuities, not their complex and expensive cousins—variable and indexed annuities. With a SPIA, you hand the insurance company a lump sum and they immediately begin paying you a monthly amount. There’s no unexpected variability, no complex indexing formulas, and no extra fees.

When should you buy an annuity, and how much annuity should you buy? These are complex questions that require personal financial planning. For example, we are in our mid-50’s, our lifestyle is flexible, we can manage our own investments, and we don’t need extra income right now. So it’s too early for us to put our retirement finances on “autopilot.” We will probably wait until our mid-60’s, when we may put about half our current portfolio into annuities. While the need for an annuity is a given in many cases, the exact timing and amount are anything but…

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com.

Read next: New Annuity Options Let You Plan Around Life’s Biggest Unknowns

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