Tuesday, April 16, 2013

The Inadequate Retirement Account: Working Longer

This is the second post of a series suggesting ways households that weren't able to save enough can improve their retirement finances. The series began with "Inadequate Retirement Account (IRA)".

One of the ways to compensate for inadequate retirement savings is to work longer. Working longer is actually a highly leveraged strategy because it helps in several ways at the same time. Working longer can:

·       Reduce the cost of retirement by shortening it,
·       Give you time to save more,
·       Give your savings and investments more time to grow,
·       Extend your healthcare benefits, and
·       Increase your eventual Social Security benefits.

First, the longer you work, the longer you can delay spending down your savings and that makes them last longer. Your retirement will be shorter. While shortening your “golden years” may not be the most fun strategy, retirement will cost less.

(The bad news is your vacation is going to be shorter; the good news is it will cost less.)

Second, you may be able to save more while you’re working. Perhaps your employer will have a 401(k) plan, for example, and you can contribute to that. Maybe your employer will even match your contributions.

Third, postponing retirement will provide more time for your retirement savings to earn interest and grow. Fourth, your employer may provide healthcare benefits, one of the largest expenses you will have after retiring.

Finally, working longer may allow you to postpone receiving Social Security retirement benefits and each year you do that increases your eventual benefits by about 8%. (Maximizing your Social Security benefits will be covered in greater detail in a subsequent post.)

Working longer is not the ideal fix, however, for inadequate retirement savings for several reasons. First and foremost, working longer simply means not retiring. It’s like telling you that the solution to your problem of not being able to retire is to not retire.

Furthermore, most households will find that their retirement savings shortfall is far too great to fix by postponing retirement a year or two. The initial response of the financial trade press to the 2007-2009 stock market crash that devastated the retirement savings of millions of Baby Boomers was, “No problem — you’ll just have to work a few years longer.”

Upon further review, as they say, the problem is often too big to fix by working longer, even if you can work longer. See, for example, “Work to Age 70? For Many, That Still Won’t Pay for Retirement” from the Employee Benefit Research Institute.

According to EBRI, the lowest-earning 25 percent of Americans would have to work until age 84 so that 90 percent of them would have even a 50-50 chance of having enough money to afford basic living expenses and out-of-pocket medical care.

Perhaps the biggest problem with the “work longer” strategy will be your ability to do so. Also according to EBRI, “consistent with prior Retirement Confidence Survey findings, half of current retirees surveyed say they left the work force unexpectedly due to health problems, disability, or changes at their employer, such as downsizing or closure”.

In other words, half of retirees consistently report that they wanted to work longer but were forced to retire for reasons beyond their control. You may plan to work to age 70 or beyond, but whether you will be able to or not is a coin toss.

If you decide to work and collect your Social Security retirement benefits at the same time, you need to be aware of two potential Social Security-related problems.  For workers who begin receiving retirement benefits before full retirement age and continue to work, SSA may withhold some benefits1 under the Earnings Test rule.

Once you reach full retirement age, the SSA will permanently increase your benefit to compensate for the benefits that were withheld. You won’t get back a lump sum, though. The withheld benefits will come back in drips and drabs.

Regardless of the age you elect to receive benefits, if you earn enough money from non-benefit sources, a portion of your Social Security benefits will become taxable.

It is even possible to have both some portion of your benefits withheld because you claimed early benefits and earned more than the Earnings Test limit and some portion taxed because you earned more than the tax-free limit.

These are issues to discuss with your tax professional, but you can generally avoid the Earnings Test withholding by:

·       Earning less than the limit ($15,120 annually in 2013),
·       Not claiming benefits until after you stop working, or
·       Not claiming benefits before you reach your full retirement age.

Your benefits won’t become taxable if most of your income comes from Social Security benefits. I wrote more on the topic in “Will Your Social Security Benefits be Taxed?”.

Working longer won’t fix the retirement savings problems facing most American households, but it can certainly help. My first piece of advice to families who find themselves approaching retirement with inadequate savings would be to work as long as you can, postpone Social Security benefits as long as you can get by without them, and save as much as you are able.

If you expect to earn more than the Earnings Test limit or the benefits taxability limits (see links above), then talk to your professional tax planner. It may pay to postpone claiming Social Security benefits.

And invest conservatively while you’re doing it — don’t risk making your shortfall worse.

In my next post, I’ll talk about the spending side of the retirement equation.

1 If you begin receiving benefits before your full retirement age and earn more than a set limit ($15,120 in 2013), the Social Security Administration (SSA) will withhold $1 for every $2 you earn above the $15,120 limit.

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