Yes, tax time is nigh. Your forms don’t arrive in the mail in January for no reason. And for those of us who may not be the most diligent of bookkeepers, those annual numbers can be slightly surprising. If you have your taxes withheld from your paycheck, you’ll see, in black-and-white, just how much money you paid to into Social Security last year. You can feel good about taking care of grandma, but unfortunately, you probably shouldn’t count on seeing that money again.
According to a recent report from the U.S. Government Accountability Office (GAO), if you are a worker in today’s economy, you are increasingly likely to have to rely on income other than Social Security during retirement. The report, aptly titled “Ensuring Retirement Income throughout Retirement Requires Difficult Choices,” (PDF) points out the already high level of retiree poverty—3.4 million people in 2009—and goes on to recommend specific actions you can take to keep yourself from experiencing a similar fate: work longer and save more.
In response to longer life spans—American life expectancy is now almost 78 years—the GAO recommends delaying taking Social Security benefits beyond the date you become eligible. For example, if you wait until you are 66, your benefits will be 33% larger than if you opt to start receiving benefits at age 62. Working until age 66 doesn’t necessarily mean you’ll work backbreaking hours at the job you’ve held for 40+ years, either. In fact, today’s older workers are less likely to hold lifetime jobs, and the increasing popularity of “encore careers” has made working into your 60s and 70s more common.
In addition to working longer, future generations of retirees must be more cognizant of their retirement savings choices and save more, beginning at the very start of their working lives. Given the financial troubles defined benefit plans have caused employers recently, defined contribution plans have become the new norm among employer-sponsored retirement savings options. On the bright side, several simple retirement savings options currently exist, including 401(k) and IRA accounts. These types of accounts often provide tax savings and, in the case of the 401(k), employers frequently match employee contributions up to a predetermined amount.
As current workers approach retirement, having money saved is only half the battle. Understanding how to get the most out of the money you’ve saved is equally important. The most important concept to understand is the drawdown rate, the rate by which you withdraw money from your savings. Most experts recommend a drawdown rate around 4% per year, with adjustments made for inflation over time. For example, if you retire with $1 million saved, you could comfortably withdraw $40,000 each year using a 4% drawdown rate. Understanding the drawdown rate also helps you estimate how much you need to have saved in order to retire. Is $40,000 per year not enough for you? Then you had better save more than $1 million for retirement.
In addition to using retirement savings for living expenses such as groceries, insurance, and gifts for the grandkids, a portion of retirement savings can be converted to an income annuity. In this scenario, when you are at or near retirement, you can purchase an annuity for a fixed amount of money (typically, this would come from retirement savings) in exchange for guaranteed payments on a set schedule for the rest of your life. The advantage of an income annuity lies in the predictability of its payments (and the interest rate, if it is fixed).
Putting aside the debate about the viability of Social Security, retirement as we know it will fundamentally change. It’s clear that the days of retiring by age 60 are long gone for most Americans, and that working and saving are more important than ever to ensuring a well-funded retirement.