The Bogleheads' Guide to Retirement Planning (31 page)

Waiting a few extra years to retire is a powerful way to make retirement more affordable. Consider waiting until age 70 to apply for Social Security if you’re in good health and have enough other income to get by for that long. Applying for Social Security at 70 instead of 62 raises your monthly benefit by more than 75 percent. You may also save on income taxes by increasing your Social Security benefits that receive favorable tax treatment while spending down some of your taxable retirement savings. The disadvantage of waiting until age 70 is that you have a shorter life expectancy at that age and will collect fewer payments over your lifetime.

Some individuals may want to take advantage of a SSA rule that lets you apply for benefits, say at age 62, then withdraw the application retro-actively at a later age such as 70 and reapply. To do this, you must file SSA Form 521 and repay all benefits you’ve received without interest. It becomes an interest-free loan to you. Between ages 62 and 70, invest the money, and then keep the interest earnings when you repay the loan. If you paid income taxes on benefits that you’re repaying, IRS Publication 915 explains how to recover such taxes as either an itemized deduction or a credit.

This strategy may appeal to a disciplined person in good health who can afford to invest the benefit money received before age 70 instead of spending it right away. What if your health and longevity deteriorate before you reach 70? In that case, you may simply choose not to repay the benefits and be glad you applied at 62.

Even if you’re still in good health, there’s no guarantee you’ll live long enough to come out ahead by reapplying at 70, but your chances are good. Also, there is no guarantee the government won’t change the rules, such as by making you repay the benefits with interest.

This method is for working couples wishing to maximize survivor benefits for the lower earning spouse. For example, Mary, the spouse with lower earnings, starts Social Security at 62 while her husband John waits to apply until age 70. John thus maximizes his retirement benefit, which would be Mary’s potential benefit as a surviving spouse. This method may work well if Mary outlives John by many years.

What if John stops working before 70? In that case, the couple may need to draw down significant amounts of retirement savings until John’s Social Security kicks in. The couple must plan their various sources of retirement income carefully. They need to make sure adequate income is available, no matter how long either spouse lives.

This method may appeal to working couples, especially those with fairly similar earnings histories. For example:

 

Using this method, Mary eventually gets her full retirement benefit as a worker. Her spousal benefit is extra, a reward for following the benefit rules carefully.

This method is for couples who want one of them to get spousal benefits while the other waits to collect retirement benefits. Normally, SSA doesn’t allow this, but a special SSA rule makes it possible by letting a person apply for benefits and then suspend payment. Here is an example:

More information on strategies 4, 6, and 7 is in the paper “Unique Claiming Strategies” at
http://crr.bc.edu
. More information on strategy 5 is in Jim Mahaney and Peter Carlson’s paper “Rethinking Social Security Claiming in a 401(k) World.” See
www.pensionresearchcouncil.org.
.

The Social Security Administration has links to benefit calculators for various purposes on their web site. The most accurate calculators use your actual earnings history, not earnings data that you enter or some kind of rough estimate. Accuracy is very helpful when you’re near retirement but not too important when retirement is far away. Here’s what SSA has available online.

This chapter has given you an overview of Social Security information relevant to retirement planning. The system covers a wide range of recipients from old age benefits to disability payment to benefits for a surviving spouse and children. It is not possible in this chapter to cover all the contingencies, but it does give you a good start. For the foreseeable future, the viability and benefits of Social Security will keep playing an important part in determining how early you can afford to retire and how comfortably you’ll live in retirement.

The end result of your retirement plan is to provide stable income in retirement that is high enough to maintain the lifestyle you wish to live. Part of that process will include making a number of decisions that will affect your lifestyle and your financial security as you approach the end of the accumulation phase of life.

While working full-time, you probably opened and funded several different types of accounts to assist in saving for retirement. One decision you will make as you enter retirement is how to efficiently take money out of those accounts. That is not always a simple decision because taxes play an important role. There are tax-efficient ways to withdraw money and tax-inefficient ways. The withdrawal decision is not as straightforward as it seems because a tax-efficient strategy in the short term may be a very tax-inefficient strategy in the long term. There are many things to consider. This chapter will provide you with the necessary tools.

The amount you need to withdraw each month in retirement depends directly on the amount you anticipate spending in retirement. Your first order of business as you approach retirement is to do a budget.

Your budget or spending plan in retirement will be somewhat different than your budget while working full-time. Some expenses will increase, and others will decrease. You are likely to spend more money doing things you enjoy, such as travel and hobbies. Perhaps your medical costs will increase if you have to pay a greater portion of the premium or change insurance carriers. On the other hand, you will not be contributing to a retirement plan any more or paying Social Security taxes. Perhaps your clothing budget will also change. Taking time to estimate how these spending changes will affect the amount you need in retirement is a worthwhile endeavor.

Most people pay far lower taxes in retirement than they paid when working, and saving for retirement is curtailed or eliminated. For example, if soon-to-retire Sally earned a salary each year, paid employment and income taxes, contributed to her 401(k), and put money into savings each year, her retirement spending wouldn’t include the employment portion of her taxes, nor would it include the 401(k) contributions or bank savings.

Estimating spending in retirement does not have to be difficult. You can either keep a detailed budget or do a rough, back-of-the-envelope estimate.

If tracking spending has never been a top priority for you, it is a good idea to attempt the exercise at least one year prior to retirement. Start by listing all of your normal expenses as they occur. That means writing down
everything
from mortgage to food, insurance, utilities, transportation, medical insurance premiums, charity, clothing, and so on. There are numerous budgeting tools available on the Internet by searching for the phrase. Much of your spending information can be found by looking over bank statements and credit card statements. Don’t forget to include things that only occur once or twice per year such as property taxes and magazine subscriptions. Leave out income taxes for now.

After documenting your annual spending while working, make estimated adjustments for spending in retirement. You may not need to buy a lunch each day or buy dinner for the family because you are late getting home from work. New retirees tend to spend more fixing up their homes and doing repairs that they have been intending to do for years. A good rule of thumb for repairs is 1 percent annually of the value of a new home, or 2 to 3 percent annually of the value of an older home. Then there are the big expenses. If you purchased a new $25,000 car every 5 years while working full-time, perhaps you can stretch that to 7 or 8 years because you will not be driving as much.

A second way to estimate spending is to simply subtract your annual savings amount from your after-tax income. Write down your annual pretax income, total income taxes paid, and your net contributions to savings accounts for the past few years. Subtract your taxes and savings from your pretax income. This is the amount you spent. Once you have an idea of your spending while you are working, make adjustments for estimated spending changes in retirement, as stated earlier.

When you have documented your spending and estimated adjustments in retirement, it is time to address income taxes. Recall from Chapter 10 that marginal tax rates tend to fall in retirement. You are earning less taxable income, and that reduces income tax considerably. You also can select the accounts you withdraw retirement money from in retirement, which means you have control over the amount you pay in income taxes. In addition, no Social Security or Medicare taxes are paid on employer retirement benefits or withdrawals from tax-advantaged retirement accounts.

The easiest way to estimate your taxes in retirement is to use a commercially available tax program such as TurboTax or TaxCut. Plug in your retirement income (Social Security, pension, dividends, interest, etc.) and any deductions to get an estimate of your new postretirement tax liability. If you are skilled with taxes and spreadsheets, create your own tax spreadsheet tailored to your specific situation and compare different scenarios side by side, or use financial tracking software like Quicken to run different scenarios. Of course, you can always use the tax forms available directly from the IRS.

A hidden expense in retirement is inflation. You should estimate how inflation may affect your income needs. Inflation affects different people in different ways, depending on housing needs, health issues, and the amount of travel you anticipate in retirement. One calculation you can do is to estimate your personal inflation rate. That is done by comparing your annual spending year-over-year and analyzing the differences. Make adjustments for large purchases such as automobiles and vacations. For example, if your budget this year was $65,000 and your budget next year is $67,500 your personal inflation rate is 3.85 percent.

Your pers onal inflation rate may be higher or lower than the government-calculated change in the consumer price index (CPI). Housing is a large part of the federally calculated inflation rate. If your home is paid off or you have a fixed-rate mortgage, and your property taxes are capped, your housing inflation rate is likely to be lower than the national average that includes rentals. On the other hand, if you have health issues, it is possible that your personal inflation is higher than the national average.

Estimating your retirement budget and personal inflation rate will assist you in forming a long-term retirement plan. These calculations do take a lot of work, but this is the rest of your life we are talking about.

People who have a defined benefit (DB) or defined contribution (DC) plan at work will need to make an important decision when they retire (see Chapter 5 for information on DB plans and Chapter 6 for information on DC plans). Upon retirement, you may be given the choice of taking a lump-sum cash distribution and rolling it into an IRA account (see Chapter 4) or receiving income from an annuity (see Chapter 7). The annuity may come from your employer directly or from a third-party insurance carrier.