Notes on Income and Retirement

Published On: May 13, 2019

Written by: Ben Atwater and Matt Malick

Our retirement series “Notes on . . .” rolls forward with our second-to-last installment, this one focusing on income.  The final essay will speak to risk tolerance and retirement.  For prior essays in this series please visit https://www.atwatermalick.com/essays.

Investment Income

For retired clients, we build portfolios that provide clients with retirement income.  These planned systematic withdrawals from retirement funds supply clients with a consistent “pay check” to replace their working income.  In a low interest rate world, we look to total return investing – generating payouts from dividends, interest and long-term appreciation (capital gains). 

Generally speaking, a sustainable spending rate from retirement funds is approximately 3% to 5% of your corpus, depending on your timeframe and whether your goals include leaving a legacy to heirs.

There are some vital factors to total return investing that are an integral part of our investment philosophy.  The first is to have an allocation of enough “safe” assets to support distributions during times when the market is depressed (like December of last year).  Another is to manage – to the extent possible – realized capital gains when raising money for distributions.  This works particularly well with an individual stock and bond portfolio where we can harvest losses and / or pick and choose which gains to realize. 

We believe that, over market cycles, it’s important to own stocks that pay dividends, but it’s unwise to move too much in the direction of chasing high yielding stocks.  Said another way, you should never try to select investments because their yield meets your spending requirements.  Higher yielding stocks tend to be highly correlated.  During some market cycles they do well, while during other cycles (like the current bull market) they perform poorly.  Investors hunting yield have been largely disappointed.  That said, your portfolio should generate a reasonable level of income for times when the market is depressed. 

Social Security Income

Even for mass affluent investors, Social Security plays an important role in retirement income planning and typically combines with total return payouts from your investment portfolio to provide for your desired retirement.  Due to the importance of Social Security benefits, please don’t make any Social Security decisions without contacting us to perform an analysis of your best options. 

In this series, we’ve been focusing on our most common experiences with retirement planning.  Therefore, as we look at Social Security, we will address benefits anecdotally based on the many analyses we’ve completed.  But, to start, here’s some basic background information on maximum benefits and full retirement age. 

In 2019, the Social Security wage base is $132,900.  Above this wage, employees and employers no longer pay Social Security tax.  As there is a maximum Social Security contribution, there is also a maximum Social Security benefit.  The benefit maximum for 2019 is $2,861 per month ($34,332 / year) at full retirement age (FRA).  To receive the maximum Social Security benefit, a person needs to earn more than the Social Security wage base during at least 35 individual working years and have reached their FRA.    

The FRA for those born in 1957 is 66 and six months, up from 66 and four months for people born in 1956, 66 and two months for those with a birth year of 1955 and 66 for everyone born between 1943 and 1954. The full retirement age will further increase in 2-month increments over the next two years until it reaches age 67 for everyone born in 1960 or later. 

Beneficiaries are still eligible to take Social Security at 62.  In the many analyses that we’ve performed this never makes mathematical sense.  Given average lifespans and the penalties involved (you receive 25% less than your FRA amount at 62), taking Social Security early can rob you of tens or even hundreds of thousands of dollars of lifetime benefits.  However, if you need Social Security at 62 to get by, obviously, you have no choice but to take it.  Another reason to take early Social Security could be health-related, whether a specific diagnosis or a grim family history. 

Otherwise, it is best to wait until at least your FRA to take Social Security.  And, again, mathematically, given life expectancy today, it makes sense for most people to wait until 70 to take Social Security.  To “breakeven” by waiting until your FRA (we will use 67 as the FRA to be conservative) you need to live until about 73.  In other words, if you claim Social Security at your FRA, you’d need to live until age 73 to earn a greater lifetime benefit than you would have by claiming at age 62.  For those who wait until 70, your breakeven will be about age 76. 

The math of waiting is compelling because your Social Security benefit from your FRA until 70 compounds at 8% plus the cost of living adjustment (Social Security calls this “delayed retirement credits”), which makes waiting an excellent investment, especially if you live into your 80s or beyond. 

The only way to make a perfect Social Security projection is to know when you’re going to die.  For this reason, figuring out when to take Social Security isn’t completely straightforward. 

Many mass affluent couples decide to have the higher earning spouse (the one with the larger Social Security benefit) wait until age 70, while the other spouse takes Social Security at FRA.  This is a good strategy because the survivor benefit for Social Security is the higher of the couple’s Social Security including delayed retirement credits.  Our projections usually show the lifetime benefit difference between this strategy and both spouses waiting until 70 to be minimal.  As we’ve said before, everyone’s situation is different.  There are the mathematical and also the practical considerations.  Please don’t hesitate to discuss your Social Security situation with us. 

Other Income

In addition to portfolio income and Social Security, some clients have other sources of retirement income like pensions, rental properties, etc.  These are fantastic assets to bring into retirement. 

Most pensions are not adjusted for inflation, so the purchasing power of the pension deteriorates each year at the rate of inflation.  Over a twenty- or thirty-year period this can prove problematic.  Conducting inflation-adjusted retirement projections allows us to address this issue head-on. 

Established rental properties can be a boon to your retirement plan.  But, don’t buy a rental property just before retirement.  Too often this can backfire as the untested property fails to meet your expectations. 

For those who plan well and take a disciplined approach to investing and spending, providing an appropriate level of income in retirement is quite achievable.