Increase your retirement income by $9,500 annually with this 1 decision
Barron’s Insight: The smartest ways to invest for retirement
‘Barron’s Roundtable’ panel provide insight and analysis on smart ways to invest for retirement.
You've likely heard financial experts tout the wisdom of delaying retirement. A few extra years of working can deliver higher Social Security income and a fatter savings balance. But the real question is, what's the dollar value of those outcomes?
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If you're at all worried about making ends meet once your paycheck goes away, you should know how to estimate the value of postponing your retirement. As you'll see below, the average worker could increase retirement income by $9,500 a year, simply by working an extra five years. And you might have an even greater opportunity available to you.
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Higher Social Security income
You can claim Social Security as early as age 62. That's not the best option financially, though. The earlier you claim, the lower your benefit. You only qualify for your full benefit as calculated from your earnings history when you reach Full Retirement Age, or FRA. Your FRA is based on your birth year. For anyone born after 1942, FRA is at least 66 years old, but could be as high as 67.
You can learn the formula that discounts your benefit for claiming early, but there is an easier approach. Create an account at my Social Security and log in to view your benefit estimates at different claiming ages. Note the substantial difference in benefits between claiming at 62 versus claiming at FRA.
According to the Social Security Quick Calculator, a 60-year-old worker (born June 15, 1960) earning $56,680, for example, stands to receive $1,126 in monthly Social Security income when benefits start at age 62 and one month. But if that worker delays Social Security until age 67, the benefit rises to $1,710 monthly. In return for five years of patience, this worker gets an income increase of $584 per month, or $7,008 per year. The increase comes largely from delaying benefits, but also from working an extra five years at a peak salary.
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Higher savings for larger retirement distributions
Postponing retirement is also good for your savings balance. The more paychecks you earn, the more retirement contributions you can make. To quantify that, look up your contribution rate and add it to your employer match rate. Apply that percentage to your salary to calculate your total monthly contributions. You can then use an investment calculator to estimate how those contributions will grow in the years you postpone retirement.
We can use our average senior worker making $56,680 annually to demonstrate the math. Let's say our senior saver has a contribution rate of 15% and is also earning 3% in employer match. That's a total contribution of 18%, which works out to about $10,000 a year, or $850 monthly. In five years, that's an extra $50,000 in contributions — plus any earnings on top of those contributions.
You can estimate those earnings, though it is a bit of guesswork. The stock market can be volatile in time periods of five years or less. That's one reason why you should reduce your exposure to stocks as you near retirement. You might set up your portfolio to be 50% or 60% stocks, for example, with the rest in bonds and cash. You'll see lower growth rates, closer to 4% or 5%, rather than the stock market's long-term average of 7%. But you'll have also have less volatility. That lowers the chances that a bout of market turbulence will strip value from your investments, just when you're about to start taking retirement distributions.
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At a 5% return, the $850 in monthly contributions should grow to about $58,000 in five years. To calculate how those extra funds affect retirement income, multiply the $58,000 by 4%. This is based on the rule of thumb that you can safely withdraw 4% of your retirement savings annually. 4% of $58,000 is $2,320.
The $2,320 in higher retirement plan distributions combined with the Social Security increase of $7,008 gets you to a total retirement income increase of $9,328 per year. That's a pretty significant sum, especially considering the numbers are based on a working salary of $56,680.
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Crunch your numbers
Number-crunching may not be your favorite activity, but it's a useful skill with respect to retirement planning. If you're stressed about not having enough income in retirement, you can run through some scenarios to gauge how your situation changes based on timing. You may decide that an extra few years of work is worth it for the breathing room it'll give you in your senior years.
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