Financial advisors love to talk about the "safe" withdrawal rule in retirement, but retirement income researcher Steve Vernon prefers to talk about the simple withdrawal rule.
Vernon is no household name and few advisors are likely to have even heard of him, but as a consulting actuary, he helped convert defined benefit plans into defined contribution plans more than 30 years ago.
During these plan conversions, a question continued to haunt Vernon. How can workers, who neither think nor plan for retirement like an actuary, generate reliable retirement income?
After decades of research and studying behavioral patterns, Vernon has concluded that for middle Americans Social Security is as close to the perfect retirement income generator as many people are going to get.
That’s why he’s recently published the Social Security/Required Minimum Distribution “Spend Safely in Retirement Strategy” model, a straightforward approach that advisors, plan sponsors and retirees could find useful.
“In essence, ‘Age 70 is the new 65,’ “ Vernon writes in the paper, “How to ‘Pensionize’ Any IRA or 401(k) Plan.” Americans who had been dreaming of a full retirement at 65 might have to hit the snooze button that dream.
Vernon is a research scholar with the Stanford Center on Longevity and his research was conducted in collaboration with the Society of Actuaries.
The Great Annuity Anchor: Social Security
Many middle market retirees with between $100,000 and $1 million in retirement assets don’t work with financial advisors or only work with them to a limited extent, and only about half of all defined contribution plans offer any options for converting balances into periodic retirement income.
Furthermore, about half of Americans 55 or older have less than $100,000 in retirement savings, which is nowhere near enough for a traditional retirement.
For this group of middle-market retirees, Social Security meets more retirement income planning goals than any other retirement income generator, Vernon said.
Though most retirees don’t realize it, Social Security is one giant income annuity and the longer they defer taking payments, the higher the income.
“All we're saying is that for middle income workers they should optimize Social Security first before looking to other annuities in the private market,” he said. “If you optimize Social Security, then it might be enough annuity income."
Social Security protects beneficiaries against risks of longevity, inflation, investment, death of a spouse, cognitive decline and fraud.
In terms of value, no other product in the marketplace can beat Social Security so the challenge is for middle-income retirees to squeeze as much as they can out of their retirement resources, especially since many employers are reluctant to offer annuities in 401(k) plans.
Spend Safely Simply
The best way for workers to implement a safe spending strategy in retirement is to work just enough to pay for living expenses to delay Social Security benefits, Vernon said.
Workers unwilling or unable to do that should use a portion of their savings to delay Social Security benefits so that instead of taking Social Security at 65, savings can tide them over until 70 when Social Security begins, Vernon said.
When the time comes to take income, the RMD tables published by the U.S. Treasury Department offer simple, easy guidance starting with the 3.65 withdrawal percentage at age 70 and increasing each year thereafter.
Optimal strategies often depend on spousal benefits, other income and taxes, but one of the most important aspects of spending safely to guarantee retirement income is to keep the variables simple, Vernon said.
“We want to suggest something that a worker doesn't have to think about,” Vernon said. “What I like about RMD is that most IRA and 401(k) providers will pay that for you, so it’s on autopilot.”
The safe spending strategy is a starting point and can be refined or augmented through other privately purchased income annuities, living withdrawal benefit or indexed annuities, he said.
Fixed Costs and Discretionary Spending
But a spending model that workers can’t outlive needs to be communicated by plan administrators and advisors who should characterize Social Security as a monthly retirement paycheck to pay for basic living expenses.
RMD withdrawals, meanwhile, should be characterized as a variable annual “retirement bonus” that can fluctuate and pay for discretionary expenses.
Since many middle-income workers are accustomed to managing their finances with secure paychecks and variable bonuses that drop into their laps from time to time, it only makes sense to continue that discipline in retirement, he said.
A retirement strategy to spend safely won’t compensate for inadequate savings or other risks like long-term care.
That’s not so much a shortcoming of the safe spending strategy, however, as other retirement income solutions deliver equal or less retirement income than a safe spending strategy.
InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected]