Improve Retirement Income

William Suplee |
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Recently I watched a very interesting presentation given by Robert Merton, known for his Nobel Prize in economics for his work on option pricing models. Dr. Merton has focused a lot of his research in recent years on how to help people plan for a more successful retirement.

For those that are unsure whether they have enough resources to adequately fund retirement, he suggested there are basically four ways they can improve their situation. The first way is to save more. This might seem trite but an adjustment in the amount that is saved on a monthly or yearly basis might be all that's needed to improve your chances of success. The second way they can help themselves is to work longer. This is often a personal choice to extend working years for the extra years of saving and fewer years of drawing down your accumulated assets. The third way is to take more risk with the investments. This is not normally my recommended course of action. While it’s true that if you take more risk, the chance of having a good outcome increases it also increases the odds of having a bad outcome. The fourth way is to improve your income benefits. You can do this by using inflation protected securities, pensions, annuities, or in some cases, borrowing against your home equity to get greater stability of spending.

Let’s just consider improving your income stream. There is a very easy way to do that. Delaying your Social Security starting age can be enough to have a dramatic effect on your spending in retirement. Why is this? It's because of the benefits formula used for Social Security. By starting Social Security before your full retirement age, you give up 7 ½% of the benefit per year. By delaying it past your regular starting age, it grows by 8% per year. This is a huge number in today’s 0% interest rate environment.

It looks like we will be in this low rate environment for at least the next three years. Bank accounts earn zero and money markets earn zero but by delaying Social Security you can have a huge guaranteed increase each year. Not only that, any future inflation adjustments on Social Security will be on the larger amount. However, Social Security currently has very substantial increases for those who are able to delay it. For retirees who have already started their benefit at full retirement age but are not yet 70, you have the option to request a suspension of your Social Security benefits. This is a good option for someone who doesn’t need their benefits yet but took them because they thought it was the right thing to do. By suspending, you get delayed retirement credits which will boost your eventual benefit 8% for each suspended year.

This is not always the best strategy for everyone. It depends upon a lot of factors including your expected longevity, your health and family history. The only way to make a good choice is to carefully consider all the factors involved in your personal situation. But it’s definitely worth going through the exercise.