Was Merle Haggard Right? (Part 2)

Last week I delivered the bad news you may already have known if you’ve ever looked up how much Social Security will pay you in retirement: it will not replace 100% of your income from the workplace—or even the 70% of pre-retirement income financial planners say you will need.  But then again….When experts say that Social Security will, on average, replace 40% of your annual income from your working years, they apparently mean 40% of your gross income.  And unless you are living way beyond your means, you do not live on your gross income.  Taxes take a big cut, maybe as much as 30% for even the average worker when all payroll taxes—including FICA, which funds Social Security—are counted. (If you are afraid taxes will still hit you hard in retirement, read my April 28 and May 5, 2017, posts, “IRA, RMD, IRA, OMG”.)  You may already be living on “70% of your pre-retirement income”.

So a worker with a $60,000 salary would gross $5000 per month.  Take away that 30% to arrive at a net paycheck and it’s more like $3500.  (For simplicity’s sake, we’ll not consider in this calculation that the employee’s net income may have been further reduced by contributions to a 401(k) plan, an expense he will not have in retirement.)  If he draws that estimated $2100 Social Security check monthly (see last week’s post), he already has climbed to 60% of the actual income on which he has been living.

To close the gap, this retiree would most likely look next to his retirement savings account(s) like 401(k) plans or Individual Retirement Accounts (IRA’s).  As a rule of thumb, financial planners often recommend withdrawing just 3% to 4% each year from such accounts as a way to stretch that money over a retirement that might last 30 years or even longer.  Assuming a relatively modest $150,000 balance, 3% annual withdrawals yield $4500 per year, or $375 per month.  Now he has reached 70% of his net income from his working years.

If there’s no pension or other steady source of income, he will probably need to work at least part-time or seasonally to reach his desired standard of living.  Working is not such a bad fate if you can choose something low-stress and enjoyable.  It doesn’t have to make you rich.  About $12,000 per year for this worker would do it. 

 

To recap, his situation looks like this:

$5000      Monthly pre-retirement income (gross)                   $2100      Monthly SS benefit

                -1500       Taxes (FICA, federal, state, local income)                  375      Monthly income from 401k)

                $3500      Net monthly income                                                +1000     Monthly employment income

                                                                                                                  $3475    Monthly Retirement income

  

But to me, even that $1000 per month employment income sounds like more of a demand than it should be for a retiree.  Personally, I think debt reduction is a much better way to make ends meet.  Credit.com reports that 73% of Americans die with debt.  The average amount is $61,554, or $12,875 if not counting mortgage debt.  The payment on that takes a big chunk of one’s income in retirement.  Eliminate that and I’d wager you could live on less than that proverbial 70%.
 

You can also stay in the full-time workforce a couple of extra years and thus delay claiming your Social Security benefits.  When you go online to check your own benefits, look at what a difference it makes in the monthly benefit to wait until age 70 to collect.  Even if you don’t want to wait that long, each month you delay increases your benefit and closes the income spread a bit more.

 

Consider downsizing your living space.  If selling a house to do so, bank the profit realized by the sale to draw on for regular income.  Or just eliminate clutter; sell your excess stuff.  Your heirs will appreciate not having to do it themselves after you’re gone.

 

I don’t recommend them, primarily because they come with high expenses, can be complicated, and may leave your heirs with some headaches and probably without the house; but homeowners age 62+ and meeting a few other requirements can convert the equity in their home to a monthly income stream—a reverse mortgage.  Just be careful and make sure you understand the terms and conditions of the loan—because it is a special type of loan.  The mortgagor does want to get his money back, and that will probably be effected by taking possession of, and selling, the house rather quickly after you die.

 

I hope I’ve given you cause for optimism.  We can discuss the viability of the Social Security system some other time, but I’m pretty upbeat about prospects for yours and my retirement.  Keep saving!

 

Until next time,

Roger

 

“If you plan and work hard, you will have plenty.  If you get in a hurry, you will end up poor.” Proverbs 21: 5 CEV