Society of Certified Senior Advisors: The Best Retirement Strategy

Stanford University examined 292 retirement portfolio strategies for middle-income earners with less than $1 million saved. This is the best one they found.

There is no perfect retirement income solution. The change from defined benefit (pension) plans of previous decades to the defined contribution options that are common today has left many people wondering how to invest their retirement nest eggs so they won’t run out of money. The sheer number of financial instruments and strategies leave many people feeling like deer in the headlights. Researchers at Stanford University have come up with a strategy that works for most of the people, most of the time.

Break-even analysis of Social Security

While the Stanford method works for the majority of earners, it’s not a perfect fit for all. That’s why it may be wise to hire a financial professional to help you tailor a plan to your specific situation. Take Social Security, for example.

While waiting to collect until age 70 is generally a good thing because the amount of your monthly check increases the longer you wait until you’ve reached that milestone, there are circumstances where beginning withdrawals earlier would be the better choice. You have to know your break-even point, or the point at which the amount you receive if you claim later equals the total amount you would have received if you had started earlier.

This break-even point usually occurs somewhere from age 77 to 83, depending on when you begin getting benefits. You can read about how to calculate your own break-even point here, but beware of the pitfalls.

Cost-of-living adjustments take place annually, with some years having no adjustment at all. If you include them, says Joe Elasser, president of Coliseum, a provider of Social Security timing software, “that’s going to slant the calculation and the break-even age to make it look as though delaying is more beneficial quicker.” He recommends eliminating these adjustments when making your calculations.

You also need to consider what you could have earned by investing checks if you took the money earlier. That’s if you would be investing the money and not spending it. Plus, if you claim early and continue to work, benefits could be reduced or be subject to higher taxes.

Additionally, Social Security benefits will never lose 40% in a market crash — they’re not a risky asset class like equities. Benefits go up about 8% for every year you delay, while the stock market may lose money in that same time period.

Finally, married couples have their own special considerations. Your spouse is a big part of the equation, because starting benefits earlier could negatively impact what your partner can eventually receive if he or she claims on your earnings record.

“I would not leave it to guesswork,” advises John Piershale, wealth advisor at Piershale Financial Group. “It’s just not that easy to figure out by being intuitive. You should really put the pencil to the paper and just run some numbers.”

Spend Safely in Retirement

Consulting research scholar Steve Vernon of the Stanford Center on Longevity, in collaboration with the Society of Actuaries (SOA), studied ways to “pensionize” a 401(k) or IRA. “What we wanted to do was identify a strategy that middle-income workers could use that’s fairly straightforward and that they could do on their own,” says Vernon. The team analyzed 292 income strategies to find the optimal way to make withdrawals. The best option was dubbed the “spend safely in retirement” method.

“This is a strategy that people can use to decide if they’ve got enough money to retire,” says Vernon. “But also, a lot of people are uncertain as to when they’ll retire and if they should work part-time for a while, so this strategy can help them think through those questions.”

The winning method offers “more average total retirement income expected throughout retirement compared to most solutions we analyzed,” according to Vernon, and “provides a lifetime income, no matter how long the participant lives.” The strategy has just two main components which are easy to follow. Sound too good to be true?

Pair of Key Elements

1. Don’t take Social Security payments until age 70.

Vernon says that for middle-income earners, Social Security will generate most of their income. “It will be anywhere from 60 to 80 percent of their total income.

“And Social Security is nearly a perfect retirement income generator: It lasts the rest of your life, it protects against inflation, it doesn’t go down if the stock market crashes, it’s paid automatically into your checking account, part of it isn’t subject to income taxes. No other retirement income generator has all of those positive features, so maximizing Social Security is a key part of this strategy.”

For some people, working until age 70 is out of the question. In that case, the report suggests creating a fund out of retirement savings using the same withdrawal amount that Social Security would otherwise pay. This “retirement transition fund” should be held in a separate account.

“Some workers might decide it should be a large enough amount to cover their estimated living expenses for a specified period, say two to five years,” the report says. “Another use for a retirement transition fund is to set aside enough savings to cover the amount of the Social Security benefit they plan to delay for as long as needed.” Either way, the fund’s purpose is to put off taking Social Security benefits for as long as possible.

But don’t make the mistake of leaving that transition fund in cash, where inflation means you lose around 2% every year. The transition bucket could be invested in a liquid fund with minimal volatility in principal, such as a money market fund, a short-term bond fund or a stable value fund in a 401(k) plan. This type of fund could protect a substantial amount of retirement income from investment risk as the worker approaches retirement, since the retirement transition bucket would be invested in stable investments and Social Security isn't impacted by investment returns.

Although Social Security income is considered stable, there are caveats to it as well. “Pessimists might point out that Social Security is subject to political risk; our leaders can change the amount of benefits paid to current retirees or older workers,” researchers admitted, adding, “when deciding on a Social Security claiming strategy, older workers must weigh this risk against Social Security’s other desirable features.”

2. Create an “automatic retirement paycheck.” Invest any remaining savings in low-cost mutual funds common to IRAs and 401(k) plans, such as target-date, balanced or stock index funds.

Then let required minimum distributions (RMDs) serve as your additional “paychecks.” These withdrawals are mandated beginning at age 70.5 so that the IRS gets its share of your savings. You can use a free RMD calculator such as the one at Vanguard to estimate payments. These RMDs are based on a percentage of the value of your account, so while they will fluctuate as your savings goes up or down with the market, they won’t run out. Furthermore, you don’t have to spend all the money you must withdraw (or face a steep additional fine), so you can reinvest it if you don’t need it, or put it aside for another year.