Most of us would like to help our children and grandchildren prepare for the changing retirement landscape. Pension plans are under siege and passing away. Although many current retirees receive generous pensions, our children and grandchildren are not likely to share that good fortune.
Their retirements will likely depend on Social Security and whatever income they can piece together from retirement investments and encore careers. To help, we can point out reasonable investment goals. Today we’ll see how Social Security influences investment goals.
The Younger World
Many young workers don’t save. Modern life is just too expensive, and retirement is a long way off. They sometimes say they will work until they no longer can, then live in retirement on whatever they receive or have.
Most retirement writers argue against such a fatalistic approach. They commonly say that retirees want a relatively constant standard of living into retirement. (Economists call this the “life-cycle” hypothesis which says that many people do behave in just that way—plan consumption patterns to allow a constant standard of living throughout their lives.)
That means their retirement income should be large enough to nearly replace a working salary. After all, in retirement, people usually pay less federal and state income tax, they no longer pay FICA taxes, they often decrease life and disability insurance, and they no longer need to save for retirement. Retirees can therefore preserve their lifestyle with less income. Let’s hypothesize 80%.
Without part-time work or pensions, that 80% goal can only be met from Social Security and investments.
The part met by Social Security varies with a person’s earning history. For low-income workers, Social Security replaces a larger part of their work income than it does for high-income workers. Low-income workers, then, need to save relatively less.
The Social Security website has a Quick Calculator,which is a good tool for estimating approximate benefits. A user enters their birthday, current income and retirement date. I estimated benefits for a person who retires in June, 2013, at age 66 (born in June 1947). Initially I entered $20,000 as a final annual income from work, then clicked “submit.”
The calculator estimated a monthly retirement benefit and an earnings history back to 1965. The benefit was $806 per month, which is $9,672 per year. That payment is a little over 48% of the $20,000 work income. To replace 80%, this retiree would need to replace almost 32% of preretirement income from investments, which is $6,328 per year.
A table at the end of the post shows similar results for many income levels. One important conclusion from the numbers is that the ratio of the benefit to final work income declines as income increases. The nearby chart shows that decline.
Low-income workers ($20,000) have nearly half (48%) of their preretirement income replaced by Social Security benefits, and high-income workers ($200,000) have a small part (15%) of their income replaced.
That pattern of benefits implies a reciprocal pattern of saving burden, which is shown in columns 6 and 7 of the table.
The low and high saving goals in the table follow the analysis in, How Much to Save for Retirement published here in January. That post described the saving implications of withdrawal rules. If retirees withdraw annually 4% of their accumulation at the start of retirement, then they need to accumulate 25 times their desired income. Retirees who use the four percent rule and want $6,328 of retirement income from investments need to accumulate over $158,000 during their working years (column 7).
Annuities are an alternative, and now, given low interest rates and existing life expectancies, a retiree may purchase a single-life, immediate annuity for about 15 times the desired annual income—a 65-year-old retiree may receive $6,300 annually for life from an annuity costing about $95,000 (column 6).
As preretirement income (column 1) gets higher, the savings burdens in columns 6 and 7 get harder to achieve. At incomes of $60,000 to $90,000, workers planning to use a four percent rule will need between $0.75 million and $1.25 million of investments.
These are reasonable savings/investment goals because their foundations lie in common retirement behavior. Many retirees want to continue their preretirement standard of living and many will use a withdrawal rule that helps ensure the longevity of their investments.
Accumulating $1 million (or thereabouts) is challenging for middle-class people, but, as we’ll see in the next post, it is also possible.