Written by Don Walter
From his column Minute with Don
As an increasing number of folks approach retirement, the reality of past behaviors on current and future income begin to settle in. Many have not focused on retirement savings or planning, and as certain birthdays become reality, the nagging questions of the past become increasingly difficult to ignore. At some point it becomes necessary to look at the numbers, and too often these don’t look good. However, there may be a silver lining behind those clouds.
Generally, one’s 60th birthday acts as a reality check. Having already passed the magic age of 59½, which is recognized in tax law as the age allowing one to take money out of retirement savings without incurring penalties for “early” distributions, the arrival of age 60 can be a milestone.
Actually, the concept of 59½ as a time for early retirement is misleading. For many individuals, taking distributions before age 67, or later, may be too early. By waiting even a few years, one’s retirement income can improve dramatically.
Let’s start with a few assumptions and compare the results of delaying retirement distributions. First, let’s assume that at age 59½ one has saved $100,000 in a retirement account. Since tax laws would now allow for distributions without “early distribution penalties,” one might be tempted to do so. That could be a costly error. Let’s look at a couple of situations with an understanding that we are using them for illustration only, not as recommendations or suggestions about retirement income adequacy.
Let’s assume we have a friend named Joe. He just turned 59½ and wants to start paying himself from the $100,000 in his retirement account. He is earning 5% on his account, and would like to start taking $500 per month, increasing that amount 2% per year to allow for inflation. Unfortunately, Joe will likely outlive his nest egg, since his account will be depleted in a little over 23 years. Assuming Joe has a normal life expectancy, he could deplete his account seven or more years before he dies. To make sure he doesn’t, he should probably not be taking more than $350 per month.
Our friend Sally also has saved $100,000 in her account, and begins doing some detailed planning when she reaches 59½. She’d like to do what Joe is doing, but she doesn’t want to run out of money. She knows her life expectancy could be age 90 or later. She’s also sure $500 per month is not enough to meet her needs. So Sally decides to keep working, putting $3,000 per year into her retirement account while not taking distributions. Assuming she earns the same 5% Joe is earning, how much better off might she be?
At age 67, Sally’s account has now grown to about $170,600. And since she hasn’t withdrawn any money, she has fewer years for which she will need the money. Some planners estimate that for every year one delays taking retirement distributions, one can add over two years of income. Sally now discovers that by waiting, adding to her account and letting compound earnings work for her, she is much better off. In fact, assuming she continues to receive 5% earnings, she can comfortably take $700 per month from the account, adjust it upward annually by 2%, and have an income for over 30 years. And if she has waited to start Social Security withdrawals beyond her normal retirement date, she will enjoy a higher Social Security benefit also.
We often talk to younger ministers about the high cost of waiting before starting to invest for retirement. It’s a fact, and has been illustrated in a variety of ways. However, near the end of our working years, waiting may be a good thing. In fact, one of the most dangerous things we can do to increase the risk of running out of money is to start taking it from a retirement account too soon. And by taking too much too soon, a person can almost guarantee they will run out of money several years before they no longer need living expenses. We all know how compounded returns can leverage the growth of savings. That can be a difficult message for persons to grasp when they are young because so little is being compounded. But for those closing in on retirement, the reality of compounding can be amazing. In our example above, it would have taken both Sally and Joe most of their working years to amass the $100,000 nest egg. But Sally was able to see that amount grow by over $70,000 simply by delaying distributions, letting earnings compound, and continuing to make regular contributions.
I am aware that the concept of “delaying retirement” has some negative emotional and psychological baggage, but when one thinks of how working longer, saving more, and delaying withdrawals can lessen the probability of becoming destitute in old age, or provide better security for a surviving spouse, it makes a lot of sense. It’s certainly a better option than trying to find gainful employment at the age of 80.
Don Walter is director of Pensions and Benefits USA for the Church of the Nazarene.