By John Rafferty
One of my favorite television shows of the 1980s was MacGyver, an agent for a fictional secret government agency. His stock in trade is best described by Wikipedia: “His main asset is his practical application of scientific knowledge and inventive use of common items. The clever solutions MacGyver implemented to seemingly unsolvable problems — often in life-or-death situations requiring him to improvise complex devices in a matter of minutes….”
One common MacGyver-esque item that should be familiar to every person within ten years of reaching Social Security full retirement age (67 for those born after 1960, 66+ for those before) is the Social Security statement of estimated benefits. If you want to be more fully engaged in your retirement preparations and when working with your financial professional, your Social Security statement is a powerful tool with which to begin the conversation. According to AARP, 89 percent of workers are eligible to collect benefits. The exceptions are foreign nationals, employees of the federal government who were hired prior to 1984, and some state and municipal employees otherwise covered by state government-funded plans.
The first step to understanding Social Security as a bedrock discussion point in your planning efforts is to set up your my Social Security account online. Once there, simply click the box that says Create an Account. I just ran through this exercise myself and it took all of 10 minutes.
The information to focus on, once you have set up your account, is Your Social Security Statement. On it, you will find not just your personalized monthly retirement benefit estimates, which shows your benefit amount assuming you begin collecting at ages ranging from 62-70, but also disability benefit and survivor benefit estimates.
Once you get familiar with your statement, run through an exercise. This exercise is, I’d argue, one of the most basic but effective methods for determining how much, if any, guaranteed income should be added to your future retirement income planning mix.
I’d approach it in a few very simple steps. Using an estimate of retirement benefits at full retirement age, let’s see what “Jack” and “Jill” might see for their benefits.
Full retirement age (FRA) for Jack and his wife, Jill: 67 (10 years from now)
Sum of all future sources of guaranteed income:
- Social Security: $60,640/annually
– Jack’s monthly benefit (estimate) at full retirement age 67: $3,369, or $40,428 a year.
– Jill’s monthly benefit at full retirement: 50% of Jack’s, or $20,214 a year.
– Total Social Security benefits for Jack and Jill: $60,640/year, $40,428 after death of one spouse
- Pensions: $0
Total guaranteed income desired at retirement: $100,000/annually: Note the focus on “guaranteed income” desired. That is the amount required to cover all non-discretionary obligations, like taxes, health insurance, car insurance, permanent life insurance premiums, food, utilities, etc. Guaranteed income would be the foundation, with total retirement income including discretionary withdrawals or dividends from non-guaranteed investments.
Total Annual Non-Discretionary Income Gap at Retirement: $100,000 – $60,640 = $39,360
Filling the Income Gap: Annuity with Guaranteed Lifetime Withdrawal Benefit (GLWB)
Their financial professional recommends they review with her a few annuities with a guaranteed lifetime withdrawal benefit. She knows these can be an excellent and economical solution for filling their future income gap as it relates to providing for their basic needs.
Next, their adviser determines the cash flow from lifetime withdrawals that the annuity is contractually guaranteed to produce in the future, expressed as a percentage of the initial premium. For example, some annuities, if purchased and deferred for ten years prior to initiating the lifetime withdrawal feature, would provide a withdrawal percentage of about 8-10% of the initial purchase amount. For simplicity and a conservative generalization, let’s call it 8%.
This would mean that for every $100,000 used to purchase the annuity, a guaranteed cashflow from the exercise of the withdrawal feature will produce $8,000 annually beginning in ten years.
Knowing that the income gap to fill is $39,360, the annuity premium they would need to commit today is $39,360/0.08 = $492,000.
Annuity Guarantees versus the Status Quo
The income gap Jack and Jill want to fill requires a commitment today of $492,000 to purchase the annuity, which will produce the needed income via withdrawals beginning in 10 years. This withdrawal amount is guaranteed to last for the lives of both Jack and Jill. While that is a considerable sum, the natural question is, what if Jack and Jill just leave their money in the market? After all, the S&P 500 has, over the long term, produced returns of about 10% per year on average.
To produce the $39,360 by simply applying a 4% withdrawal rule to assets would imply that Jack and Jill need about $39,360/0.04 = $984,000 in ten years. That would mean, if they chose to keep their $492,000 invested instead of buying the annuity, they would need to double their money in ten years. Doubling it requires a compound annualized growth rate of 7.2% per year, which is less than the long-term average produced by the stock market. It is, however, far more than what many financial firms are projecting over the next decade. Vanguard, for example, in their 2022 economic and market outlook, expect total compound annual returns of 2.3%-4.3% for domestic stocks, and 1.4%-2.4% for domestic bonds. The annuity in this environment may be the lowest cost way to get to that future desired cashflow.
But let’s get back to the initial premise here. We are trying to create a future cash flow that is immune to market forces and one in which probabilities have no place. Jack and Jill don’t feel comfortable hitching their future cash flow wagon intended to cover non-discretionary expenses, to the vagaries of the capital markets.
Channel Your Inner MacGyver – Review Social Security Estimates to Build Your Plan
Social Security is probably the only guaranteed income source most pre-retirees can anticipate. It will serve as the foundational income source for many people who have no pensions waiting. But it will likely not be enough to cover basic, non-discretionary expenses for many. Review your own Social Security statement to see how solid your foundation is.
Get your inner MacGyver to see the power of becoming intimately familiar with the most common and perhaps overlooked element in a retirement planning discussion: your Social Security benefits. Then schedule an appointment with your financial professional and start a conversation about identifying and setting in place a plan to fill your own income gap. A deferred annuity with a guaranteed lifetime withdrawal feature can be an excellent and economical way to fill that gap and inject a much-needed dose of certainty into future retirement plans.
About the author: John Rafferty
John Rafferty has spent much of his 30-year career building annuity marketing departments at MassMutual, AIG/American General, and Symetra. He holds a B.A. in economics from Colby College and an M.A. in public policy from Trinity College, and currently operates an annuity sales and marketing consultancy, RaffertyAnnuityFraming.com.