10 tricks to raise your retirement living standard



Social Security rules are complicated and change often. For the most recent “Ask Larry” columns, check out maximizemysocialsecurity.com/ask-larry.

Boston University economist Larry Kotlikoff has spent every week, for more than two years, answering questions about what is likely your largest financial asset — your Social Security benefits. His Social Security original 34 “secrets”, his additional secrets, his Social Security “mistakes” and his Social Security gotchas have prompted so many of you to write in that we feature “Ask Larry” every Monday. Find a complete list of his columns here. And keep sending us your Social Security questions.

Kotlikoff’s state-of-the-art retirement software is available here, for free, in its “basic” version. His new book, “Get What’s Yours — the Secrets to Maxing Out Your Social Security Benefits,” (co-authored with Paul Solman and Making Sen$e Medicare columnist Phil Moeller) was published in February by Simon & Schuster.

Watch Larry explain how Paul and his wife could collect an extra $50,000 in Social Security benefits:

Those of you who read this weekly column on Social Security know that getting Social Security straight is like discovering a gold mine — potentially a very large gold mine — right in your front yard.

But this is not your only gold mine waiting to be discovered. I thought I’d take a break this week from answering Social Security questions to illustrate additional perfectly safe ways to raise your living standard.

When it comes to your personal finances, economics has one message – smooth (stabilize) your living standard (your consumption) over time and across times – good times and bad times.

None of us wants to splurge today and starve tomorrow, nor do the opposite. None of us wants to live with indoor plumbing and heating when our house is intact and live on the street when it burns down. And none of us want to eat steak when the stock market booms and cat food when it crashes. This is why we save, buy insurance and diversify our portfolios – to even out or smooth our consumption (living standards).

The desire to smooth consumption reflects our physiology. We don’t seek to eat everything we can at once. I tested this with my youngest son, David, when he was 10. I bought him 20 delicious chocolate cupcakes and told him that a) Mom wasn’t home, and b) he could eat as many as he wanted. He scarfed down the first in a nanosecond. The second disappeared in 2 seconds. The third took a minute. As he was proceeding very slowly through the fourth, I reminded him that he could eat as many as he wanted. He said, “Dad, let’s save these for tomorrow.”

Every question in personal finance begins and ends with our living standard. If I retire early, how much more do I need to save today to prevent my living standard from dropping at retirement? If I contribute more to a 401(k) will I be able to lower my lifetime taxes and raise my living standard? If I get an MBA will the payoff exceed the costs so I can have a permanently higher living standard? If I take a mortgage with points does that raise or lower my sustainable spending power? If I wait to take my Social Security retirement benefit will the higher benefits make up for the waiting and let me spend more now as well as later? And the list goes on.

Let me illustrate the power of economics, mathematical algorithms and modern computers to safely raise your sustainable living standard.

Meet John and Jane Smith, a married California couple who are both age 56. The two plan to work till age 62, take their Social Security benefits at that age and spend down their retirement account assets – John’s 401(k) and Janes’ IRAs — smoothly starting at 65. John makes $75,000 and Jane makes $25,000. They have $50,000 in a checking account. John has a $400,000 401(k) and Jane has a $100,000 traditional IRA. Their $500,000 home is paid off, but keeping it up is expensive. Annual property taxes run $7,500. Homeowners insurance costs another $2,500 per year, and the upkeep averages $2,000 annually. John is contributing $2,000 per year to his retirement account. His employer is matching the $2,000 contribution. Jane isn’t contributing anything anymore to her IRA.

I ran John and Jane through my company’s ESPlannerBASIC software. It shows that the Smiths can spend $46,058 each year (valued in today’s dollars) after paying all their federal FICA and federal and state income taxes, their life insurance premiums, their Medicare Part B premiums and their housing costs.

I’m now going to take you though 10 magic tricks that produce, in terms of the resulting higher living standard, the equivalent of their finding $793,000 on the street!

1. John and Jane retire later.

Both John and Jane have the option of working longer. So let’s have them both work until age 65, take their Social Security benefits at that age, and, in John’s case, continue, along with his employer, to contribute to his 401(k). This raises their sustainable discretionary spending from $46,058 to $55,357. That’s a whopping 20.2 percent increase in their ongoing spending power. The explanation is not just earning more and saving taxes by contributing more to John’s retirement account. By working longer John also receives four extra years of employer contributions to his 401(k).

2. Jane and John move to Texas.

John and Jane don’t need to live in California. They both work for companies with offices in Texas. And living in Texas means paying no state income tax. Moving to Texas raises their living standard yet further – from $55,357 to $56,287.

3. John and Jane “downsize” their home.

After arriving in Texas, John and Jane realize they can get by with a cheaper, but far larger house than they had back in California. Accordingly, they sell their California home and buy a new one for $300,000. The new house also has lower property taxes, insurance premiums, and upkeep. All told, this “downsizing” of their home brings them to $66,902 in annual spending, which, by the way, is an amazing 45.2 percent above the Smith’s original annual spending level of $46,058.

4. John doubles his contributions to his 401(k).

John, being 56, realizes it’s time to get serious about saving for retirement. So he doubles his own tax-deductible 401(k) contributions. Doing so raises the couples’ sustainable living standard (what they can spend on a discretionary basis in today’s dollars right out to age 100) to $67,057.

5. Jane contributes to her IRA.

John convinces Jane that she should start contributing again to her IRA. She does this to the tune of $2,000 per year. Now their living standard is $67,211, with the increase in spending paid for by a reduction in their lifetime taxes.

6. Jane takes her Social Security retirement benefit at 70.

This trick, which increases Jane’s retirement benefit by almost 40 percent, raises the Smith’s living standard, again, starting at their current age 56, to $68,681!

7. Jane takes her Social Security spousal benefit at 66.

Between full retirement age and 70 Jane can take a spousal benefit because John is filing for his retirement benefit at 65. Now the couple’s annual expenditures are $69,672 — 51.3 percent higher than where they started. And it’s all been achieved with absolutely zero risk.

8. John files and suspends his retirement benefit at full retirement age and restarts it at 70.

This change in John’s Social Security strategy doesn’t limit Jane’s ability to collect spousal benefits. And because John’s retirement benefit, when he starts receiving it, is now also almost 40 percent higher, John’s new Social Security strategy raises the couple’s living standard to $73,089! Now we’re 58.7 percent above the couple’s original sustainable spending capacity!

9. John contributes to a Roth, not a 401(k).

This raises the couple’s living standard to $73,230. Part of the reason this saves taxes is that I specified that the couple would take their taxable retirement account money (their 401(k) and IRA funds) out first. Since the taxable retirement account withdrawals impact the taxation of Social Security benefits whereas Roth withdrawals do not, this lowers the couple’s lifetime taxes and let’s them spend a bit more each year, right through to their maximum ages of life of 100.

10. Jane and John annuitize half of their retirement assets.

The final magic trick I’ve considered (and I have plenty more in my bag) is to have John and Jane annuitize half of their retirement account withdrawals. I’m assuming, in calculating their annuity, that they receive only a 2 percent return above inflation. But the annuity pays them a higher payout than is reflected by the 2 percent due to the fact that if they pass away the annuity payouts stop. I.e., I’m talking about single life annuities. Annuities permit people who live a long time to spend the money of other annuitants who die early. And it can make a big difference to a household’s sustainable spending. Indeed, John and Jane can now spend $73,786 on an ongoing basis. This is 60.2 percent above their initial level!

If I return to the initial profile – i.e., I don’t apply any of the 10 magic tricks – how much more money do I need to put in John and Jane’s checking account such that they can achieve a living standard of $73,786? The answer is $793,000. That’s more than all the assets the couple owns. It’s also almost eight years of labor earning!

Now, I realize that a good chunk of this gain comes from John and Jane working a few more years. But physically and psychologically, working longer is likely to be a good thing as well.

The main point, though, is that economic science has an incredible amount to offer when it comes to helping you safely raise your living standard. I recently spoke to a NASA engineer who uses our software. He was curious about the algorithm. When I explained that it is based on dynamic programming he said that NASA uses this technique all the time in modeling space flight. Apparently, doing financial planning right truly requires rocket science.

Editor’s Note 5/8/2015: Larry answered this reader’s question.

Beth — Kansas: You have recently answered several questions regarding my calculations and scenarios on your website. After reading Mr. Kotlikoff’s latest edition of “Get What’s Yours: The Secrets to Maxing Out Your Social Security,” I have another question for you.

On the Maximize My Social Security website, the following statement is found on page 15 of “What’s Under Our Hood” (3rd paragraph under “#3. File and suspend strategies for married couples”):

It might also be optimal for one spouse to collect retirement benefits as early as age 62 and then wait till his or her FRA to collect unreduced spousal benefits from then on. It is feasible to do so and avoid deeming provision if the other spouse waits to file and suspend (or collect) his or her retirement benefits until the month after the first spouse files for his or her early retirement benefits so that he or she is not deemed by law to be entitled to reduced spousal benefits when applying for early retirement benefits.

The first sentence of the above paragraph seems to contradict “Gotcha #2” and “Gotcha #3 (located on pg. 229, Get What’s Yours.) Gotcha #2 states:

Once you file for your retirement benefit you can NEVER take an auxiliary benefit by itself. The instant you file for your retirement benefit you forfeit FOREVER your ability to file for any other benefit just by itself. This is true even if you suspend your retirement benefit.

Gotcha #3 states in part:

…taking your retirement benefit will likely mean never receiving a spousal benefit because a) taking your retirement benefit keeps you from ever taking another benefit by itself (Gotcha #2)…

So, my questions: Gotcha #2 and #3 seem to imply that, whether or not you were initially deemed to be applying for both benefits, you can NEVER switch to a spousal benefit after beginning your own retirement benefits. Is this correct? And if so, how is it possible to begin taking retirement benefits at age 62 and then switch to spousal benefits at FRA (as suggested above)?

Larry Kotlikoff: The book is correct. The only way you can only take your retirement benefit early and not be deemed to be simultaneously filing for a spousal benefit if you are married is if your spouse has not yet filed for his retirement benefit. If you are divorced, the only way is if you ex is not yet 62. In either case, if you then wait until full retirement age to collect your spousal benefit it will be your excess, not your full spousal benefit that you will receive. This is true even if you suspend your retirement benefit at full retirement age.