John Shoven Stanford economics professor John Shoven.

Great news for older retirement-saving laggards who are paying into Social Security: They can catch up to a striking extent and increase their standard of living in retirement by working just a bit longer than planned.

So says Stanford University economics professor John Shoven, in an interview with ThinkAdvisor. He and three of his former students have written a working paper, “The Power of Working Longer,” which is eye-opening and has practical applications as well.

Even Shoven was initially surprised at the results of his study, issued by the National Bureau of Economic Research in January. It found that postponing retirement by just three to six months is equivalent to saving an additional percentage point of earnings for 30 years. Further, later in life — the mid-60s age range — working just one month longer is indeed equal to saving more ten years before retirement.

Shoven presumed one would need to work a couple of years longer — not months — to produce the additional retirement funding.

The study mostly applies to people ages 62 to 69 who have a retirement plan in place, such as a 401(k) or IRA, but who realize they’ll have less money in retirement than they desire, explained Shoven, Charles Schwab professor of economics and a senior fellow at the Stanford Institute for Economic Policy Research. He is on the boards of American Century Funds, Exponent and Financial Engines.

The study doesn’t address the super-affluent; nor would it much apply. The findings are most relevant to workers with an annual income of up to about $200,000 and who will rely largely on Social Security.

The key to increased income in retirement: deferring Social Security benefits to match up with a revised, later, retirement target date. For example, a person in their mid-50s may need to work only six more weeks than originally planned.

Not only will the amount of monthly Social Security checks rise, but because the individual is working longer, the balance in their retirement account — a 401(k), for instance — will of course increase, too.

ThinkAdvisor recently interviewed Shoven, on the phone from his Stanford office. Co-author of a book about Social Security and health reform, “Putting Our House in Order” (2008), with former Secretary of State and Treasury George Shultz, the professor talked about how financial advisors can best explain to clients the concept of working longer for a more comfortable retirement. He also stressed the advantage of buying an annuity later in life.

Here are excerpts:

THINKADVISOR: Your study shows that working just a little longer is, for future Social Security recipients, the equivalent of saving 1% more for 30 years. That’s pretty striking.

JOHN SHOVEN: You really get quite a handsome payoff from working longer. When I started this study, I asked a few friends — one, a Nobel Prize winner — if someone was saving 1% more for 30 years, how much longer do you think they’d have to work to have the same financial impact on their retirement? They guessed about three years — but the answer is about three months to six months, depending on the rate of return you earn on your 401(k) or other retirement plan.

But what if you saved quite a bit?

There’s no saving you could possibly do that would affect your retirement resources as dramatically. You can change your savings rate from 6% to 26%, and it still wouldn’t have as much power as working a few extra years. And if you save 1% more for your final 10 years of work, that would be equivalent to working about one month longer.

What rate of savings return did you use in the study?

About 6% to 8% inflation-adjusted real returns and a very safe strategy of investing primarily in bonds. But even if you took more risk, it didn’t change things too dramatically. It still showed that working longer was the [better] way to raise your income.

“Working longer” doesn’t mean working into old age, according to your paper, does it?

Right. We’re not talking about people working till they’re 80 or even 70. We’re saying that adding just a few years of work in their 60s — retiring at 66 instead of 63 or 64, say. One year, three years — all of that will help.

Did you have a hypothesis when you started the study?

Kind of. But the results initially surprised me. I thought that you’d have to work a couple of years longer — not just three to six months longer — vs. saving for 30 years. That’s pretty stark. If you really went crazy and saved 10% instead of 6%, you would need to work only another 18 months or two years instead of saving for 30 years. It seems so much easier to work longer.

Why does working longer impact retirement income that much?

When you save more, your Social Security benefits don’t go up. But when you work longer, they do. Saving more raises only one source of income: your 401(k) account, IRA or whatever plan you have. It doesn’t affect your Social Security at all: Your check doesn’t go up because you’ve saved more. But when you work longer, your Social Security goes up; and your 401(k) withdrawals also go up because you [make] more contributions for that extra work you did — there’s more compounding.

How should financial advisors present the working-longer concept to help clients increase their standard of living in retirement?

Let’s say a client plans to retire at 64. The advisor should say: “Let me lay out for you how much more you’d have if, instead of retiring at 64, you retired at 66. By working two more years, you can have 15% more to live on for the rest of your and your spouse’s life.”

How else could the FA bring up that idea?

Ask the client when they plan to claim Social Security [benefits]. Then they could say: “Because you have another source of income — a 401(k) plan — you can delay claiming Social Security till you’re 70 and [thus] receive more income in retirement.” Financial advisors are too quick to say, “I’ve got a fund that I think you should be in” [etc.]. They immediately get into investment advice.

Well, that’s important.

It can be. But other things are probably more important: when you’re going to retire and when you’re going to claim Social Security. Most people claim it when they retire, but you don’t have to.

The paper shows how investing in low-expense index funds vs. actively managed mutual funds in order to save for 30 years, as opposed to working longer, would pay off. How does that pan out?

It still doesn’t look as strong compared to working longer. It looks similar to saving 1% more. By the way, you could do both — save more for 30 years and invest in inexpensive funds. That would be equivalent to working about one year longer. But it would be the same if you didn’t save more and didn’t use [index funds] — but worked just one more year.

Your paper points out that a delayed annuity purchase results in lower annuity prices. Please elaborate.

When you buy an annuity, you’re really buying the opposite of normal life insurance, which could be called “death insurance.” Buying an annuity is building “long-life insurance.” It pays off if you live a long, long time. One of the biggest financial risks people have is that they may live longer and run out of money. The paper shows that we’re protecting someone against that: They can be fully protected and fully annuitized.

In the study, what sort of annuity do you suggest they buy?

Say you’ll have money accumulated in a 401(k) account and want to convert it into monthly income that will last for the rest of your life — and maybe your spouse’s life. That would [suggest] a joint survivor annuity. Annuities get cheaper [to buy] [the older you are]. So every year, or even every month, that you delay annuitizing your wealth, the annuity deal gets better.

For whom would such an annuity be ideal?

What we had in mind is someone who says, “I don’t want to take any risk that I’ll run out of money; therefore, I’ll annuitize.” An annuity guarantees monthly checks for the rest of your life.

What’s one way to annuitize?

You can turn your 401(k) account into an inflation-indexed life annuity. You’ll have monthly Social Security benefits and the annuity payments, both inflation-adjusted. That would provide you with “long-life insurance”; that is, if you live to be 107, you’re going to get checks till you’re 107.

In the study, what situation did you explore first?

We started with the primary earner in a family, age 36, who has been contributing 9% of their salary into a 401(k) plan and has been [paying into] Social Security. But then they realize that in retirement, they’re going to have only 52% [of the money] they [were earning] when they were working and are dissatisfied with that prospect. Of course, [the results] depend on your age when you recognize that you’re not happy with how [your retirement] is going to turn out [financially].

To whom does the concept of working longer for more money in retirement most apply?

This is really powerful for middle-income Americans. The middle of the distribution [amount earned] is $50,000. Even if someone has been a big-time saver, about 80% of their retirement income is going to come from Social Security. They basically have two sources of retirement income: Social Security and 401(k) withdrawals. The big check is from Social Security. When you save more, you’re making the smaller check bigger but not changing the big check at all.

But if you work longer and defer collecting Social Security?

Both checks get bigger. Social Security goes up generously — by about 8% a year — when you claim later. Everything goes up when you work longer, but everything does not go up when you [just] save more.

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