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?