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Save More or Work Longer?

Which adds up to more retirement income: working 6 months longer or saving 1% more for 30 years?

Well, although the assumptions can impact the outcome, a new research paper, “The Power of Working Longer” claims that postponing retirement makes a significantly bigger difference.

What are those assumptions? Well, that retirement accumulations are used to purchase an inflation-indexed joint survivor life annuity with 100% of the monthly benefit continuing for the survivor, that workers claim Social Security upon retirement (which, as they note, matches actual behavior of most Americans and appears to be a social norm), and that individuals who continue to work continue to contribute to their employer’s defined contribution plan.

The researchers note that postponing retirement impacts the sustainable standard of living in retirement for several reasons: (1) commencing Social Security at a later age results in higher monthly benefits; (2) working longer involves additional contributions to retirement accounts; (3) delayed withdrawals from retirement accounts results in additional compounding of previous account balances; and (4) delayed annuity purchase results in lower annuity prices (that is, a given amount of wealth will convert to a larger monthly annuity payment).

‘Base’ Lines

The researchers’ “base case” was someone who started saving for retirement at age 36 and contributed a total of 9% of earnings to a 401(k) plan, but who thereafter experienced 0% real wage growth and 0% real investment returns during their career, before retiring and drawing Social Security at age 66. Their retirement income was composed primarily of Social Security benefits (81%), with 19% coming from the annuitized 401(k) balance. The researchers note that by working longer and deferring the commencement of Social Security benefits, the primary earner could increase both the Social Security monthly benefit and the annuitized monthly income. On the other hand, they note that by saving 10% rather than 9% for the entire 30 years, the affordable 401(k) annuity increases by 11.11%, but that increase applies to only 19% of retirement income. Or said another way, “deferring retirement increases all sources of retirement income, whereas saving more only increases the relatively small contribution of annuitized defined contribution balances.”

Roughly speaking, deferring retirement by one year allows for an 8% higher standard of living for a couple and the subsequent survivor, and that effect compounds for two-, three-, and four-year work extensions.

Later, Greater

The authors acknowledge that saving an additional 1% of earnings would affect the retirement standard of living much more at age 36 than at age 56, and that the impact of choosing cost-efficient assets diminishes with age since there are fewer years to enjoy the benefit of a lower-cost portfolio. In contrast, changes to planned retirement and Social Security claiming dates continue to have the same impact on retirement living standards as a person ages.

However, they also explain that 83% of the impact of delaying retirement comes from additional Social Security benefits. “The saving adjustment required to achieve a particular increase in retirement income is larger the later in the career that the adjustment takes place,” they write.

Thus, they note, “working longer may be a much more attractive option than saving more for people who are reoptimizing their retirement plans 10 or so years before retirement.”