How much longer would you have to work beyond your full retirement age to equal an additional 1% retirement savings over the thirty years prior to your retirement? You might expect to work an extra year or two – but according to a recent study published in the National Bureau of Economic Research (NBER), you would only need to work an extra three or four months.
To arrive at this conclusion, the authors came up with a baseline case – a worker who began saving for retirement at age 36, put aside a total of 9% of their earnings to a 401(k) plan, accumulated no real wage growth or investment returns over their career (in other words, their gains equaled inflation), and retired at the current Full Retirement Age (FRA) of 66. To simplify comparisons, the 401(k) plan was annuitized at retirement.
According to the study authors, there are four primary reasons that putting off retirement has a disproportionately positive effect on your pocketbook:
1. Social Security benefits increase significantly by postponing retirement. Your monthly benefits increase 0.67% for every month you delay retirement past FRA (8% per year) until you reach age seventy.With an FRA of 66 as assumed in the study, benefits could be increased by a maximum of 32% by waiting until age seventy.
The study doesn't consider another way postponing retirement could raise benefits. Social Security benefits are calculated on your 35 highest years of inflation-adjusted earnings. If you replace a zero-dollar or low-income year by working several extra months, your benefits will also increase as a result.
2. You'll keep making contributions to your 401(k) program as you continue to work. The effect is multiplied, since you are putting in new funds as well as not taking any out.
3. Your retirement plan will continue to grow while you work. This assumption is shaky when you are comparing small time horizons – if your market timing is really horrible, you could experience a significant loss by working longer – but it's consistent with the long-term earnings assumptions in the study.
4. At or near retirement age, the funds in your 401(k) will purchase a larger annuity (due to the shorter expected lifespan).
Under these assumptions, the sustainable retirement income is composed mostly of Social Security benefits (81%), with the remainder from the annuitized 401(k) plan. Looking at the tradeoffs from that perspective, it's clear why working longer has a greater impact than saving.
When you work longer, you're affecting both sources of retirement income. Both your Social Security benefits and your 401(k) values will increase. By saving more throughout the course of your career, you only affect the 401(k) plan and subsequent annuity size – affecting just 19% of your monthly income source.
Your situation may be far different from these assumptions. Your investments may have performed well above or below average, you may be working on a second career with a significantly different salary than your original job, or you may have been forced to raid your 401(k) to cover expenses prior to retirement. The point is that an average person is more likely to have a far greater effect on their retirement nest egg by working longer compared to saving more along the way.
The NBER paper reinforces the point that you should enter retirement with a solid plan and an understanding of the options available if you must change that plan. You don't have to work much longer to make a large financial impact – but that decision is up to you.
Let the free Retirement Planner by MoneyTips help you calculate when you can retire without jeopardizing your lifestyle.