How Delaying Retirement Can Help You

Deferring retirement by five years can easily raise monthly retirement income by 40 percent.

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Delaying retirement has been one of the most consistent pieces of financial advice for older Americans reeling from the recession. The major financial benefits of deferring retirement are the ability to continue earning money, adding to your retirement assets, deferring drawing down those assets, and delaying the date you begin to receive Social Security benefits.

Situations differ, of course, but here's a rough look at the impact of deferring retirement for five years, from age 65 to 70. Use this finding to see how your own situation would be affected if you were to delay your own retirement.

The assumptions of such an exercise are crucial. My hypothetical 65-year-old earns $50,000 a year, which is also the figure we'll use to calculate the person's Social Security payments. The person also contributes $3,000 a year to a 401(k) and the employer matches half of that, or $1,500. The person has a nest egg of $250,000 when he or she turns 65. I am making no assumptions about how a five-year retirement delay affects housing or healthcare expenses.

Lastly, there is no inflation component built into these assumptions. I don't think this will throw off the numbers too much. Social Security, of course, already has an annual cost of living adjustment, or COLA, although there's a good chance the formula will be made less attractive in the near future. It's one of the most popular suggestions for trimming the program's long-term financial stress. Also, the investment returns used here are already adjusted for inflation.

Anthony Webb, a research economist at the Center for Retirement Security at Boston College, provided the key numbers used in this exercise. The Center has loads of solid retirement research and advice that can help people who are concerned about their retirement security.

Someone who is 65 today will collect 100 percent of her full retirement benefits when she turns 66 and reaches full retirement age. I wish Social Security would update this misleading phrase because your annual benefits actually increase—by a lot—for every year you delay benefits until your 70th birthday.

You get 100 percent of your average indexed monthly earnings (AIME) if you begin receiving benefits at full retirement, but only 93 percent of this amount if you begin taking Social Security at age 65. However, if you delay Social Security until your 70th birthday, you will collect 132 percent of your AIME. That's nearly 42 percent more every month for the rest of your life. That's an enormous gain—8 percent a year plus inflation adjustments.

In fact, it may make sense for some people to spend some of their savings if it helps them delay claiming Social Security. With interest rates so low today, who wouldn't want a guaranteed annuity whose lifetime monthly payout rises by 8 percent a year for the next five years? I've heard the arguments about the costs of those "lost" years of benefits. And for those in poor health or with family histories of shortened lives, delaying benefits may not make sense. But for others, particularly those in good physical and mental shape, the odds of living into your 90s makes a persuasive argument for collecting 40 percent more in benefits for 20 to 30 years.

Webb has done the math to show what this delay means. We're assuming that your $50,000 salary is used to set your AIME. (That's a drawback of using simple assumptions.) You will get a monthly Social Security payment of $1,659 if you begin benefits when you turn 65. If you wait until age 70, your monthly payment will be $2,346. That's $687 more each month and $8,244 more every year, for the rest of your life.

There's also a chance that your annual salary in the next five years will be higher than in some of your earlier earnings years. This would raise your earnings base and entitle you to still higher Social Security payments when you finally begin receiving them. To find out your own Social Security benefits, you can use the agency's online Retirement Estimator.

The second big benefit is that instead of spending down some of your $250,000 nest egg, it will increase by $4,500 a year plus the annual earnings of your investments. Webb says a reasonable assumption for real (as in inflation-adjusted) investment gains would be 4.6 percent a year. If you apply that to your savings and factor in the added 401(k) contributions, your nest egg at age 70 would have grown by nearly 30 percent, to $320,000 from $250,000.

Not only is this more money, but it has to last five fewer years because of your decision to keep working. How much to pull down from these funds each year is a key question. How long do you think you might live? Do you want to plan to spend down your assets to zero or leave something for heirs? If you turned your nest egg into a lifetime annuity for you and your spouse, Webb says, the monthly income it would produce would rise from $910 on $250,000 today to $1,339 a month on $320,000. That's $429 more a month, or $5,148 a year.

Together with your higher Social Security, your annual income in retirement will have increased by $13,392 every year for the rest of your life. If you want to factor in a five-year shortening of retirement and spend more of your nest egg each year, your annual income would be even more. Taxes will certainly take a hefty chunk of these higher earnings. But the gains might make the difference between 25 more years that are stressful and 20 years that are enjoyable.

Twitter: @PhilMoeller