Working a Little Longer Pays Big Dividends for Retirement

Working a Little Longer Pays Big Dividends for Retirement

Worried about not having enough income in retirement? You are not alone. Most retired Americans rely on two sources of income: Social Security and systematic withdrawals from retirement savings. But, according to a recent poll by the Employee Benefit Research Institute, nearly 40 percent of Americans are “not too confident” or “not at all confident” about the state of their finances once they stop working.

The standard recommendation is to save more, and most policy discussions about retirement security focus on making savings opportunities more broadly available and better utilized. However, while saving more increases the potential income from 401(k) assets, it does not increase Social Security benefits. And for middle-income households, Social Security is the main source of retirement income.

The good news is that saving for retirement isn’t the only way to increase retirement income. Another option is to work longer and wait to claim Social Security. 

In a recent working paper released by the National Bureau of Economic Research and the Stanford Institute for Economic Policy Research, we found striking results when comparing two ways to increase retirement living standards: For most people approaching retirement, working just a little longer can substitute for a lifetime of saving more. 

Suppose you are the primary earner in your household and started saving for retirement at age 36. Your plan is to fund your 401(k) by contributing 9 percent of your salary for 30 years until you reach age 66. At 66, you plan to retire, draw Social Security, and use your 401(k) balance to augment your income by purchasing an inflation-indexed joint and survivor annuity. 

The combination of Social Security and the annuitized 401(k) plan will replace about 52 percent of your pre-retirement earnings. That forecast may be disappointing. So, what can you do about it? One option is to save more. But that turns out to be an unsatisfactory solution.

For example, consider increasing your 401(k) contributions to 10 percent of your salary. Even if you could do this for the full 30 years your retirement income would increase by a measly 2 to 4 percent, depending on investment returns. 

Now suppose you waited until 10 years before retirement to address your retirement income problem. At that point, saving more is even less effective. In this case, saving 1 percent more of your salary for the last 10 years of your career will have the same impact on your retirement standard of living as working just five to six weeks longer. So working three to six months longer and delaying your Social Security benefits would be equivalent to — and yes, you are reading this correctly — 30 years of additional saving. 

What if you wanted to enjoy a significantly higher standard of living in retirement, such as 25 percent more money per month? Getting there by saving more is unrealistic unless you think saving an additional 10 percent of your salary for 30 years is a possibility. However, delaying retirement and Social Security by about three years will do the trick.

Working longer and delaying Social Security is so effective because it increases retirement income from both sources. Your Social Security check goes up by about 0.67 percent for each month you delay (through age 70), and the annuity income you could get from your 401(k) goes up too. For your 401(k), working longer means more contributions, and more time for the balance to grow. Moreover, retiring later means the 401(k) balance goes further because income annuities get cheaper as you get older. All told, each additional year of work delivers a 7 to 8 percent increase in your retirement standard of living. 

Of course, since the growth in Social Security benefits is the biggest contributor to higher living standards, you can also achieve a pretty big boost by delaying Social Security without working longer. This strategy could work if you have 401(k) assets or other sources of income to pay for your living expenses while you delay. But our previous research has shown this strategy to be unpopular. Claiming Social Security upon retirement appears to be the norm.

Our findings are good news if you are close to retirement and have neglected your nest egg. All is not lost. A little extra time on the job can pay huge dividends in terms of retirement income. And compared to trying to save more, working longer might just be the best way to make ends meet in retirement.

Sita Nataraj Slavov is a professor at George Mason University’s Schar School of Policy and Government and a visiting scholar at the American Enterprise Institute. John B. Shoven is the Charles R. Schwab Professor of Economics at Stanford University. Gila Bronshtein is an associate at Cornerstone Research. Jason S. Scott is an independent researcher.

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