Getting Your Financial Ducks In A Row

Photo credit: jb

The question comes up often: I’m ready to retire at age 55, and I can begin collecting my pension right away. Should I? The amount of the pension increases to almost double if I wait to start collecting at age 62, and two-and-a-half times if I wait until age 65. What’s the best way to do this?

Obviously, there are a lot of factors that will go into the answer to such a question, so right off, it’s hard to say for sure, but here are the basics of making this decision:

These types of pensions are based on the employer’s assumption about your life expectancy. If you live to exactly the expected age, the cost to the employer will be roughly the same no matter which option you choose. You just need to do the math – bigger payments later are made for (expected) fewer years.

It goes without saying that if you were sure you’d die at age 60, you would be much better off starting your pension payout as early as possible. On the other hand, if you live longer than expected, starting your payout as late as possible will likely make up for the late start. But at what projected life span does this make sense?

An Example

Let’s start with an example: Say at age 55 you could begin a pension paying $1,229 per month, or at age 62, $1,990 per month, or you could begin receiving $2,263 per month if you wait to age 65 to begin collecting. For the purpose of simplicity, the example will not factor in taxes or any cost-of-living adjustments.

At age 70, your first option is still ahead of the other two. So, if you were to die before age 71, the first option, collecting at age 55, works the best, because you would have collected a total of $221,220 by that point, versus $214,920 for the age 62 option and only $162,936 with the age 65 option.

However (and isn’t there always a however in life?) – if you lived beyond that age, the other options begin to take the lead. If you lived to at least 71 but not to age 85, the age 62 option would work out the best. Anything from age 85 on up, you’re best off to wait until age 65 to get started.

What about spouse benefits?

The above example considered only a single life – what about if you have a spouse who may be dependent on your pension in retirement? In those cases, you have the option of choosing a “joint & survivor” pension option. These are often presented in terms of the original pension amount and an amount to be paid to your surviving spouse. The amounts here are based on your age as well as your spouse’s age, since the actuarial calculations have to account for two lives receiving the money instead of just one.

As we’ve discussed in other articles, for a couple who are both age 65, there is a 72% chance that one of them will live to at least age 85, and a 45% chance that one will live to age 90. These factors cause a further reduction in the pension amounts.

So here is a sample table illustrating the benefit amounts for some example options using Joint & Survivor (J&S) pension amounts, as well as a 10-year certain annuity:

As you can see, the more pension that is available to the surviving spouse, the lower the overall pension payment. This is due to the fact mentioned earlier that when considering the lives of a couple the actuarial chance of one spouse living longer is increased.

The various benefit level differentials are offered in order to allow the pension recipient to provide a benefit for his or her surviving spouse, depending upon the perceived future need for benefits. The single life option provides no further benefits after the death of the pension recipient, while the 100% J&S option continues to provide the same benefit to the surviving spouse after the death of the pension recipient. The other percentages provide a benefit to the surviving spouse, but in a limited amount.

The 10-year Certain option provides a level benefit for the greater of 10 years or the life of the pension recipient. So if the pension recipient died the day after he or she started the pension, it would be paid to his surviving beneficiary or his estate for 10 years. If the recipient lived longer than 10 years after starting the pension, it will be paid to him or her until death but no surviving spouse benefits would be paid.

The title of this article is “When” to start your pension payout, so we won’t reflect on the reasons why you might choose one type of benefit over another, we’ll just run some numbers to see what timeline provides the best benefit amounts for the various payout options.

We covered the crossover points for the Single Life option above. If we look at the 100% J&S option next, we see that the outcome is very similar to the Single Life option, but delayed a bit. If the pension recipient chooses to start his or her pension at age 55, this will provide the most benefits if either member of the couple lives to age 71. This is because the benefit paid out is exactly the same before and after the death of the recipient. After age 71, the age 62 option pays the greatest amount of benefits up to the point where either member of the couple lives to at least age 89. This is a bit later than the Single Life option – and a statistically significant period of time. From that point forward the age 65 starting point pays the best.

So, according to averages, the age 62 option is an attractive choice for this payout level, since the chance of one member of the couple living beyond age 90 is (as we noted above) approximately 45%. But still, the age 65 option will provide the most benefits from age 90 onward, so it still may be the best option for your situation.

Looking at the other J&S options – at this point we need to start thinking about when the first (recipient) spouse will die, because after his or her death the benefit amounts are reduced, often dramatically. In all cases if the recipient spouse lives beyond age 90, waiting to age 65 to start is superior. But if the recipient dies earlier, the results start to favor other options.

If the recipient spouse dies at age 73 for example, the age 62 option provides the greatest benefit for all 3 of the J&S options (other than the 100% option). Any age between 75 to 85 produces (essentially) the same outcome – the crossover point is around age 100 for a death age of 85 at the 75% survivor benefit level. Any earlier death (before age 73) results in the age 55 start age being the best choice.

And The Point of This Is…?

The point of all this, well actually there are two points: First – the answer to the question of when to take the pension depends on what you’ll do with it, and whether or not you need those funds right away. Couple those factors with how long you’ll live, as well as how long your spouse will live (if you have one). If you’ll need a larger amount to live on, such as if you don’t have any other retirement savings, the longer you can wait before starting your pension payouts the better, especially if you’re in good health and expect to live beyond age 80.

The second point is that, even if you have a pension available to you, it is definitely in your best interest to develop a savings strategy in addition to the pension. And this is doubly important if your pension is fixed (no cost-of-living adjustments) as in our example.

The best way to answer this question is to gather all of these factors, along with considerations regarding investment risk tolerance, tax implications, family longevity and your own health, as well as your lifestyle costs, healthcare costs, and propensity to continue working after your official “retirement” – at whatever age that might be – and then run the calculations.