A New Way to Measure Retirement Savings

Impact: Draw different conclusions depending on how old you are. If you’re far from retirement, look at the number as a starting line for making more retirement contributions, not as a forecast. “The number is more valuable the closer you are to 67 and retirement,” says Jill Gianola, a financial planner in Columbus, Ohio.

Your contributions

As a snapshot in time, the estimates consider only what you have saved up as of the last day of the benefit statement period. Future contributions and growth of your savings aren’t included. “They wanted to make sure it was simplified and standardized,” explains Craig Copeland, director of wealth benefits research for the Employee Benefit Research Institute. “But it’s not realistic, because it only tells you what you have now, if you never contribute another dollar.” If you are 50 and plan to retire at 65, you would have 15 more years to sock away more savings and for your current amount to grow.

Impact: Don’t despair if the number is low; get an estimate that takes into account expected future contributions and investment growth. Try AARP’s Retirement Calculator or any number of tools available from different financial organizations. (Do an online search for “retirement income calculator.”) Your quarterly statement might even include, along with the mandated standardized illustration, an additional estimate based on the plan administrator’s own methodology.

Inflation

The monthly payout number on your statement is assumed to stay constant over your lifetime. In other words, if the illustration for a 57-year-old is that she’ll receive $1,000 a month, that’s the expected amount she’ll receive when she’s 67 and when she’s 97. And because inflation eats away at purchasing power over time, she’ll be able to buy less with that $1,000 at age 67 than she can buy now, and probably much less at age 97.

In contrast, the benefits and estimates of benefits you receive from the Social Security Administration are adjusted for inflation. So if the SSA today tells a 57-year-old that her estimated monthly benefit will be $1,000 a month if she claims at 67, her benefit when she claims 10 years from now will be higher than $1,000 — increased by an amount intended to provide the same buying power as $1,000 in today’s dollars. And as she ages, the dollar amount of that monthly benefit will grow each year to stay abreast of inflation.

Impact: As you plan for retirement, keep in mind how valuable Social Security is as an inflation-adjusted annuity, and how you can make it even more valuable. Dan Danford, a financial planner in Lenexa, Kansas, points out that for each year up until age 70 that you delay claiming, your monthly benefit increases as much as 8 percent. Those inflation adjustments are added on top of that. You can buy inflation-adjusted annuities on the open market, but the initial payout will be far below the number you see in your lifetime income illustration.

Your gender

The Labor Department requires the monthly income calculation to be gender-neutral — one figure to cover both women and men. And if an annuity is offered within a retirement plan (other than those for government workers or affiliated with a religious institution), men and women have to be offered equal terms. But women, on average, live longer than men, so insurance companies selling annuities on the open market will offer smaller monthly payments to female applicants than they will to male applicants of the same age paying the same amount.

Impact: Be aware that a growing number of 401(k)s and 403(b)s subject to Labor Department oversight are offering gender-neutral annuities within those plans. Women who buy those annuities might get a better deal than they would with gendered pricing.

Your withdrawal plans

The calculation assumes that upon retirement, you use 100 percent of the funds to buy an annuity. In reality, few people would do that. “It’s simply not optimal,” Cope­land says. To start, most people want to keep a large portion of the funds invested for growth, usually via stocks. Second, you likely want to have a fair amount of funds available to you in case of an emergency or large cash outlay. But once you put all your retirement savings in an annuity, Gianola points out, “if you have a big expense, you can’t get an advance.”

You may not need or want to buy an annuity at all. For one, there are other ways to create a stream of income. You may not want to tie any money up with a plain-vanilla annuity like the one incorporated into the illustration, and you may be turned off by the complexity or cost of other annuities on the market, such as variable annuities and fixed index annuities.

Impact: If you like the idea of supplementing Social Security or any pension you have with additional guaranteed income, consider using only a portion of your retirement savings to buy an annuity. If you’re afraid to do that all at once, you can divide up the money you’ve budgeted for annuities and buy one annuity in one year, another in the next year, and so on.

“That way you don’t invest everything in a low-interest-rate year,” Jones says. Alternatively, you can keep all your investments in a well-diversified portfolio — a mix of stock and bond funds that can help protect against both inflation and major market downturns. “You can build a strong case that it will do a better job,” Danford says. Then you can take withdrawals based on your own criteria, be they related to taxes, risk level or other factors.