I Made $250,000 on the Internet Last Night, and You Can, Too!
Last night, I asked a simple question and the internet upped my net worth a whopping $250,000. When the US Social Security (SS) office announced a zero increase in benefits for 2016, I got curious and asked the Social Security Administration how much per person the average monthly benefit is. It turns out to be $1225 per month. That’s about enough to pay a retiree’s Medicare B obligation, rent a cheap room, and qualify for food stamps. While that’s not great, it’s something.
So I took the next step and asked how much $1225/month is worth. Firstly, I multiplied by twelve months to get the yearly amount of the benefit, which comes to $14,700 per year. That actually sounds a bit better than the monthly amount. If I have other financial resources, I can buy a nicely equipped new car every other year courtesy of SS. But then, my driving needs should be declining as I traverse my senior years, and you really should want less of me on the road as I grow older. Perhaps a well-equipped adult tricycle would be a better choice.
Next, I asked the question, “How much would I need to put into a CD to get back $14,700/year in income?” I used a CD interest rate of 2.25%, but if you’re doing your own calculation, use any rate reasonable for you. A higher interest rate will decrease the amount of principal needed, a lower interest rate will increase the principal needed. Dividing $14,700 by 2.25% equals $653,333. That means that if you qualify for the average SS benefit, you would need $653,333 in a CD at 2.25% to equal the amount SS will pay you each year. Low interest rates help young people get affordable mortgage payments in their house-buying years, but low interest rates dramatically increase the amount of money one must save for a safe retirement fund.
There is a problem with the $653,333 figure. It assumes that the CD holder will live to infinity, and go on drawing the $14,700/year forever. That is not the case. Many actuarial tables advise a 65-year-old to plan on 20 years of retirement. If that is the case, then some of the principal can be withdrawn each year. This is where the internet financial calculators make things complicated, and rightly so. You don’t want to make a mistake on this one.
Since you’ll now be drawing out some of the principal in addition to the interest each year, you’ll need less interest income to make the $14,700 yearly benefit. Also, since it’s Social Security, there is usually (but not always) a yearly increase, called COLA, in the benefit. I decided to set this increase at a 2% COLA. There is also a yearly loss in purchasing power (inflation) most years, which I set at 3%, and there is the annual bite of income taxes, which I set at 15.1%. To cope with this complexity, I went to financial calculators at Bankrate.com and selected Retirement Income Calculator .
It took some trial, error and fiddling to come up with a figure that satisfied my desire to know how much the average $1225/month SS benefit is worth to someone retiring at 65 and expecting to live 20 more years. The short answer is that you would need $250,000 in an account yielding 2.25% to make the benefit. At the end of 20 years, you would have drawn the money down to zero. Thankfully, SS does not go to zero; it lasts your lifetime. If you participate in Social Security, that $250,000 is part of your nest egg, a plus on the net worth side of your personal balance sheet. You have more saved than you probably thought.
You can perform the same calculations if you have a defined benefit pension plan. If the retirement payout options you select include a monthly benefit of $1225, your nest egg is worth an additional $250,000 projected over 20 years, but again, it is most likely going to last a lifetime if you live more than 20 years.
If you wish to run your own calculations on the Bankrate.com Retirement Income Calculator, you’ll need to make some adjustments. I set current age to 64, with a retirement age of 65. I set “Annual Contributions” to 0. In the bottom half of the calculator, you’ll need to click to open up “Investment Returns, Taxes and Inflation”. I set “Rate of return before retirement” to 0% and “Rate of return during retirement” to 2%. I put “Current Tax Rate” at 0, and “Retirement tax rate” at 15.1%. I set “Inflation” at 3%. Remember that the goal is to find out how much you’d need in a 20 year, liquidating CD to equal the benefit you’ll be eligible for at age 65. The result will be a solid figure you can make part of your net worth. If you’re like most in this tough economic climate, I hope I’ve helped you feel better about where you are in the retirement savings race. May you finish in first place!
Karl Drobnic is the author of A Lesion of Dissent, a full-length novel available from Amazon for only $0.99. If you liked the Sixties, you’ll love the novel.
He is also an independent arbitrageur who posts about financial hedges on his LinkedIn profile page at LinkedIn Posts
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