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Physicians: Is your Retirement Capital Sufficient?

| November 20, 2015
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Optimal Method for Determining Retirement Income Needs and Social Security Benefits

Retiring today can be exciting and yet also frightening for many physician couples and individuals. The prospects of having the freedom to enjoy a new carefree life is mingled with the fear of the unknown. Even physician retirees express fear of running out of money as one of their greatest concerns. Obviously, proper planning for retirement involves the proper methodology for the calculation of future retirement expenses. Another major decision for a couple is determining when to start taking Social Security benefits. Simply taking Social Security as soon as eligibility allows can be foolish when considering all factors such as longevity and integration with both spouses.

Proper retirement cash-flow projections involve more than simply taking a ratio of pre-retirement income needs. The use of a lifecycle model provides best estimates for determining expenses in retirement and likewise provides a better tool for accessing proper wealth accumulation for retirement. The standard use of replacement rates by financial planners in calculating a pre-retirees income needs in retirement is flawed. Scholz, Seshadri and Khitatrakun argue that often households will receive substantial shocks in middle and older ages due to expenses miscalculated by simply taking a ratio of early preretirement costs (615). Healthcare costs are a good example of an expense that will continue to climb at a disproportionate rate in retirement. In addition, financial planning rules of thumb like replacement rates ignore the role of children in retirement planning and do not fully comprehend single individuals compared to married couples. Scholz, Seshadri and Khitatrakun make an interesting point in the errors of using a broad replacement ratio in comparing two different married couples, one couple with children and the other couple being childless, as their preretirement consumption rates are different (615).

The lifecycle model takes into consideration the uncertainties of lifespan, income needs, and old age health shocks in determining expenses in retirement. These are important considerations for retiring physicians and their spouses to consider as often the nest egg built for retirement is considerable yet can rapidly deplete if longevity is combined with poor health. The authors of the research propose that households will best determine expense needs in retirement by discounting the consumption choices from the lifecycle model across periods of their retirement, rather than one lump timeframe. Later years in retirement have higher expenses. The article points out complicated calculations (Appendix 1 -8) based on different earnings distributions and drawing periods to show the variation and likewise utility of employing lifecycles and their relevant expenses during retirement planning. This cannot be done by simple rule of thumb estimates.

By using data provided by the Health and Retirement Study (HRS) conducted by the University of Michigan in Ann Arbor, Scholz, Seshadri and Khitatrakun point out that older Americans are, for the most part, preparing reasonably for retirement when using lifecycle modeling, while younger Americans are probably not on target for proper retirement expenses (637). Households may have variations in future variables which can include rate of return, life expectancy, future bequests intentions and future reductions in the Social Security system which the HRS data does not fully comprehend (636). The ability of households to comfortably weather large out of pocket future medical costs however is something the authors admit the lifecycle model is not able to accurately forecast or predict.

The life cycle model, as presented by Scholz, Sechadri and Khitatrakun, is defined in clearer age bands by Somnath Basu with the assumption that the typical retiree lives about 30 years in retirement, presumably age 65 to 95 (Basu 30). Basu suggests that the retirees segregate expenses into categories such as taxes, living expenses, health care and leisure and then calculate the anticipated expenses in the year of expected retirement for each expense, with an adjustment to these amounts that reflects post retirement lifestyle changes.

Then these amounts are extrapolated in Basu’s formula through 30 years of retirement using appropriate rates of inflation and then present value of the post-retirement expenses are calculated to arrive at an amount to fund the costs of the next decade. Proper risk levels can then be used with proper rates of return (31). By this method, a retiring couple can calculate retirement cash flow needs without placing extra burdens on their current savings rates as in a typical retirement income calculation in a typical financial plan that uses a form of the replacement ratio method to calculate these future expenses.

In a traditional approach, the planner also uses a reduced rate of return for the portfolio because there is the assumption that the retiree has a high degree of risk aversion. With Basu’s method of age banding, the benefit is that the retiree can employ a separation of the portfolios based on the age band, which allows the retiree to seek higher rates of return. This enables lower savings for the retiring physician, which is a more suitable and reasonable approach.

It is safe to say that there will be flaws in any retirement expense-forecasting model when considering unexpected costs such as health care or unexpected longevity. Also, assumptions about expenditure patterns at various future life cycles in retirement can be guess at best. Will I really spend more at age 70 than I do at age 85 in retirement? However, the use of a lifecycle model best approximates the retirement needs of individuals planning their financial futures as it breaks the retirement period into cycles of expenses.

Social Security Benefits and the Physician

In considering the best method for determining when a couple should start taking Social Security, several important factors should be considered. For most physician couples, the addition of the Social Security benefit does not make or break the ability to retire comfortably. I will often show a financial plan no consideration of the Social Security benefit to reflect a more conservative view of retirement income. But the decision on when to start taking the benefit is relevant when one considers that there is often tens of thousands of dollars in difference between the various elections when considering total lifetime benefits. Because of complex tax laws and Social Security rules, an individual must consider many elements before electing the best Social Security benefits start date. Couples have the added burden of considering multiple combinations of start dates and integration in order to maximize total Social Security benefits.

The best method for determining the start date for drawing Social Security benefits is an approach that, among other things, considers the alternate use of a retiree’s money. Thomas M. Dalton points out in “Retirement at 62: Is Receiving Social Security Early Worth It?” that using a rate of return such as 5% and calculating all possible combinations that a couple could use will yield the best answer (Dalton 3). Current retirees have the flexibility of deciding if they would like to collect the benefit at age 62, at full retirement age of 66, or a delayed age of 70, which would be the largest amount possible for a monthly payment. Often a physician can retire earlier at age 62 or 66 without detrimentally affecting the total financial plan since the Social Security benefit is a smaller part of the total incoming cash flows. But it doesn’t make sense with the taxation penalty in place for a physician to draw Social Security income at age 62 or even age 65 if he/she is still in practice. In a typical couple in which the physician is a male (becoming less common however) the mortality tables show that the wife will outlive her husband by many years. Likewise, the wife’s survivor benefit will usually be reduced (assuming the physician spouse was the higher income earner) because her husband’s choice to take Social Security benefits at age 62 or 66 and not wait until 70. It is not uncommon today to see physicians that enjoy or choose to work into their late 60’s or later. Such cases really benefit the cashflows in retirement for obvious reasons, but also because the election to take Social Security at age 70 becomes an easy choice. The spouse also receives the maximum survivor benefit in this example. Of course what is “typical” may not apply to your situation and it is important that you work with a financial planner that understands the calculation methods. In my practice we will calculate all 18 variations of taking social security to determine which method gives the largest lifetime benefit.

Life expectancy is an important variable in this analysis as well. Dalton points out that the rate of return assumption is the most critical, as a lower number such a 2% shows that delayed retirement age options are more advantageous than early retirement at 62 (4). Couples that are relatively healthy, and have positive health habits reflect a life expectancy that could easily exceed the mortality risk average assumption. Nevertheless, planning should also consider that a long life might not be case for either.

Social Security benefits can be calculated using the quick calculator on their website ( in lieu of your annual Social Security benefit statement. The calculations will show a current dollar approach or an inflated dollars approach. The 2011 Trustees Report utilized by the Social Security folks to determine some of the inflated dollars calculations show that total inflation will be 2.8% or less in the next 20 years or so and does not consider health cost inflation, a major future expense, which has been averaging 6% per year. Also, the Trustees Report projects future income growth of around 4% a year, which is less than most physician’s wage growth. Considering these factors, when using benefit estimates in a financial plan I prefer to use the base numbers in today’s dollars and adjust inflation and wage inflation to a level more appropriate for physicians inside the financial plan.

The portfolio can be structured in various ways to allow for increased liquidity when the first spouse dies. The financial plan would include the assumption that an increase drawdown of retirement capital will compensate for the loss of Social Security income when the first spouse dies. Other techniques used in the portfolio could include the use of  annuities. A joint and survivor annuity will provide income so that at the death of one, the surviving spouse will receive a percentage of the original amount that could compensate for the shortfall.

Dalton also points out that retirees who intend to begin drawing early must also consider the earnings rate of their savings and whether it is cost-effective in the long run to use early benefits in lieu of draining their savings. Permanently lower benefits may not be worth an extra three or four years of benefits that are used to protect retirement savings, depending on the rate of return of those savings (5).

In conclusion, retiring physicians will have the most accurate retirement costs estimates and maximize their Social Security retirement benefits by using the techniques of life cycle models and realistic Social Security calculations that consider the alternate use of a retiree’s money.

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