Life of Riley Index

It requires gobs of money to be a person of independent means when you are young.

But age changes everything.

Once you have achieved geezerhood, your personal fortune can be a small fraction of what a younger person needs, and you’ll live just as well.

There are two reasons for this--- Social Security and what might be called the Old Mortality Trick. Let’s tackle Social Security first.

While more young people believe in flying saucers than believe in Social Security, the reality is that Social Security is the largest source of retirement income for the vast majority of Americans. According to a recent study by EBRI, the Employee Benefit Research Institute, Social Security provides an average of 38.6 percent of all income for people age 65 and older. That’s more than double the 18.6 percent that comes from pension and annuity income or the 15.6 percent that comes from assets.

Even if your income puts you in the top 20 percent of all retirees, Social Security benefits are a big deal. The same EBRI study shows that top-quintile seniors still get 17.2 percent of their income from Social Security.

Impressed? You should be. Every dollar of Social Security income eliminates the need for $20 to $25 of retirement savings. As a consequence, you need a whole lot less in savings to live the Life of Riley as a retiree than you would need as a young playboy or playgirl.

How much is a whole lot less?

Well, last week I showed that you needed $3.1 million to live the sweet life with an income that put you in the top 25 percent of all American households--- an estimated $70,000 a year. Using figures from the Aon Consulting replacement rate studies, retirees can live at the same standard with a mere $490,000 if they will risk a 5 percent withdrawal rate, or $612,500 if they use a more conservative 4 percent withdrawal rate.

That’s a whole lot less than $3.1 million.

How does that happen?

Simple. The Aon Consulting studies, which I’ve cited in other columns, adjust your current earned income for employment taxes you won’t have to pay, for saving you won’t need to do anymore, for income taxes that may be lower, and for work-related expenses that are no longer necessary. At the $70,000-a-year level, they figure you need to replace only 77 percent of your income to retire and enjoy the same standard of living. Social Security will provide 42 percent, leaving 35 percent, or $24,500, to come from places like your retirement savings.

The Old Mortality Trick is equally direct. If you want to live on an independent investment income at age 25 or 30, you’ll have to live on the actual interest and dividend income produced by your portfolio. That’s now at the dismal level of 2.25 percent. You’ll need to do that because young people are going to live a really, really long time. The young can’t take little bits from their principal every year and have any certainty that their money will last as long as they do. They have to invest as though they were as immortal as they feel or as though they were close relatives of Anne Rice’s best-known vampire, Lestat.

Once you have achieved geezerhood, however, living a really, really long time isn’t a problem. You won’t. You may live a long time, but it won’t be that long. Think of it as the upside of death. It means you can dare to take 4 to 5 percent from your investments, even if they don’t produce that much income.

So between Social Security and a higher withdrawal rate, you can knock down the entry cost of the Good Life to as little as $490,000. That’s a small fraction of the $3.1 million you’d need to live the good life as an equally idle young person.

On the web:

IRS Statistics of Income

EBRI/Income of the elderly

Aon Consulting: 2008 Replacement Rate Study

February 6, 2005: Social Security Is an Important Part of Personal Finance

June 13, 2004: Estimate Your Needed Retirement Income and Nest Egg

April 30, 2002: The Life of Riley Index, Retiree Version

October 27, 1998:  The Life of Riley Index, Retiree Version