Retirement Terms explained

Retirement Terms Explained

John Brennan, Senior Vice President, Trust & Financial Services and Rick Ciolino, Trust Investment Officer, at Cape Ann Savings Bank talk with John Maher about retirement. They look at the three-legged stool of retirement — pensions, Social Security, and personal savings. Then, they explain why personal savings has become so important in recent years. They also cover why retirees need to think about longevity risk, cash flow, and other essentials as they plan their retirement.

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Transcription Disclosure: Below is a transcript of the conversation between John Maher, John T. Brennan and Rick Ciolino. Please note, this is an unedited "word for word" rendition of the actual conversation and is not intended to be grammatically correct.

John Maher: Hi, I'm John Maher. I'm here today with John Brennan, Senior Vice President of Trust and Financial services, and Rick Ciolino, Trust Investment Officer at Cape Ann Savings Bank in Gloucester, Massachusetts. Today our topic is retirement terms explained. Welcome John and Rick.

John Brennan: Hi John.

Rick Ciolino: Hey John.

What Is Retirement?

John Maher: Yeah, so our first thing obviously is just retirement. What is retirement or what's the definition of that?

John Brennan: So retirement is when someone stops working. Okay. Retirement is when they basically leverage the financial assets that they have and they leverage them towards their life post-work. So how do you leverage accumulated savings? How do you leverage your social security? How do you leverage any potential benefits you might have received through your workplace? And how do these pieces come together to meet your needs in your post-work life?

Social Security Basics

John Maher: Okay. And then can you tell me a little bit more about Social Security and what full retirement age is and what does that mean?

John Brennan: Sure. Social Security is an entitlement that we see through the federal government, and you are eligible for Social Security at age 62. Your full retirement age, your full retirement age depends on the age of your birth, but that is when you are eligible for the hundred percent of your social security benefit. For most people now, it's probably age about 67. Okay. So that means if you get your retirement benefit from Social Security at 62, it will be reduced, it will be forever reduced. Your full retirement age is when you're getting a hundred percent of that benefit. And then you can wait until after your full retirement age and then receive your benefits at age 70, in which case your benefits will be increased. So your social security benefit will forever be increased. What is at play there is longevity risk. Okay.

Because if you start taking early, it's less money, but more time. You take it late, it's more money, but less time. Typically, when we've done analyses of people's Social Security, the lines cross, meaning the break even point is about 87, 88. Okay. So if you're extremely healthy, it really makes sense to wait and take your Social Security late. If your health is precarious, it makes sense to take it early. Typically I tell people, take it when you retire, when you stop working and when you need it. The perfect, the enemy, the good with Social Security. So that's how the full retirement age applies, and that's usually how I analyze it.

Full Retirement Age for Social Security Benefits

John Maher: So full retirement age is the point at which you get 100% of your social security benefit?

John Brennan: Yes, exactly.

John Maher: And that's generally 67 years? It can vary?

John Brennan: Yeah, it can vary. It depends on the year you were born. So you can have, say, I'll put in, I was born in 1970, for instance. The former retirement age for somebody born in '43 to 1954 is 66. And that's how you determine it. And it's literally a calculator on the social security website. So if you have any questions about it, it's a type of thing, you can literally look it up, punch in your birthdate, and then it will say the schedule for how your potential benefit would be reduced. So I am looking at if you're born between, really after 1960, your full retirement age was 67. So for a lot of us it's going to be 67.

John Maher: Okay. All right. And that's because the Social Security Administration just changed the rules at some point and said, okay, we're going to make full retirement age a little older.

John Brennan: And full retirement age also applies to how your earnings, your Social Security earnings are taxed. Social security is actually kind of complicated. It's the thing, you could have a seminar, we can do a podcast on that, but it is complicated and it has a lot of nuance to claiming and the timing of your benefits.

How Medicare Factors Into Retirement

John Maher: What is Medicare and how does that factor into your retirement?

John Brennan: So what happens is one of the things, one of the ways to just think about how we do healthcare in this country. A lot of countries have nationalized healthcare. And in our country, healthcare is really a benefit that's attached to your workplace. Well, Medicare is when healthcare becomes nationalized in the US. So at age 65, you are eligible for Medicare, meaning the federal government will take some, providing you sign on for it, responsibility for your healthcare bills.

One of the things that's important about Medicare is when does it happen? It happens at the end stage of your life when you're most apt to need more healthcare. So it is an important benefit because one of the things that matters is as you get older, healthcare becomes more expensive. So if you had to privately pay for your healthcare from ages 60 to 65, it could be prohibitively expensive. So eligibility for Medicare and that age 65, which is sort of like that classic retirement age, is something that people have to look at because it's usually much cheaper to be on Medicare with some supplemental plan rather than a private pay insurance that you'd have to get elsewhere.

How to Determine the Best Time to Retire

John Maher: How do you determine when you can retire? This maybe goes back a little bit to the Social Security factor, throwing Medicare in there as well. How do you determine when the best time is for you to retire?

John Brennan: Well, it's the question of costs really. Because the rough with retirement planning is one of the things we don't know, and the biggest fact we don't know is when you're going to die. Okay? If we knew the date and time of your death of any of us, it would be easy to plan for because then you have a fixed point on the horizon. But what we have now is that with a lot of people, one of the things that has come up with retirees lately is you can switch into retired life and all of a sudden you're getting more exercise, you're getting healthy, healthier than when you were working.

So people are having these very long retirements. When Social Security came to pass, most Americans were dying in their early seventies. Now average lifespans are in their mid to upper eighties. So for a lot of people that's a 20 year retirement. So it's a question of what you can afford. There's this concept of the three-legged stool, which I think we'll talk about in a minute, but it's a question of affordability. Do you have the assets you need for the retirement you want? Some people are happy with less, they want to stay home with their cats, that's fine. But if you want to travel to Australia and do various ambitious things in your retirement, obviously that's going to cost more money.

Three-Legged Stool of Retirement

John Maher: So yeah, go ahead and talk about the three-legged stool of retirement and what that is. What do you mean by that?

John Brennan: So the three-legged stool is an old classic, as some would say outdated concept of retirement planning. But the concept of the three-legged stool was essentially… think of a milking stool where you sit on when you milk your Bessie, your old cow, right? One leg of it would be social security, one leg of it would be accumulated savings and the third leg would be pensions. Now, one of the reasons why people say this concept is dated is that a lot more people don't have pensions the way they used to.

Pensions used to be almost part and parcel of an employer-employee relationship, but responsibility for an individual's retirement has crept from the employer to the employees. So most individuals really have to do their own savings for their retirement, and they don't have the pension leg anymore. But that concept of the three legged stool was those were the three that would underpin your retirement.

John Maher: Have companies replaced pensions with things like matching donations into a 401k and things like that, that they're maybe doing more now and less pensions?

John Brennan: Yes. But those types of plans do not replace pensions. Pensions were what's called, they were a defined benefit plan where you really could count on those assets. And that makes a big difference because the other thing too, the responsibility for that is with the employer, they have to come up with money.

What has happened as responsibility has switched back to the employee, that means the onus is on the employee to save. And while there might be some stuff around the edges, pensions were expensive and challenging to administer and a lot of companies have moved away from them unfortunately. It's a great benefit to have if you have a workplace that offers them, but there's not as many of them as there used to be.

Considerations of Retirement Planning

John Maher: Okay. So Rick, I want to talk about some of the central considerations in retirement planning and what they are. And one of those is cash flow. Can you talk a little bit about cash flow and why that's important to be thinking about as you're going into retirement?

Rick Ciolino: Well, yeah, certainly. And I think your retirement plan is really based on your ability to pay your expenses through the rest of your life. So what you're trying to do with the financial plan is you're trying to make sure that your investments are generating enough cash flow to cover your expenses. And at the same time there's enough growing so you're covering for future years.

John Maher: And then another thing to consider is longevity risk. What do we mean when we're talking about that?

Rick Ciolino: This is basically the risk, longevity risk is the risk of outliving your money. And John mentioned it earlier as to when you're planning on dying. I at one point worked with a gentleman who would do financial plans, and the first thing he said when he sat down with a client was, "So when are you going to die?" Because that is by far your biggest risk, and that's what you need to plan for.

Unfortunately, a lot of people reach retirement and it's not your grandfather's retirement, you're not done doing things. A lot of people see it as time to travel, see it as time to do things with the grandchildren, see it as time to be more active, and their expenses don't necessarily go down. So that needs to be planned for in advance, otherwise you'll run out of money before you pass away, and that is not a fun situation.

Individual Savings for Retirement

John Maher: Right, sure. And then the final essential thing to consider with retirement planning is individual savings. What do we mean by that?

John Brennan: That's exactly what it sounds like. What do you have in the bank? What do you have in your 401k? What do you have in your IRA? One of the things that we were talking about pensions, a term I wanted to just establish is defined benefit is something where it's a pre-established benefit.

But a defined contribution is exactly what it sounds like, what you have contributed, what you have saved, what is either in a qualified, meaning a retirement, something where you can... The money's deducted from your paycheck and goes into an IRA 401k, or is it just something that goes into a savings account or a brokerage account or some other reservoir of assets.

What Are Retirement Patterns?

John Maher: And finally, John, what are retirement patterns and what do they look like?

John Brennan: So a retirement pattern is really what people talk about when people retire. One of the sort of, going back to quantitative and qualitative. A qualitative aspect of retirement is a lot of retirees, it's really helpful to retire to something. So like retiring may retire to woodworking or quilting or maybe a longstanding hobby. You have music as part of your life. You could retire to spend more time singing in a choir or being in a band or some activity where you used to have the constraints of your working life around it. Now you don't and it allows you to really fully explore that hobby.

They have done studies on people who have retired to something, and it really helps their identity, it helps them in the day-to-day. When you retire from, it means you're a lot of times say, if you have a really high-paced, demanding work by being a doctor where they're, you have a lot of responsibility, you have a lot of people talking to you. My father's a doctor. When he retired, he didn't know what to do with himself because he didn't really have many hobbies. So that's the notion of retiring to something rather than from something, because that notion of retiring to something that allows you to spend your time in a way that's enjoyable can make a big difference for a healthy retirement.

Contact Cape Ann Savings Bank to Talk About Retirement Planning Today

John Maher: All right. Well that's really great advice. John and Rick, thanks again for speaking with me today.

John Brennan: Sure thing, John.

Rick Ciolino: Great to be here.

John Maher: And for more information, you can contact Cape Ann Savings Trust and Financial Services at 978-283-7079 or visit the website at capeasavings.bank.

Investments purchased through the Cape Ann Savings Trust and Financial Services department are not FDIC insured, not FDIC guaranteed, not bank guaranteed and may lose principal value.