I Might Build a Bridge

The closer I get to my retirement goal the more I focus on risk analysis.  Up to this point of my journey I have viewed risk from a macro or big event perspective.  The process for mitigating the risk was fairly straight forward, I would calculate the total financial value of the risk, plan a cash position to mitigate, and call it a day. 

However, recently I decided to take a more micro view by year to see how much of my planned income was being exposed to market risk and it changed my view on how much emergency cash I was allocating foe sequence of return risk.

Under our current plan I will retire at 59 and my wife will retire at 65 while I ride on her health insurance until we both switch to Medicare and file for Social Security at age 67.  Financially we could both retire at 59 but my wife has only recently entered back into the workforce and loves her job working with special needs children. 

As long as my wife finds it rewarding, I will not push her to retire early but will take advantage of it for the healthcare and income.  Until she hits 65, the gap in income will be backfilled from our dividend checks that keep rolling in.  Considering her earned income from age 59 to 64, 69% of our annual income will be exposed to market risk.

After my wife retires, we have a 2-year gap from age 65 to 66 with no earned income and no social security.  Our entire annual income will come from our dividends which equates to 100% of income that will be exposed to market risk.  After that we both collect at 67 and our income exposed to market risk drops down to 41%. 

I was comfortable with risk exposure from 59 to 66 however my wife was not.  We have always had an agreement that since our finances are combined, we have to be on the same page. To get us on the same page I had roll up my sleeves and come up with a different solution we would both be comfortable with.

My search landed on the concept of using a social security bridge.  In short, the bridge concept is using retirement funds for income needs until you are eligible for the maximum social security payout at age 70.  This is not a new concept and it does have drawbacks with the two largest being; longevity (lack thereof) and needing income now (i.e., little to no retirement savings).  The only added twist for us was the funds had to have no exposure to market risk and we would not reduce our existing dividend portfolios. 

Regarding longevity, if it was just myself this would be a no-go but my wife’s side of the family tend to have long lives into their early 90s and as such this concept had merit for consideration. As far as a funding source it left us with one choice, my current 401K plan (wife’s employer does not offer a 401K). 

The next piece was selecting a source that did not have exposure to market risk.  The options available are cash, CDs, government bonds, or an annuity.  Cash is a no-go for me as it would earn near 0 for 10 years.  Building a CD ladder might be viable using brokered CDs but I run the risk of lower interest rates in the last 5 years.  For bonds, an ETF or mutual fund would not work because you would be exposed to bond market risks so it would have to be laddered individual government bonds held to maturity. The simplest approach would be to use an annuity.

In the past I have expressed buying a lifetime annuity would not be a good fit for me as I already have a lifetime annuity with a built-in COLA via social security and we are willing to take on risk for bigger portfolio gains/growing dividends. 

A 10 year annuity on the other hand fits in perfectly for this scenario.  I would consider this as a viable option as from a return perspective it sits neatly between CDs and bonds with the returns being +/- 0.5% of those options after annuity fees are factored in (slightly better than a CD and slightly below individual bonds).  For this analysis we chose to use the annuity and would fund it with 10% of our portfolio coming from my 401K and the payout would be the same as claiming social security at age 62.

Implementing the annuity and moving our social security claim out to age 70 changed our exposure to market risk with every age bracket improving except the 67-69 range which increased from 41% to 72%.  The largest impact is in the 70+ range as we are looking at a potential 20 year period with just 28% of income exposed to market risk.

Advantages & Disadvantages

The long-term reduction in risk reduces my sequence of returns risk which in turn reduces my emergency cash position by 44%.  This money can now be funneled back into the stock portfolio. Disadvantage is the portfolio value at time of death (circa age 90) would be 5.1% lower.  

From a tax perspective we also get a slight improvement as our projected effective tax rate after age 70 would drop from 8.7% to 7.89% but the downside is our effective tax rate from age 67 to 69 goes up from 8.7% to 15.3%.  Stretching this out over the full 30 years we will only pay a projected $4,000 less in lifetime taxes which is a negligible amount and hardly a benefit.  However, the important piece is the increase in income and discount in taxes comes when we need income the most at the end of life.  Expenses in retirement are not a linear straight line going up.  It’s more of a rollercoaster where expenses gradually go down but start steadily rising in later years as medical costs and assistance needs become greater. 

Other Considerations

Raising the monthly bridge payout equal to what we would have received at age 67 and 70 were considered. When I ran these two scenarios my wife loved it but I just could not warm up to it. In both scenarios we would not have enough funds from my current 401K and as such we would have to pull funds from our other portfolios. Getting a larger payout on the front-end at the sacrifice of growing dividends on the back-end when we need the most income for health care or long term care just did not sit well with me.

Declining cognitive ability is something we have both considered and highly probable based on my wife’s family medical history.  Not an enjoyable conversation to have for sure but a reality we need to address. A larger social security payout diminishes some of that concern as it removes some decision-making regarding investments.

Lastly, we considered that current state of the Social Security program.  Will benefits remain the same, get cut or eliminated completely?  We both agreed for now its nothing more than political banter.  The voting block for both Boomer and Gen X is too large and any politician looking to cut or eliminate social security would be committing political suicide.

Conclusion

The beautiful part of marriage is the ability to compromise. While I initially approached this with skepticism and my wife with optimism we met part way. We both liked the use of 10% of our portfolio as a bridge as it brings her satisfaction of less risk but still leaves enough on the table for significant future returns. Those future returns should be enough to fund any long term care my wife may need and still have the ability to leave our children with a decent inheritance.

When I started this process I thought there was no need for a bridge, but after running through different scenarios I have changed my tune. This may be the most affordable route to buying longevity insurance via social security.

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