Rule #9: Understand Benefits of Social Security

Rule #9 is to understand the benefits of Social Security (SS).  This logic is based on the assumption SS will be operational for years to come.  To make this possible, all congress needs to do is write one line of code into law.  “Remove the cap from Social Security and do nothing else.”  That will save SS for those most in need of this leg of the retirement stool.  The other legs are represented by pension income, personal savings, and possibly income from another job.

How important is Social Security to retirees?  For far too many retirees, SS is keeping them out of abject poverty.  In his book, The Four Pillars of Investing, William Bernstein explains the importance of SS by capitalizing it as follows.  Assume you and your spouse collect $25,000 per year from Social Security.  To determine the bond equivalent take $25,000/0.06 = $417,000.  You own, in essence, a $417,000 bond that is generating the income of $25,000 per year.  How did I come up with 0.06 or 6%?  That is an estimate of how much the bond will yield to produce the income.  If this seems high, then use 0.04 (4%).  Then the bond equivalent becomes $625,000.  Regardless of the interest rate you assume, there is a significant bond equivalent behind the SS payment.

As you prepare for retirement, not only calculate the possible income from SS, but also determine the bond equivalent so you can figure it into your stock/bond asset allocation plan.  There are still a few fortunate workers who retire with sufficient income from SS and a pension to live comfortably.  If this is the case, then the stock portfolio can be invested entirely in equities.  There is no need to add addition bond holdings unless one wishes to be ultra-conservative with their investment portfolio.

Rule #8: Should I Invest In a Roth IRA or Traditional IRA?

Which type of IRA account should one use for a personal retirement account?  Is it best to use the Roth IRA or traditional IRA.  With the Roth IRA, one pays the taxes before investing and the money is available tax free in retirement.  With the traditional IRA, one deducts taxes going in and pays taxes when the money is withdrawn.  You may find this surprising, but it makes no difference which you use so long as the tax code does not change.  How likely is it that the tax code will not change over a lifetime of investing?  Highly improbable.

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