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With traditional pensions gone, more retirement accounts dependent on the stock market and Americans living longer than ever, planning for retirement has become dangerously close to gambling.  When the career wheel stops spinning, will your number be high enough?

If the Great Recession taught us anything it’s that no investment is guaranteed and even strategies that worked in decades past can prove ill-fated.  Case in point: Social Security.  Although one would think that retirement income backed by the US government would be a sure thing, a recent report by the Journal of Economic Perspectives suggests otherwise.  The report demonstrates that the Social Security Administration has been gravely overstating the program’s financial health, and misleading the public about its solvency. 

Social Security on Shaky Ground

The fact that Social Security isn’t enough to fund anyone’s retirement is old news.  Many Americans already believe that Social Security won’t be around in thirty years, at least not in its current form.  Younger generations are especially skeptical; a 2014 Pew Research Center survey reports that 51 percent of millennials don’t think that there will be any money left in Social Security when they retire.

Even the Social Security Administration isn’t optimistic.  According to the 2014 Social Security Trustees Annual Report, Social Security reserves are expected to run out in 2033.  After that, only about 75 percent of scheduled benefits will be paid out through 2088, the last year for projections.

What is new, however, is that even though many think Social Security’s status is shaky, it may be even worse than was previously thought.

Fudged Forecasts

A 2015 report by the Journal of Economic Perspectives compares Social Security Administration forecasts with actual outcomes and maintains that while forecasts were unbiased until 2000, they become “systematically biased afterward, and increasingly so over time.”  As a result, policymakers and other people relying on those forecasts for information were led to believe that the Social Security Trust Funds were more financially sound than they actually were.

Why does this matter?  Demographic information, such as mortality, fertility and migration rates, is used to determine how many people will be drawing Social Security benefits and for how long.  If this information is off, even by a small amount, it can skew the actual number of beneficiaries.

For example, the Journal of Economic Perspectives report states that in the years after 2000, every forecast for male and female life expectancy for the year 2010 was underestimated.  In just one instance, the Social Security 2005 Trustees Report under-forecasted male life expectancy at age 65 in the year 2010 by 1.3 years, which translates into approximately 151,000 male beneficiaries.  More beneficiaries could place more strain on Social Security reserves, especially if there aren’t enough tax-paying workers to cover the difference.

The Journal of Economic Perspectives report further notes that the data and methods the Social Security Administration uses to make its forecasts are not made publically available, preventing others from corroborating the SSA’s math and projections.

Diversification

Although the Social Security Administration stands by its forecasts and maintains that it’s impossible to predict the future (especially an economically crippling event like the Great Recession), it’s tough to know how much money you can expect to receive from Social Security.  Or, if retirement is still many years away, if you’ll receive any money at all.  There is an increasing body of data suggesting that most Americans are not saving enough for retirement, which grows scarier every month as baby boomers grow closer to retiring.

Beyond saving enough of a nest egg, the key to any good retirement plan is diversification.  A stock portfolio including a wide range of industries and/or index funds, with low annual fees, is a good place to start.  As you grow closer to retirement, bonds can provide more stability.  Rental properties are excellent for high returns and passive income, but of course require more expertise and time than index funds.  

Rents and property values also tend to rise over time.  Recently the rental market has done more than merely keep up with inflation: demand has surged over the past several years and is set to outpace home value growth of the end of the year, according to Zillow’s January 2015 Real Estate Market Report.  Zillow’s Rent Index from the same month also reveals that out of 859 cities, 72 percent showed rental prices greater than a year ago.

Rental Income for RetirementCash In by Renting Out

For the right person, rental properties make excellent income sources.  They provide a steady stream of income that’s relatively passive, meaning you don’t have to do too much to earn it.  That’s not to say that there’s no work involved, but by properly vetting your applicants, choosing your investments wisely and staying on top of repairs, taxes and the like you can look forward to receiving a regular monthly check without having to check in at the office.

Rental income is also a nice hedge against inflation.  While investments with fixed rates of returns (like bonds) can actually lose money over time to inflation, you can increase rents to match – or even exceed – the rate of inflation.  There’s also the likelihood that your rental property’s value will increase over time, further enhancing your investment.

One of the greatest advantages of rental properties is they are extremely tax efficient.  Aside from being able to deduct every conceivable rental property expense (including paper expenses like depreciation), you can even invest in rental properties as part of your 401(k).

Rentals as Part of the “25X” Strategy

Rental properties also fit in nicely with the “25 times” rule of investment.  This strategy is based on the idea that if you calculate retirement needs based upon what you currently spend – not earn – then you could retire (and live) forever on a nest egg that is at least 25 times your annual spending.  Assuming that your investments offer an annual rate of return, your nest egg will continue to grow as long as you stick to your initial spending levels. 

The great thing about including one or more rental properties in your portfolio is that their profits can easily exceed what you’ll make on other types of investments.  So even though a rental property may make up a relatively modest portion of your portfolio, its rate of return can make up a substantial chunk of the money you’ll need to cover your annual spending.  Read more about the 25X rule for retirement to see how rental properties change the math for retirement

This type of investment for retirement is not for everyone.  Keep in mind that you’ll need a cash reserve in order to cover taxes, repairs and potential vacancies.  However, every type of investment carries with it some kind of risk, and you may just decide that the risk involved with leasing out income properties is a safer bet than relying on a Social Security Administration that fudges its numbers to maintain the appearance of solvency.

Related Reading:

Rental Properties as Retirement Income: Golden Rules for the Golden Years

Is There a “Great Senior Sell-Off” Looming over the Next Decade?


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