Tarhill Photos Inc./Corbis
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Running on Empty
By Karen Hube, November-December 2004
She has nothing saved for her retirement. Can she make a comeback in record time?
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Kerri Volpe, a 55-year-old paralegal in Sugarland, Texas, would like to
retire in 10 or 12 years, but there's one hitch: she doesn't have a
dime in savings. Until lately, she's used any extra money to pay down her
overdue credit union loans. She finally cashed out the $20,000 she had accrued
in her 401(k) to settle the loans. Now, debt-free except for a $6,000 car loan
(she rents her apartment, so there's no mortgage), she wants to rebuild her
savings.
The Problem
With a $43,500 salary ($2,600 a month, after taxes), Kerri claims she can
sock away only $350 a month. Will that be enough for her to retire? How should
she invest it?
The Solution
Does your heart go out to Kerri? Mine did too until I learned that she spent
her money on vacations. Say what? She sunk her retirement fund on trips? I hope
they were fun, because she's not going to have much of a travel budget in
retirement…if she can retire at all.
Her first move—to put off saving for retirement for one more
year—doesn't sound logical, but it will be critical to her long-term
success, says Lisa Osofsky, a certified financial planner and accountant in
Edison, New Jersey. During this first year, Kerri should pay off her car loan
(at 9.8 percent she's paying more on the loan than she'd earn on
retirement savings) and then build up some cash in a money market account
(rates are listed at bankrate.com). That slush fund
can then be set aside for emergencies, like a car repair.
Now for the savings task. Kerri has two chief options. First, she could put
pretax money in her 401(k) and let it grow tax-deferred, meaning she would not
owe taxes on the contributions and earnings until withdrawal. (While many
employers match a portion of an employee's 401(k) contribution, Kerri's
doesn't.) Or she could put money in a Roth IRA—the most generous of
IRAs—since she earns less than the $95,000 income limit for singles. She
could invest only after-tax cash in a Roth, but it would grow tax-free
(she'd pay no taxes on her withdrawals, ever). Which strategy is best?
"Use the 401(k)," Osofsky says. The reason: Kerri's tax rate
will most likely go down in retirement, so she's better off taking a tax
break on her savings now rather than later. Of course, the 401(k) would be the
no-brainer choice if her employer matched funds.
The bad news: even if Kerri begins saving right away, she won't be able
to retire in 12 years if she saves only $350 a month. Assuming a 5 percent
annual return from a conservative portfolio, she'll have approximately
$70,000 by age 67. That nut would generate about $450 a month in income for
about 20 years. Add $1,300 in Social Security and she'll get $1,750 a
month—far short of her current $2,600. And we're ignoring inflation.
Most people need less cash in retirement, but $1,750 is too little.
Kerri has hard decisions to make: she can keep her job into her 70s, work
part-time in retirement, find a higher-paying job now, or scrimp to save
another $250 a month (for $600 total, which could later yield an in-come of
about $750 a month). In fact, if Kerri forgoes her exotic vacations, it
shouldn't be too difficult to sock away that extra $250 a month. None of
these choices is a day in Spain, but any will help Kerri enjoy an occasional
(inexpensive) trip when she retires.
Karen Hube, a financial reporter in Westport, Connecticut, tries her best
to vacation wisely.
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