Ingram Publishing
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Retirement Planning Made Easy
By Jonathan D. Pond, January & February 2008
Isn’t it time to get your future in order? A leading financial expert tells how, in four simple steps
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A recent study of 2,500 folks ages 45 through 64 lays out the retirement riddle for Americans. Seventy-one percent admitted they are worried about having enough money for the retirement they envision. Yes, 71 percent! With 78 million boomers in this country, that suggests 55 million may be concerned enough about the state of their savings to be keeping tabs on every penny.
But wait. The study, commissioned by Thrivent Financial for Lutherans, also found that 56 percent believe they’ll have a standard of living in retirement as good as or better than their parents had. Topping this heady blend of anxiety and optimism is one more statistic: 59 percent of folks in the study have not done any serious calculations about retirement, either on their own or with a financial professional. This is all the more remarkable considering that, according to the Federal Reserve Board, as of 2004 half of households headed by workers 55 through 64 had less than $88,000 in retirement accounts.
Top Five Retirement Obstacles
Starting to save too late (35%)
The cost of health care or insurance (32%)
Low-paying work (29%)
Credit card debt (28%)
The cost of housing (27%)
Source: survey of 2,500 preretirees by Thrivent Financial for Lutherans
I think I understand the paradoxical place these people are coming from. Most of us who don’t plan fall into two camps. There are those of us who have a vague sense we’ve saved steadily and that when retirement comes, we’ll manage. And then there are those of us who have a sense we aren’t set, and, finances being what they are, what can we do? (Thrivent’s study shed some light here, too. The most-cited obstacles to saving are shown in the box at right.)
To both camps I simply say, it pays to know how things are tracking. Retirement planning is never precise given that it forecasts needs over two or three or four decades. Yet you can get a good notion of where you stand, and it’s always better to know what you’ve got coming. According to McKinsey & Company, Americans retire earlier than they expect to 40 percent of the time, usually prompted by a job loss or an illness in the family.
Many of you will find things aren’t as bad as you feared, or that you can make small adjustments that will lead to a more secure future. To get started, just answer these four questions.
1. How much money will you spend?
Forget rules of thumb that say you need to have 70 or 85 or 100 percent of your preretirement income in retirement. Everyone’s situation is different, and many people are pleasantly surprised by how much expenses drop. If you are a homeowner and your mortgage will be all paid up, for example, you may need just 50 or 60 percent of prior income. Sure, costs such as health care go up, but a lot of other costs decline after you exit the workaday world. Income taxes decrease. You may need one fewer car. And people somehow forget that if you’re done saving for retirement itself, that’s another expense you don’t have anymore.
You need to put pencil to paper or fingers to keyboard to find out just how your own retirement budget will look. Many websites offer helpful guidance on budgeting, including www.free-financial-advice.net/create-budget.html and www.aarp.org/money/financial_planning/sessionthree/budgeting_and_record_keeping.html. Don’t forget to include infrequent big-ticket items such as a roof or a furnace. Estimate how much they will cost you in the first decade of retirement, divide by ten, and add that to your annual spending.
HOW LONG YOUR SAVINGS WILL LAST
Pick a likely rate of return on your savings (in our highlighted example, it's 6 percent), and look in the column below it for how many years you need a nest egg to last. Use the percentage to its right to figure out the amount you can afford to withdraw from savings each year, including a small annual increase for inflation.
Source: Deena Katz, Evensky and Katz, Coral Gables, Florida
2. How much money must you save?
Once you know what your spending might be, the next step is to see how big a nest egg you’ll need to see you through. Let’s say your annual spending estimate came in at $38,000 and you’re looking to retire at 65. Actuaries now say that if a married couple are healthy at 65, there’s an even chance that one of you will still be around at 92. That’s 27 years in retirement.
The chart above shows the number of years a nest egg will last. The variables are how much your invested savings earn in retirement and how much money you withdraw. For example, the column assuming a 6 percent return shows your savings can last 29 years if you start out by withdrawing 5 percent of the money the first year. (The chart assumes a 3 percent-a-year increase in your total draw to cover inflation.)
So how big a stash must you start with? Let’s go back to that $38,000 spending goal. Assume you have Social Security and lifetime pension payments that total $22,500 a year. That leaves $15,500 that would need to come from your nest egg—your IRA, 401(k), and other tax-advantaged plans, or any private savings. Let’s again assume a 6 percent return on your investments during retirement. Run your finger down the 6 percent column, checking the withdrawal rates to the right. To meet your budget for at least 27 years, you shouldn’t withdraw more than about 5 percent of your savings. For the required $15,500 to equal 5 percent, you’ll need to start retirement with 20 times that (since 5 percent x 20 = 100 percent), or, in this case, $310,000. Figuring on a shorter, later retirement? In the same return column, a 22-year retirement allows a 6 percent withdrawal, which means that $15,500 budget calls for $258,000 in savings.
Are your eyes drawn to the rightmost columns, showing returns of up to 10 percent in retirement? Well, let me say this about investment return: it varies. If your savings are well diversified and include at least half stocks, you can assume a 6 to 7 percent annual return over the long term. If, like many retirees, you invest more conservatively, with more bonds than stocks, assume a 4 to 5 percent return and lower the withdrawal rate. For example, a 4 percent return would allow a 4 percent initial withdrawal rate, so you’d need to save up 25 times your annual expenses.
RETIRING LATER = RETIRING RICHER
3. What if you wait?
If running your numbers is a gulp inducer, don’t despair. We haven’t factored in the greatest of moneymakers: you and time. Remaining in the workforce can do wonderful things for your retirement income. Here’s a case in point: Betty is 63, earns $50,000, and has $200,000 in retirement savings. Her Social Security benefits statement indicates that if she retires now, she will receive $12,000 in her first year of retirement.
But Betty, who lives well within her means, could delay retirement and add $10,000 per year to her 401(k) plan at work. That ups her nest egg and her earnings (we’ll assume 6 percent annual growth before retirement). And, of course, every year she works is one less year her savings will have to support her. Her Social Security benefits would rise as well, increasing by about 6 percent each year that she delays drawing benefits from age 62 to 66, and 8 percent a year from 66 to 70. (What the Social Security Administration calls full retirement age is rising to 66 in 2009 and will be 67 for those born after 1959.)
Share Your Thoughts
Do you have enough put away for retirement? How is your savings plan going? What stands in your way? Share your successes and struggles—and speak up for change—on the Divided We Fail website, where you can join with AARP in a movement to bring lifetime financial security and affordable health care to all Americans.
The chart below shows what a difference delaying retirement makes in the income Betty can draw on through age 92. Waiting three years, until age 66, she’ll have $30,000, 36 percent more than at age 63. If she delays retirement until age 69, her income will start at $39,000—that’s 77 percent more.
Substantial improvements even come without adding another nickel to your savings by taking the hint Social Security drops by rewarding later retirees with bigger checks. A 2004 report from the Urban Institute—subtracting income taxes and the cost of health insurance premiums—found that by retiring at 70 instead of 62, an average unmarried male would have twice the net income: $34,790 instead of $17,338. Women and married men saw similar gains.
If you’re thinking of putting off retirement, you’re in good company. Half of boomers expect to work after age 65, McKinsey reports. So evaluate your skills and experience to see how you might stay employed. Extending your career is probably the surest way to retire on your own terms.
4. What if you move?
Your home can become a pivotal source of money for retirement. It’s the single biggest asset many people have. What’s the best way to get at that equity? Despite the enticing ads hosted by Robert Wagner, reverse mortgages—loans you needn’t pay back as long as you live in the home—remain very expensive propositions. And since the amount you receive from a reverse mortgage is tied to your life expectancy, those in their 60s and 70s will likely be disappointed in the sums reverse mortgages will fetch. But the obvious way to free up home equity still serves: selling, even in a chastened real-estate market, can work for those whose homes have enjoyed tremendous appreciation.
If you can recoup $100,000 by selling a house at 65, that’s another $5,000 a year in income for the length of your retirement. (And in most circumstances the money you’re able to pull out of your home is free of federal capital gains taxes on the first $500,000 in profit for couples, and $250,000 for singles.) The savings from lowering your housing expenses can also be huge. While it’s hard to generalize, moving from the nation’s high-cost corridors in the Northeast and California can result in a 30 to 40 percent reduction in overall living expenses, and sometimes even more. The same goes for moving from, say, a four-bedroom house to a two-bedroom apartment. Utility costs and property taxes will be reduced, and upkeep should be lower, as well.
Remember, too, that you don’t need to wait until you’re retired to downsize. The best time to sell might be years before you retire. Given a decade before you tap it, that $100,000 profit will become $225,000. That’s $11,000 a year for life. As legendary investor Bernard Baruch once remarked, “I made my money by selling too soon.”
For many people these will be just the first steps in financial planning. But they’re the essential basics, and they’re worth attempting on your own even if you’ll turn to a financial planner later. After all, it’s your money, and your job to weigh an adviser’s counsel. With a budget, an income estimate, and a healthy appreciation of savings—in both senses of the phrase—you’re sure to have a good idea of when you can retire.
Jonathan D. Pond’s 12th book is Grow Your Money! 101 Easy Tips to Plan, Save, and Invest (Collins, 2007). His TV special of the same title will air on most PBS affiliates in December 2007 and March 2008.
For black-and-white reprints of this article call 866-888-3723.
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