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On Personal Finance
By Jeff Brown
Inquirer Columnist
How do you know when you have enough money to retire?
A. The doctor gives you six months to live.
B. You win the Powerball.
C. Your children invite you to live in their basements.
D. You discover you want to spend your sunset years serving Big Macs.
Have things really changed this much since the booming '90s, when many Americans were expecting to retire comfortably in their 50s?
There's no question the retirement situation isn't as rosy as it was then. The stock market is in a slump, still well below the highs reached in 2000. Wages are stagnant. Inflation is picking up. Social Security and Medicare are in trouble.
Of course, we've all been through rocky times and joked about them later. And there are some sound strategies for getting through this one and improving the odds of retiring at a reasonable age and living well.
Still, it's best to take a sober look at the situation.
One of the "problems" in planning for retirement is something we're otherwise happy about - living longer. When they were born, men turning 65 this year had a life expectancy of about 70 years, while women were expected to live to 75. But men who have made it to 65 can now expect to live to 83, women to 85.
Those are averages, and many of us will live much longer. It's only prudent to plan for a retirement that could last 30 or 40 years - about as long as we worked. That's going to be expensive.
Since the Depression, Americans have been advised to base their retirement funding on a "three-legged stool" of traditional pensions, Social Security benefits, and personal investments. But the stool is not as solid as it once was.
Thirty years ago, 40 percent of American workers had traditional pensions, in which the employer provided a guaranteed benefit based on the worker's wages and years on the job.
About 20 percent had some other type of retirement plan, such as profit-sharing. Now, only 20 percent have traditional pensions, while 40 percent have "defined-contribution" plans such as 401(k)s, which don't promise a set retirement income. With these changes, the risk of investing for retirement through the workplace has shifted from employers to employees.
Traditionally, Social Security has been the rock-solid provider of retirement income, designed to provide low- and middle-income people with benefits equal to about 40 percent of their preretirement wages.
About two-thirds of people 65 and older get more than half their retirement income from Social Security, and for one-third this source is more than 90 percent of income, according to the nonprofit, nonpartisan think tank the Economic Policy Institute.
But starting in 2017, the Social Security system will pay out more than it takes in, forcing it to draw on the trust fund that has been building for decades. It's not at all clear that the system can continue providing benefits as large as it has promised.
The stool's third leg, private investments, has also become shakier. After the great bull markets of the 1980s and '90s, stocks crashed in 2000 and 2001. The Dow Jones industrial average remains 12 percent below its 2000 peak, while the Standard & Poor's 500 and Nasdaq composite are off 24 percent and 61 percent, respectively, from their peaks.
Stocks have historically produced average annual returns of 10 percent to 11 percent over long periods. But many experts expect no more than 6 percent or 7 percent over the next decade or two, which would severely undercut the benefits of compounding. Invest $10,000 today at a 10 percent annual return and you'll have about $67,000 in 20 years. Cut the return to 6 percent and you'll have just $32,000.
Rough rule of thumb
Obviously, you need more money to fund a 30-year retirement than a 10-year retirement. But how much do you really need?
Let's say that on top of Social Security and any pension income, you'll need your investments to produce $50,000 a year before taxes - a tad more than $4,000 a month. As a rough rule of thumb, a retiree can withdraw about 4 percent from his savings and investments a year to keep the fund going indefinitely.
That assumes you earn about 7 percent a year on your investments, but have to reinvest $3 of every $7 earned to offset 3 percent inflation. The withdrawals could thus get larger every year to match inflation, and the fund would last indefinitely.
At a 4 percent withdrawal rate, you'd need a $1.25 million nest egg to get $50,000 a year in today's dollars. Put it this way: For every $1,000 in annual withdrawals, you need $25,000 in savings and investments.
As an alternative, you could take as much as $60,000 out a year by dipping slightly into principal and still not run out of money before turning 95.
This is a scary prospect. Suppose you're accustomed to an annual income of $100,000, have no pension, and don't want to count on Social Security. You'd need to accumulate $2.5 million. For many people, that's just not possible.
In bits and pieces
Unfortunately, there's no silver bullet. Attacking the problem is done in bits and pieces - some budget tightening here, some smarter investment there, some changes in our view of what retirement will be like and when it will start.
Although retirement planning involves lots of uncertainties, there is one fact you can take to the bank: The more money you set aside before you retire, the better off you'll be when you're old.
Invest an extra $100 a month at a 7 percent return and you'll have an additional $52,000 after 20 years. Even if you did this for only five years before retiring at 65, you'd have an extra $20,000 when you turn 80, if you left the money alone until then.
So planning has to begin with a close look at today's budget. There's nothing fancy about this - just keep a list of how every penny is spent over the next few months. Then trim the costs that can be cut painlessly - snacks, lunches out, extra cable tiers, cell-phone plans with too many minutes. Look for savings in insurance policies and other non-pleasure-giving expenditures.
Then look at the big-ticket items and control the urge to keep up with the Joneses. Do you really need to replace your vehicles as often as you do? The most economical approach is to buy vehicles that are three or four years old and keep them 10 or 12 years, until repairs get too expensive. And, of course, smaller vehicles are cheaper to buy, run and insure. A two-car family might easily cut transportation expenses by $500 a month or more. Investing that can dramatically improve the prospects of retiring well.
These days, anyone who doesn't shop on eBay and other Internet sites is throwing money out the window. If you don't have a computer, go to a library and ask for help.
Retirement planning should start with an assessment of your likely finances. If you have paid into Social Security, you should get an annual statement several months before your birthday estimating your benefit. Also check with your union or your employer's human-resources or benefits people to find out what work-related benefits you'll have in retirement.
Most homeowners have seen their property values soar in recent years, allowing their net worth to grow even if their stocks have lost value. But this may be fool's gold because other homes you might move to have gone up in price as well. Home equity can fund retirement only if you're willing to move someplace cheaper, or to borrow against the property and pay interest.
Still, home equity is a good fallback. In your final years, you might tap it with a reverse mortgage, which is a loan against the equity built up in the property. There are no payments, and you don't need an income to qualify, as you do with a second mortgage or home-equity loan. The principal and interest owed on a reverse mortgage is paid only after you die or sell the property, and the lender cannot foreclose.
Rework your budget
Look at your annual budget and try to figure how it will change when you retire. Will your mortgage be paid off? Will commuting and other work-related expenses fall? Will medical expenses go up?
What kind of retirement would you like? Outline several plans, from expensive to cheap. Would you consider retiring a few years later or working part time? How about selling your home in a pricey suburb and buying one just as nice in a cheaper community?
Finally, look for ways to tweak your investments. One of the easiest is with the discipline provided by dollar-cost averaging, which means investing a fixed amount every month or quarter. Because a given sum buys more stock or mutual-fund shares when prices are down, and fewer when prices are high, this approach reduces your average purchase price per share, increasing your profit.
For most people, mutual funds are the best instruments for stock and bond investing. They provide inexpensive professional management and broad diversification - spreading your eggs among many baskets to reduce risk.
As a rough goal, a portfolio for a middle-age person should be about 60 percent stock funds, 30 percent bond funds, and 10 percent cash. Historically, stocks have the highest returns, but you have to be willing to tie up your money for at least five years to ride out the downturns. Younger investors can afford to put more into stocks; older investors should put less into stocks and more into bonds.
Avoid funds that charge loads, which are up-front sales commissions. There are thousands of no-load funds that are just as good or better. Also, look for funds with low annual expense ratios. Many managed stock funds charge 1.3 percent or more a year, while good index-style funds charge as little as 0.1 percent.
Managed funds charge bigger fees because they employ teams of analysts and stock pickers to seek hot investments. Indexers simply buy and hold the stocks (or bonds) in an underlying market gauge, such as the Standard & Poor's 500. Because index-fund managers do little selling, they don't trigger big annual distributions of capital gains, which can bring big tax bills.
The low expenses and taxes really matter. Someone investing $100 a month in a stock fund that averages an annual return of 7 percent would have $52,000 after 20 years. If expenses and taxes cut the rate to 5 percent, the same investment will grow to only $41,000.
Budget-cutting, scaling back retirement dreams, grubbing for a little extra investment return... . It's not fun. But you're not alone - millions of Americans worry about retirement, or should.
And who knows? Things could look a lot brighter in a year or two. The economy and financial markets are full of surprises.
Source: Philidelphia Inquirer
Senior Citizen Aticles | Personal Finance
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