A recent article in Time featured a study by the Deloitte Center for Financial Services suggesting many American pre-retirees are throwing in the towel when it comes to saving or planning for retirement. Insufficient savings combined with the market downturn five years ago, a housing bubble, extended low interest rate environment and a Federal government seemingly bent on making it difficult to plan for the long term has created a perfect storm for many. This will be a significant problem facing Boomers over the next few decades.
But, this blog is not meant for those near retirement. This is for the Millennials entering the workforce and the Gen Y folks already there. It’s a brief wakeup call about your future financial goals and retirement plans. The short version – you’re on your own. Your retirement plan is not and cannot be that of your parents.
For most, pensions are a thing of the past. 401(k)s and similar plans are great places to start saving, but have their limitations. Social security is likely headed for substantial reform that will leave future benefits unclear. Medicare will face significant changes over the long run. Many of the sources past generations have relied on to help care for them in their later years are more vulnerable than ever before.
Sound frightening? It is. But it’s no excuse to throw in the towel. Inaction is not an option. There are simple, but not always easy ways to put meaningful plans and processes in place to enjoy today while keeping a mindful eye on tomorrow. You just have to be willing to commit to a plan and stay true to your own values.
The bottom line? Knowledge is the key. Not about which stock to pick or what your magic number is for retirement. Instead, you need a firm grasp on what you really value in life, what you want to do for your children or others close to you, and a realistic view of what resources you have and how much you’re willing to balance those resources between goals for today and those for tomorrow. You need to revisit these questions on a regular basis to make sure you’re on track and be clear in how you communicate expectations to all those impacted by your financial decisions.
I’m no pessimist. Quite the opposite as I think the future ahead is very, very bright. I also believe that we can meet our goals, provided there’s a plan in place, we stay true to that plan, protect against the unexpected to a responsible degree and really have a grasp on what’s important to us as early as humanly possible.
The most dangerous things we put off are those that are important, but not urgent. The best time to start mapping out your plan for today, tomorrow and well down the road is now. It may not feel urgent, but it may be the most important thing you do any time soon. The you that is 20, 30 and 40 years down the road is counting on you.
I met with a couple recently to deliver their financial plan, and throughout the first half of the meeting we laughed repeatedly as they seemed to have guessed my recommendations and either did or planned on doing exactly what I had written down.
They’ve been contributing 15% of their wages to their long-term retirement plan, have no debt other than a mortgage that will be paid off well before retirement, are able to pay a college tuition bill within their cash flow, and up until recently have been making it a point to contribute to Roth IRAs.
Aside from the validation from a professional, what possibly could this couple have needed with a financial advisor?
Admittedly, not as much as many clients I see, but one of the major observations was the excessive amount of importance on trying to be as efficient as possible. They put every available dollar towards the long-term retirement plan or into paying down their long-term mortgage debt, and in doing so they blew past step one in creating a solid financial foundation – having an adequate amount on hand for short-term emergencies and cash needs.
Our sample couple here came to me wondering how in the world they will be able to pay for a second tuition bill, or purchase new cars. They recently stretched their budget even further by refinancing their 30 year mortgage to a 15 year, and increased their monthly minimum payment. I also pointed out that they had no options to cover any other short-term emergencies that life may send their way other than to go into debt, or raiding a retirement fund.
In preparing their recommendations, I gave them a financial scorecard they would receive the following grades:
Long-term savings – A+
Credit and consumer debt – A+
Living within their means – A+
Having adequate liquidity – D
Overall financial health – B-
What this couple was lacking is cash on hand. Unlike most of your other financial priorities, holding cash is never the most efficient thing to do and so its importance is often overlooked. Compared with paying down a mortgage at 4%, or earning 5-10% in a long-term investment, cash earning next to nothing just isn’t an attractive idea!
But, having an emergency cash reserve is a critical piece of a financial plan. It acts like a moat around your financial castle. It protects you from the need to sabotage your long-term investment plan, or take on high interest debt in order to cover cash needs.
Having a minimum of three months of your net income in an emergency cash account is a requirement of any complete financial plan (Note: three months is a minimum. If you are self-employed, have rental properties, or other concerns about income remaining stable you may need to be at six or more). Even at the expense of not fully funding a retirement account or not paying extra on that student loan for some time. Make having emergency cash in a savings account or money market a priority now, and when the time comes to need it you won’t have to worry.
First off, if this situation applies to you then let me say… “Congratulations!”
You’re doing a great job of saving for your future, and it will be well worth it down the road.
For many, saving to your employer plan may not be enough. You may have progressed in your career enough to where you need to catch-up, or you may just be a fantastic saver and need to find other places to invest.
Below are a few ideas for those that save:
You can always contribute to an IRA. I meet with many who know they are outside of the contribution limits for a deductible IRA or Roth IRA. However, many are not aware that they can always contribute to an IRA and just not receive a deduction. The benefit of this approach is that your contributions will not be taxed when withdrawn. A strategy here may be to contribute to your IRA to convert that money to a Roth IRA later.
Set-up a taxable brokerage account. If you are saving for goals 5+ years out, consider setting up a brokerage account to invest for higher returns. If this is saving for the long-run, you may want to consider revisiting your portfolio asset allocation decisions to determine if a tax-efficient stock mutual fund may be a good investment.
Get aggressive with paying down your debt! Paying down debt will save you on interest costs more so than what you will earn on short-term savings, so make getting out of debt a priority.
Improve your emergency and short-term savings. Many that save well for the long-run still suffer like the rest of us to have cash on hand for emergencies. Make sure to have at least three months worth of expenses on hand, and consider increasing that to between six and nine months. Next, figure out what large cash needs you will have that you may have traditionally financed like the need for a car or to replace something major around the home. Start to segregate these goals and figure out a monthly amount that can be saved towards them today. Having multiple bank accounts labeled for each goal can be a great way to keep track of your savings needs and goals. SmartyPig is a bank that takes this concept of goal-based saving and allows you to see your progress toward each of any number of savings goals you may have.
If you own your own business you have other options which may include setting up other tax-efficient accounts or pension plans.
Maxing out your employer savings plan may not be the end of your options for investing for the long-run. What is best for you will depend on your personal goals, and creating a plan to meeting them.
Year-end tax considerations for businesses are not quite as up in the air as is the individual tax situation so let’s take a look at a few of them.
Will the 3.8% Net Investment Income Tax Come Into Play? With respect to that 3.8% net investment income tax coming in 2013, don’t worry, the tax doesn’t apply to income from trades or businesses conducted by a sole proprietor, partnership, or S corporation. But income, gain, or loss on working capital isn’t treated as derived from a trade or business and thus is subject to the tax. Additionally, gain or loss from a disposition of an interest in a partnership or S corporation is taken into account by the partner or shareholder as net investment income and, therefore, could cause the 3.8% tax to apply.
Considering Buying Equipment?
Current law allows you to ‘write-off’ (expense), up to $139,000 of qualifying property placed in service in the tax year. If you have already placed in service $560,000 of qualifying property this strategy will not work because for every dollar of qualifying assets that you place in service above this level you lose a dollar of ‘expensing’ benefit. If you haven’t exceeded the maximum yet, and you need the machine but do not have the cash, put the purchase on your credit card that will qualify it as having been purchased this year. You can also get substantial write-offs in 2012 from a purchase of a more than 6,000 pound vehicle that may be used in a trade or business.
Do you need to ‘shelter’ income or want to save for the future? Setting up a retirement plan is fairly easy. The costs of a plan can be very minimal or they can get very expensive if you want ‘tailored or targeted’ plan design or a, so-called defined benefit plan, which has annual actuarial costs and other expense factors. Without going into details regarding selection or design factors let’s look at some of the basicchoices for retirement plans other than an individual retirement account …
Plan Type: Simple
Establish Date: October 1st
Fund By Date: Due date return + Extension
Max. if <50 yrs. old: $11,500 + 3% or 2%
Plan Type: 401 (K)
Establish Date: December 31st
Fund By Date: Due date return + Extension
Max. if <50 yrs. old: $16,500 + 25%*
Plan Type: Defined Benefit
Establish Date: December 31st
Fund By Date: Due date return + Extension
Max. if <50 yrs. old: Actuarially Determined
Plan Type: SEP
Establish Date: Due date of return + Extension
Fund By Date: Due date of return + Extension
Max. if <50 yrs. old: $49,000 (25%* of comp)
[*Note that 25% is actually 20% because it is 25% of income ‘in respect of’ (after) the deduction so $100,000 of income minus $20,000 =’s $80,000. $20/$80 is 25%]
Need Employees? If you are thinking of hiring, consider hiring a veteran before year-end to qualify for a work opportunity credit. The credit, a dollar for dollar reduction in tax liability, can range from $2,400 to $9,600 depending on a variety of factors.
Are you a Corporation? If you are incorporated, you may want to consider a stock redemption (buy-back) which may, depending on a multitude of factors, create a long-term capital gain or a dividend which will receive the favorable 15% tax rate if done this year. Remember, unless Congress acts, capital gains rates will be going up and that 3.8% net investment income tax could apply if you make more than $250,000 married, $125,000 married filing separately and $200,000 individually.
Are you a Partnerships or a S-Corporation? When our ‘amount at risk’ in an activity is not sufficient to allow us to, possibly, take a loss from an activity, our loss will be ‘suspended’ until such time as we have sufficient amounts ‘at-risk’. If you might not be able to utilize a loss currently because you didn’t have sufficient amounts ‘at-risk’, consider adding capital, or, alternatively, if possible, add debt that you are ‘personally responsible for’ to the activity which, by definition, will increase your at-risk. That will allow you, then, to take the loss currently. Remember, though, if this is a passive activity, there are other hurdles to overcome in order to take a ‘passive loss’ currently.
Closing Thoughts These are but a few of the year end considerations. For 2013 ‘larger’ small businesses who offer health care to their employees, or even those that do not offer health care to employees currently, will need to review provisions of the Patient Protection and Affordable Care Act to determine the tax impact of the Act on their benefit plans and what course of action might be most prudent to pursue with respect to benefit plan(s) design for the business.
I hope that your 2012 tax year was a good one for you, your family and your employees, and I hope that 2013 is even better for ALL!
David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal The David Bergmann Group Marina Del Ray, CA
The timing could not have been worse. The largest generation of retirees in our nation’s history is entering their retirement years during the worst economic downturn since the Great Depression. Not only have baby boomers witnessed their retirement accounts shrink by as much as 50% during 2008, they also have to deal with anemic yields on bonds and CD’s, a decimated real estate market, and record high unemployment rate. Coupled with a significant increase in life expectancy thanks to modern medicine, retirees certainly have their work cut out for them.
Fortunately, it is never too late to start the retirement planning process. But retirees need to avoid many of the common mistakes because the acceptable margin of error is much smaller than ever. Here are 5 of the most common mistakes made by retirees, and how to fix them.
Having a Plan with Outdated Assumptions. While most people who are near retirement age have a sense of how much assets they have accumulated, how much they will need to spend in retirement, and how long their money might last, most of people fail to have those numbers checked against different market conditions. As long as the world economy continues to struggle, one needs to challenge the conventional wisdom regarding expected annual rate of return, inflation rate, GDP growth, etc, because any one of these macroeconomic factors can easily derail a carefully crafted retirement plan. Therefore, potential retirees should consider updating their plans using a variety of market returns assumptions (both good and bad), rate of inflation (both benign and extreme), and other macro factors. If your numbers come up short, it’s time to consult a professional.
Retiring Too Soon. Working even a few years beyond what you’ve planned can pay a surprisingly large bonus in retirement security. Social Security defines age 66 as the typical retirement age for most people, but about half of all Americans don’t wait that long. You can avoid the early-filing benefit reductions imposed by Social Security by working until your full retirement age (as defined by IRS). At the same time, you can keep contributing to your retirement-savings plan, building additional balances that can be put to work in the market. Every additional year of working income is a year in which you’re not supporting yourself by drawing down retirement balances. The upshot is that staying on the job a few additional years can boost your income in retirement by one-third or more.
Underestimating Health Care Cost. Even for those on Medicare, health care costs can erode spending power and economic security for most retirees. Out-of-pocket expenses for people in retirement have jumped 50 percent since 2002–and that doesn’t include the possibility of needing long-term care insurance. Health care costs pose one of the most serious risks to retirement security, so it’s important to understand how to plan for this major expense, navigate the system and manage your spending. There are many public and private resources available to help you plan. Do not wait until retirement to seek advice.
Not Diversifying Your Portfolio. It is not uncommon for a retiree who has worked at the same company for many years to accumulate a large amount of that company’s stock in his or her portfolio. Some retirees choose not to diversify because they feel that they “know their company the best”, and others simply neglect to do so. From a diversification and risk management perspective, a retiree’s investment portfolio should hold no more than 5% ~ 10% of any one particular stock, so that ones portfolio can be protected should an investment goes awry.
Putting the Kids College Before Your Retirement. As I’ve told many of my clients, “there is always college aid for your kids. But there is no retirement aid for you other than yourself”. A retiree should never jeopardize his or her own retirement by either withdrawing, or borrowing from their retirement accounts to help fund their children’s college education (or home purchase, wedding, car, etc). Instead, they should focus on building and protecting their nest egg to last them through their golden years.
It is never too late to start planning for your retirement. If you find the task of mapping out your financial life for the next thirty years overwhelming, it might be time to lean on professionals to get a second opinion.
When you think about your retirement, what images come to mind? For many of us, including me, the picture of retirement is not very clear. We know how we spend our days now. For some of us, it is easier to picture what we will stop doing than it is to picture what we will do. That concerns me.
I have run into a few people whose only retirement plan is to leave their workplace. One friend was counting down the days until he could retire. The only trouble was that he had ten years of days to count down. Someone else accepted a job he hated because it paid more than other opportunities and would allow him to retire at the age of 55. Let’s see, does it make more sense to take $50,000 from a job I hate for 30 years so I can retire early or should I do work I love at $40,000 for 40 years? I wonder if their retirement planning moves beyond what they will not be doing long enough to plan what they will be doing.
An adviser friend talked with pride about his success with one client. The client had been planning to retire in only a few years when their job was eliminated. The adviser did a great job of evaluating the situation and finding the capacity for an early retirement. I complimented the adviser and asked how the client is spending their retirement.
“Watching daytime TV,” was his sheepish response.
That is not how I want to spend my retirement.
Frankly, there is little chance that I will spend my retirement that way. I am self employed and have no trouble whatsoever finding activities to keep me busy eight hours per day (or 12 hours per day for that matter). One of the reasons I do not have a clear vision of my retirement is that I love what I do and cannot imagine giving up my daily activities. How could retirement be better than this?
My initial thought was that with all the doing, all the activity, I may not be doing enough goal setting and focusing. It reminds me of the General Accounting Office report on duplication of government services. In the government, we have too many people looking for ways to take action and not enough people looking at the big picture to see which agency should handle which task and how we should balance, on the one hand, our need to invest in infrastructure and education with our need, on the other hand, for the private sector to produce goods and services.
However, goal setting is a regular part of my work. I do spend time “working on my business” as well as “working in my business.”
Maybe my plans for retirement would become clearer and my desire to start retirement would become more intense if I thought about those goals differently. Suppose my framework for those goals was creating a personal legacy rather than an ongoing company. More broadly, suppose my framework for those goals was to incorporate my wife’s goals as well…perhaps even giving some consideration for the goals of my two sons. How would my strategies and tactics change?
For instance, my wife wants to retire at a “normal” retirement age. So far my assumption has been that we could accommodate that by reducing my hours somewhat so we can travel and do a few more activities jointly. If she wants to continue to foster lifelong learning in retirement as she has in her career, we may find some ways to integrate that into my desire to enhance financial education. Talking about our retirement goals and how we can enhance our individual and joint goals might be a good starting place.
How about your goals for retirement? How would conversations with your loved ones about their goals help you to define your retirement? Let’s find a way to retire to our retirement goals and activities rather than retiring from our jobs.
Fall is typically the season when many have the opportunity to review their workplace benefits and make changes.
Here are four items to keep in mind as you review your benefit elections and options:
Make sure you have taken major life changes into account. Have you recently married or had a child? You may need to increase your life insurance coverage. Also check that you are covered adequately for disability, especially if your family depends on your earnings. There are no magic rules of thumb to pick the needed amounts, so discuss your situation and needs with your financial advisor.
Review your health plan choices. It can seem daunting to explore the choices in the marketplace, but it is well worth the time. If you and your family enjoy good health, you might benefit over your working life from true insurance in the form of a High-Deductible Health Plan (HDHP) combined with a Health Savings Account (HSA). HSAs are like IRA accounts for health benefits where contributions grow tax-free if used for healthcare costs and are tax-deferred if withdrawn for other purposes.
Take advantage of the use-it-or-lose-it plans. Dependent care reimbursement accounts and Flexible Spending Accounts (FSAs) can provide a great tax benefit if you have eligible expenses, even though legislative changes will make them less attractive. Beginning January 1, 2011, purchases of over-the-counter medicines will require a doctor’s prescription to be eligible reimbursements from FSAs. Then in 2013 FSA plans will be capped at $2500 (and indexed for inflation starting in 2014).
Check if you’re paying for insurance you don’t need. Accident insurance typically is not worth buying. Don’t confuse it as a replacement for life or disability standard life insurance. There is often no good reason from a financial or protection perspective to purchase these policies.
Although you are probably not restricted to the fall to make changes to your company’s retirement plan, it’s a good idea to do a full plan review as well.
Start out by making sure beneficiary designations are up to date. Ensure your investments are allocated appropriately and that company stock is not an overwhelming part of your total investment assets (try for no greater than 5-10%). Make sure to take full advantage of any matching plan your employer may offer. If it is an attractive plan or your best option for retirement savings, maximize your contributions beyond the match.
I also recommend making it a habit to increase your contributions by at least 1% annually, and at any point in the year you receive a pay raise. It may require some discipline to do, but the difference that 1% annually will bring over the years will make all of the difference financially when you come to need it.
In our debt-filled society, I occasionally get the refreshing question from younger clients or friends, “My wife/husband and I are fairly cash flow positive and want to put money aside for our retirement and education goals, however, we are unsure of how or in what vehicles to save. Can you help us?” I like to call this the order of saving. There are many variables from a person’s financial picture that should enter into the equation when answering this question and obviously careful financial planning is best and recommended. But where does someone start? For this illustration let’s assume this couple is in their early 30s, one child, earns about $150,000 per year and has about $30,000-$40,000 above their primary expenses that they believe they can save. They have basic debt items of a mortgage and car payment, but no credit card debt.
First and foremost, I always recommend an emergency fund that can cover basic expenses (not income) for an extended period of time. It is critical to evaluate an emergency fund based on a particular situation and not employ the generic 3 to 6 months (if not appropriate). Many things should be taken into account when evaluating this including: your/spouse’s health, your career (stable vs. volatile), your geographical location (local economy), national economy, outlier resources (family you can fall back on), your other risk capital (investments, liquidity), and ability to trim expenses (renter vs. owner, dependants, debt, etc). Expenses by the way are not mochas from Starbucks or a Coach purse. Bottom line is you need to be able to cover the basics (food, shelter, transportation) for an extended period of time if something happens. For the couple above — let’s assume their bottom line expenses are $60,000 a year and we have looked at their particular situation and variables noted above, and determined they need 9 months of expenses (or $45,000 of fairly safe, liquid funds) covered.
Now let’s look at the order of saving. In looking at prioritizing free cash flow I always ask if there is a retirement plan at either spouse’s employer, and if so, is there a match? A match is provided by employers to incentivize their employees to save for retirement. A match is free money and a guaranteed return on an investment that you will not get anywhere else. It makes no sense to leave it on the table, so invest in your company retirement plan at a minimum up to the match. Let’s say that works out to $3,000 for each spouse in our illustration.
The next order of savings I will typically recommend is, if eligible, to an Individual Retirement Account (IRA). Specifically, for the couple above I would lean toward recommending a Roth IRA (even before finishing out the contributions to their company retirement plans — unless they have a Roth 401k option) but perhaps not for the quantitative reasons you may suspect. Here are a few of the classic quantitative arguments for either Roth IRA vs. a Deductible Traditional IRA/Company Plan: 1) Roth — tax-free compounding and expected rates will be higher in the future (your retirement years), 2) Roth — no required minimum withdrawals for owner, and can pass to heirs tax free, 3) Traditional — taxes saved now for payment later when in assumed lower bracket (less need), 4) Traditional —deferred savings lowers current bracket, lowering tax obligation, and allowing free up of funds for other things more immediately beneficial, 5) Traditional — unknown stability of Roth benefits; somehow may negate or create some kind of double taxation down the road.
The risk of number 5 aside, the qualitative reason I might suggest a Roth is because the couple above can pay the taxes now without it significantly impacting their lifestyle. I have run into a few older couples who, after the events of last decade, are in need of liquidity; and are drawing from their IRA to fund their living expenses (more than anticipated). For these clients, the problem is emotional; they don’t want to pay the taxes now because it cuts into the amount they can draw on. Long forgotten are the tax benefits received years ago when the contributions were made. But now that they are older, their health may not be quite as good, perhaps the return to work prospects are slim, grim or undesirable, the enjoyable retirement is a hands breath away; those taxes are front and center and a point of consternation. Younger people on the other hand typically have their health, their long careers (still ahead), children, and more active lives that keep them very busy and in all likelihood less likely to see and feel the emotional impact of the taxes going out because the contributions are coming from after-tax money. They also have more flexibility to adjust if significant events impact their lives. Let’s assume the couple above does not have a Roth 401(k) option available at their work, and instead makes a $5,000 contribution to an Individual Roth IRA for each. Total retirement savings is now $16,000 (+ an additional $6,000 from their companies) annually.
The next decision, in my opinion, is the most difficult and requires the most careful planning. This is where I believe those who have engaged a financial planner to facilitate their overall savings process will most benefit. Let’s say the couple above has additional savings available of $24,000. There are three options to consider for them: 1) they go back to their company plans and finish out their deferrals, 2) they save to a taxable account and invest according to their overall plan and savings goals, and 3) save for college.
Numerically, the tax benefits from continuing the contributions to the company on the surface make this an easy choice. However, I believe there are some risk factors here that need to be taken into consideration: tax diversification, liquidity and lifestyle risk. Tax diversification and liquidity risk are fairly similar and simply the idea of having some significant long term savings (beyond an emergency fund) available in a taxable or easily accessible account, so that if there are events or reason you need access to liquidity (especially before age 59.5) and it is available beyond those funds found in a company retirement plan, traditional, or even a Roth IRA. The thing to be careful about here is capital gains and income/dividend taxation and the potential for those rates to change in the future.
Lifestyle risk I would associate with two things: 1) are they saving too much and sacrificing their current lifestyle or goals because of nervousness about their future, and 2) college savings. The idea of sacrifice is one that has to be evaluated by each individual/couple and is more a definition of happiness than anything. The college savings association is easier to discuss. Most parents (I am a parent myself) want to do everything they absolutely can to provide for the best possible future for their children. I usually recommend college savings be the last item saved for. Why? Because the couple in our illustration knows at some point all the factors of aging mentioned above will come into play in their lives (retirement, health, aging, etc). What they don’t know is whether their child will even go to college, or what college they will go to if they do … Bottom line is that they can’t borrow enough for their future but their child has time, age and momentum on his side when planning/paying for the future.
Again, every situation is different and requires careful analysis, but my recommendation to the couple above with their remaining dollars would probably fall closer to: 1) contribute an additional $10,000 total to your retirement plans, 2) save an additional $8,000 to a taxable account and invest, and 3) save the balance for college for their child. If the college goal ends up being more then they save for, they can always access their taxable assets in the future and make direct payments of tuition or gifts to their child.
The key here is to evaluate each topic in the context of a personal situation when it comes to savings. Sometimes the numerical answer, while logically arguable, will not make the most sense in the context of the greater picture.
For those of us between the ages of 45 to 54, the thought of retirement should be popping up a few times these days. For those between 55 and 64, the thought may be taking on urgent tones. Many of us are reconciling to the idea that it may be a fact that we have to either postpone our retirements or live a much simpler life during retirement. Whatever the thoughts may be, what’s driving them is our preparedness to retire. In the next few columns, we examine what the component (dos and don’ts) may be for people to assess whether they are on the right path in their preparations to retire. It is somewhat easier if we consider the preparedness issues of the expectant retirees along the two age groups we tagged earlier. It is possible that we may find that the proper components of our retirement plans may already exist for us and we need to give them a good and disciplined effort to carry us through in the retirement years. It is also important to note, in this vein, that as a nation, our savings rate has gone from -0.6% in 2006 to about 5% today. While most of the increase in savings is the result of people building back an emergency nest egg, we can also take heart in the fact that the savings habit has not become obsolete or even rusty, and given the proper motivation (e.g. a sub-standard retired lifestyle), we can alter our destinies by riding on the same savings wave.
Let us begin by describing the possibilities for the younger group (ages 45-54) of employees pondering their retirement moves. There are two aspects of retirement that needs consideration. First is the contemplation of the needs associated with retirement lifestyles and the corresponding financial requirements required to sustain such lifestyles. The second is to consider our current lifestyles, living standards (consumption), our income and savings and to assess whether we are set to achieve our retirement lifestyle targets. To understand the many possibilities, we will examine some typical scenarios using data from the Employee Benefits Research Institute (EBRI). Note that all calculations are only approximations for a typical individual.
If you are about 50 years of age, have worked and saved for about 20 years (in a 401(K) or other pension plan) and earn about $100,000 a year, you should have about $200,000 in your retirement account today. Assuming that Social Security (if the organization remains viable and makes its required payouts), covers about 27% of your needed retirement expenses. You could expect a Social Security payment of about $30,000 per year at age 65. This would mean that in about 15 years, you would need to generate an additional $80,000 per year from your own savings. While you may think that you are not consuming $110,000 worth of lifestyle today, it is useful to note that this estimate is in future (and inflated) dollar terms.
This brings us back to the second question of how much you may be consuming today. If you are paying about 25% as taxes and saving another 5%, then you are currently spending about $70,000 today. At a 3% inflation rate, in 15 years this amounts to a spending of $110,000 on an income of approximately $160,000. Thus, if your 401(K) balance does not change from now till retirement and you estimate to plan for a 25 year retirement phase, then your 401(K) account will be equivalent to about an additional $8,000 per year, which itself will grow every year minimally at the inflation rate. If you assume the 401(K) plan will itself grow at about 7% a year over the next 40 years (from ages 50 to 90) then at retirement (age 65) you’ll have about $550,000 and be able to withdraw about $50,000 per year. This will leave you with a shortfall of $30,000 per year. To be able to afford retirement to its fullest, you’ll need to save an additional $15,000 per year for the next 15 years. Before you begin thinking that is a doable task and start assessing which parts of current lifestyle to pare, note that many of the assumptions above may not hold true. For example, earning a 7% average rate of return over 40 years is no simple task; Social Security may not be able to deliver on its promise. Job security is an issue. Paring current lifestyle is a bigger issue. Healthcare and leisure types of costs during retirement may increase by more than 3%, even as you consume more of these retirement lifestyle services. Thus, you may want to continue enjoying your current lifestyle and consider worrying about retirement about 10 years (or more) later or you may take stock of your current situation. If your situation is worse than the average person portrayed above, a big issue for you is to keep your physical and mental health well balanced and not depressed and medicated; plan to postpone retirement and work longer, albeit in good health.
If you are about 60 years of age, have worked for about 25- 30 years, earn $100,00 per year and have about $350,000 in your retirement accounts, your problems are more exacerbated and your fears (of postponing retirement, paring current or future lifestyle or not being able to make up shortfalls) are much more real. The strategies remain the same from earlier in that you have to make some urgent and difficult decisions. Decisions that cannot be postponed any longer.
Somnath Basu
President AgeBander
Thousand Oaks, CA
A recent article in Time featured a study by the Deloitte Center for Financial Services suggesting many American pre-retirees are throwing in the towel when it comes to saving or planning for retirement. Insufficient savings combined with the market downturn five years ago, a housing bubble, extended low interest rate environment and a Federal government seemingly bent on making it difficult to plan for the long term has created a perfect storm for many. This will be a significant problem facing Boomers over the next few decades.
Robert Schmansky, CFP®
Somnath Basu
All Things Financial Planning Blog 