This week, Gail demonstrates how smart planning now can make a difference down the line when it comes to your retirement.
I can’t count the number of times people have said, “Gail, I know I should be saving for retirement, but I have no idea how much I’ll need. I just keep throwing money into my 401(k) and IRA and hoping it’ll be enough.”
Their fall-back position if it turns out they won’t have enough saved to cover their retirement expenses? “I guess I’ll just keep working.”
Folks, that is not a plan!
You’re in Good Company
Making sure you’ve got the assets needed to generate 30-40 years worth of income after you retire is a daunting prospect. But sticking your head in the sand isn’t going to make it go away. In fact, it makes it worse.
The thing to recognize is that you’re not the only one in this situation. According to the Employee Benefit Research Institute (EBRI) most of us* have not taken the time to calculate the nest egg needed for the retirement lifestyle we want.
Maybe, just maybe, some of the reluctance is due to the fact that we’re afraid of the answer we’ll get. And, admittedly, in addition to the fact that the calculations involved can seem overwhelming, it’s not exactly an activity we look forward to tackling on a Saturday afternoon.
But what if I told you there is now a relatively simple way for you to finally get a handle on your retirement savings? A way that will help you to figure out where your finances stand today, where you need to be, and suggested ways to make up any shortfall?
Better yet, what if I said it’s free?
Retirement Clues for the Clueless
In conjunction with the 2006 “Savers Summit” being held in Washington, D.C. this month, the Department of Labor has produced a booklet called “Taking the Mystery Out of Retirement Planning.”
It lives up to its billing.
In terms that everyone should be able to understand, this 44-page brochure walks you through the decisions and even the math required to put you on the path to a financially secure retirement.
The Time Has Come
Assistant Secretary of Labor Ann Combs says the brochure’s debut is no accident. “With the youngest Baby Boomers turning 60 this year and concerns about traditional pension plans and Social Security,” retirement planning has become a big focus.
It’s also got the attention of the federal government, which faces huge and expensive problems if tomorrow’s retirees have to lean too heavily on public support systems. Politicians and retirement experts recognize that the most effective way to help people achieve the financial independence they say want in their later years is to give them the tools. Besides, Boomers are sponges for information!
Retirement Math Made Easy
“Taking the Mystery Out…” is geared for people who are in their mid-fifties and, thus, about ten years away from retiring. It covers such things as why it makes sense to consolidate your retirement accounts, how even a seemingly “low” inflation rate can wreak havoc with your income as a retiree, discusses long term care insurance, and provides a timeline of important birthdays (reduced Social Security benefits can start at age 62, but Medicare doesn’t kick in until age 65).
At the heart of the booklet are a series of short, simple (I swear!) worksheets that will walk you through estimating how much income you’ll need when you retire, and, based on what you’ve saved up to now plus what you plan to sock away over the next few years, how much of a shortfall you face.
Closing the Gap
Don’t panic. As the authors write, “Few people will have exactly the amount of money they will need in retirement. Most will get a negative figure — a gap — when they do the math.” But once you’ve got this number, at least you have a sense of the size of the gap and the steps you need to take to close it.
The booklet lists five, ranging from increasing your contributions to your company retirement plan, to working a few years longer (if only to have health insurance until you’re eligible for Medicare), to investing your money in things that are likely to provide a higher return. (Yes, this government publication actually ventures into a brief discussion of asset allocation.)
Pages 33 and 34 have a handy chart that illustrates how cutting some expenses — no matter how small — today can reduce the chances you’ll have to lower your lifestyle later. For instance, if you forego the $50 a week you and your significant other spend on a restaurant meal, that frees up $200/month you could add to your savings. Assuming a 5% compounded annual return, in ten years your nest egg would be almost $100,000 fatter.
Leave (Your) Home Alone
There’s also a timely comment about not counting on the increased value of your home to bail you out of your retirement shortfall. “People forget,” says Combs, “that getting access to that cash means you generally have to sell your home.” Moreover, you’ll still need a place to live when you’re retired, so not all of the proceeds will be available.
Furthermore, most retirees say they don’t want to move. One way to turn your home equity into and income stream is a “reverse mortgage,” something Combs predicts will become more common.
Consider Creating Your Own “Pension”
Annuities have gotten a bad rap in the media, but you’re likely to see renewed interest in them as more and more large companies (IBM, Xerox, the airlines, etc.) replace their traditional pension plans with “defined contribution” plans such as 401(k)s.
The latter make it the responsibility of the account owner instead of the employer to invest properly so that the account provides a life-long income stream. If you’re thinking, “I don’t think I’m up to the task,” you’re probably right. That’s why annuities — which shift the responsibility to an insurance company — are likely to become more popular. According to Combs, “We need to educate people about the value of an annuity. You may want some portion of your income in guaranteed payout form.”
To Spend, or Not to Spend
The goal of “Taking the Mystery Out of Retirement Planning” is not only to make sure you’ve saved enough. Combs says it should also help you determine “how to spend down your assets so you don’t outlive them or deprive yourself of a standard of living you could otherwise afford because you’re not sure how much you can take out.”
Lower Your Expectations
The one area where I disagree with the booklet is where it gives the projected returns you should expect for various investments. Because the numbers are derived from the ten-year period from 1995-2004, the average annual returns on stocks — 12.07% for the S&P 500 and 11.54% for the Russell 2000 (small caps) — are skewed by the record-breaking returns we saw during the late 1990s.
Even the bear market stocks went through after that doesn’t bring the S&P 500 in line with its longer, historic average of 10-11%. In fact, most market experts predict the equity markets will post returns in the single digits for perhaps the remainder of this decade [Click here to read an archived column of Gail's on this topic]. The 7.72% that bonds earned over this same period also seems too optimistic given where interest rates are currently.
When estimating how your stocks will grow, my recommendation is to use the factor that corresponds to the average annual return for bonds (7.72%). To estimate how much the fixed income portion of your portfolio will grow a more realistic rate would correspond to the average return on 10-year Certificates of Deposit (5.42%).
If the financial markets give us better returns than these over the next few years, you’ll end up with a bigger retirement stash than you expected....which is better than assuming recent history will repeat itself and coming up short.
Free for a Phone Call
You can order a copy of “Taking the Mystery Out of Retirement Planning” by calling the toll-free number at the Employee Benefits Security Administration: 1-866-444-3272. While the information is aimed at pre-retirees, there are plenty of good ideas for those who are younger as well as those who are already retired.
Do yourself a favor: Don’t expect to digest all of the information and work through all of the calculations in one sitting. As the booklet itself advises, a good place to start is to “simply read it to get familiar with retirement issues.” When you see the big picture, then start gathering the information you need to begin filling in the worksheets. Ideally, you’ll want to update your worksheet calculations every couple of years so you have a clearer picture of where you stand.
When it comes to planning your retirement, it’s never too late to start. As Combs says, “the most important thing is to be prepared and have realistic expectations.”
It’s official: No more excuses!
Hope this helps,
*58%. However EBRI’s data only includes people who are employed, so when you add in those who are not, the real number is likely to be higher.
If you have a question for Gail Buckner and the Your $ Matters column, send them to: firstname.lastname@example.org , along with your name and phone number.