Catch-Up Savings Secrets
By: Source: AARP.org Date Posted: 2003-07-10 12:59:00-04:00
In the heady 1990s, a soaring stock market and booming economy made all retirement dreams seem possible. Quitting before you turned 60. Traveling to exotic places. Lazy days spent golfing or gardening. Volunteering for a worthy cause. Every goal appeared within reach. But since 2000, some $7 trillion in market wealth has evaporated, taking many retirement dreams along with it.
How bad is the damage? Three out of four Americans between the ages of 50 and 70 lost money in the stock market during the recent downturn, according to a new AARP survey. One in four saw the value of their investments drop by 25 to 50 percent. Another 9 percent lost more than half of their savings. As a result, 20 percent of those still working have postponed retirement; 15 percent of those already retired either have returned to work or believe they'll have to soon. When they are finally ready to stop working altogether, six out of 10 believe they'll continue to feel the effect of their losses throughout their retirement.
Given this grim outlook, can you ever retire as you once hoped? The answer, surprisingly, is yes. Good times may not last forever, but neither do bear markets, recessions, or dashed dreams. Eventually your savings will grow again. Until that happens, here's what you can do right now to craft a practical plan to determine when and how to begin the next phase of your life.
GO FIGURE
You can't reasonably expect to calculate when and how to retire if you don't know how much it will cost. Yet only a third of American workers ages 40 to 59 have ever attempted this exercise. "We spend more time researching the purchase of a new refrigerator than we do gathering the basic facts we need to plan our retirement," says Deena Katz, a certified financial planner in Coral Gables, Florida, and author of Taking Charge of Your Retirement.
Don't rely on that old notion that 70 to 80 percent of your pre-retirement income will be enough. Active lifestyles and longer life spans dictate that we'll usually spend as much as—if not more than—we did while we were working, particularly in the first few years of retirement. Of course, if you don't have a yen for travel, fine dining, and other pricey pursuits, and will have paid off your mortgage and your children's college bills by the time you retire, you may thrive on less than 60 percent of what you used to make.
Start with a realistic look at how you spend your money now. On a sheet of paper or computer spreadsheet, list what you pay for your mortgage and property taxes, home maintenance, utilities, insurance, and other fixed expenses. Then examine recent checking account and credit card statements to add on what you spend for food, clothing, transportation, travel, entertainment, and other variable expenses.
Next, review these categories to consider how each expense might change once you've retired. For example, you're likely to spend much less on clothing, dry-cleaning, and commuting. If you plan to move to a smaller home or less expensive area after retiring, housing costs may drop sharply, too.
On the other hand, health care expenses are likely to rise, partly because you'll have more medical problems as you get older and partly because you're likely to be footing more of the bills out of your own pocket (only 29 percent of large employers offer health insurance to pre-Medicare-eligible retirees). Travel and entertainment bills may balloon as well, particularly at first. "From a psychological standpoint, after 40 or so years in the workforce, you'll probably feel like you're entitled to have some fun," says Stan Hinden, author of How to Retire Happy. "Remember, though, that the cost of fun is extra-often, a lot extra."
COUNT ON IT
The next step: calculate how much money you can rely on to pay those bills. With luck, you will have a variety of income sources: Social Security, a company pension, other employer-sponsored retirement accounts, and personal savings.
First, familiarize yourself with the rules for collecting Social Security benefits. Contrary to popular belief, 65 is no longer the milestone birthday that entitles you to full benefits. Beginning in 2003, recipients born in 1938 must be 65 and two months to collect full benefits, and that age requirement rises gradually over the next several years, peaking at 67 for people born in 1960. You can, however, begin collecting as early as age 62 if you're willing to accept permanently lower benefits—typically 20 to 30 percent lower, depending on when you were born. Conversely, you can get even higher benefits if you delay your start date beyond full retirement age. Depending on when you were born, you'll get a 6 to 8 percent increase for each year you postpone benefits, until age 70. The annual statement you get from the Social Security Administration clearly lays out these scenarios for you. Or you can check out Social Security's online retirement planner.
If you're among the dwindling number of employees enrolled in a traditional pension plan—only about one in five workers in private industry are these days—get the lowdown on how it works from your employee-benefits office. Specifically, you'll need to know when you're entitled to begin receiving your pension (typically you can start collecting reduced benefits at age 55 or full benefits at 65), how much you're likely to receive, and in what form the money is paid (lump sum or monthly check). Repeat this exercise with any former employers for whom you worked long enough to qualify for a pension (generally five years or more).
Finally, determine how much cash you can reasonably withdraw each year from your 401(k), IRA, and other retirement accounts without running the risk that you'll outlive your money. For a rough idea, conservatively estimate that you'll earn around 5 percent annually on your investments; if you withdraw about 5 percent of your balance every year, your money should last about 25 years. So, with a $150,000 nest egg (and accounting for inflation), you could comfortably withdraw about $7,500 a year to supplement your Social Security and pension benefits. This calculation is best done by a professional adviser who can help you make reasonable assumptions about how much you'll earn on your savings over time and how long you need your money to last.
CONSIDER THE TRADEOFFS
If you add up all your expected assets and income and the total falls short of what you think you will need in order to retire when you want, in the style you want, you've got three choices: Work longer, lower your expectations, or find other means to generate cash and fulfill your present ambitions.
Staying on the job is often the answer, but it doesn't have to mean continuing to toil 40-plus hours, five days a week. You might cut back the number of hours or days you go into the office, or shift to a different job or position with reduced responsibilities in exchange for a modest reduction in pay. "People tend to think of retirement as a great divide—you either are or you aren't," says Ralph Warner, author of Get a Life: You Don't Need a Million to Retire Well. "This concept is passé, with more and more people transitioning into this phase of their lives, rather than leaping into it."
Say you are 60 years old and decide that, instead of quitting work altogether at 62, you'll work part-time until you're 66 and qualify for full Social Security benefits. Assuming you earn about $50,000 annually, the delay will boost your Social Security benefits by more than 40 percent, from an estimated $938 to $1,330 a month. Say you've also managed to save $150,000 in your 401(k) or IRA. Postponing withdrawals from these accounts for the same four years will increase the size of your nest egg by more than $32,000, assuming you earn just 5 percent a year on your investments—even if you don't save another dime. If, however, you are motivated enough by the idea of full retirement to sock away an extra $3,500 a year (the maximum IRA contribution now allowed for taxpayers 50 or older), your savings will grow to nearly $200,000 by the time you're ready to retire. That in turn would generate about $2,500 more in income a year for the next 25 years, assuming you draw down your savings by 5 percent annually. The total increase in your ultimate retirement income if you work part-time from 62 to 66: at least $7,000 a year.
But what if your heart and mind are set on stopping work altogether? A more modest version of retirement is probably in order. That doesn't mean giving up on your anticipated lifestyle entirely. Perhaps you might travel for two months of the year instead of six. If your ideal is playing golf all day, try public instead of private courses, and on weekdays instead of weekends, when rates are cheaper. With a little ingenuity and a modicum of research, you can find countless deals and discounts on all kinds of things. Two books that can help: Unbelievably Good Deals and Great Adventures That You Absolutely Can't Get Unless You're Over 50 by Joan Rattner Heilman and Free Money For Your Retirement by Matthew Lesko. Alternatively, if you're among the four out of five Americans age 50 and older who own their homes, you might consider tapping the equity in yours to bridge the gap between income and outgo in retirement. Say you sell your house and move to a less expensive area or to a smaller home that costs less to maintain. If you net $150,000 from the sale, you could then invest it in an immediate annuity; at recent rates, this combination insurance and investment product would, for example, pay a 62-year-old woman about $900 a month for the rest of her life.
DON'T FORGET PLAN B
No matter what, unforeseen events may trip up your plans. Investments, as we've seen recently, may not perform as projected. Health problems may force you to stop working prematurely. You may be laid off and unable to find another job. A spouse may fall ill or die, leaving you not only bereft but also without an income you were counting on. "You can't possibly anticipate every setback," says Katz. "But you can certainly have a Plan B in mind for the most likely problems." Since work is such an important safety valve for retirees, Plan B must include keeping job skills up to date. "Stay informed about developments in your field, maintain your professional network, and get computer literate if you aren't already," advises financial planner Paul Westbrook, author of J.K. Lasser's New Rules for Retirement and Tax.
Plan B should also include saving as aggressively as possible for as long as you keep working. Saving more allows you to build up a bigger cushion for financial emergencies and is your best defense against a continuing stock market slump.
Consider, too, how you or your husband or wife will manage financially if one of you is no longer around. This is particularly critical for women, who typically live several years longer than men, are less likely to have their own pension, and are more likely to qualify for lower benefits when they do.
If you will be eligible for a traditional pension when you retire, one way to ensure some financial protection is to choose a form of payment that continues to provide income to your spouse after you die. Typically, when you retire, your employer will give you a choice of pension payout options. They usually include: a single-life pension, under which you get a monthly check in perpetuity; a 50 percent joint-and-survivor option, which sends you a slightly smaller (typically 10 to 15 percent) check for as long as you live and sends your spouse a check for half that sum after you die; or a 100 percent joint-and-survivor option, under which you get an even smaller (probably at least another 10 percent) check, with the same amount going to your spouse after you die. It's up to you which choice complements your situation. In the end, the best you can do is to stay flexible: Take what precautionary steps you can now and revisit those decisions as circumstances warrant. "Putting together a financial game plan for retirement is not a one-time event-something you do today and then you're done forever-but rather something you should constantly reevaluate," says Katz. "Times change and your plan has to change along with them."
Contributing editor Diane Harris writes about personal finance and work.
Additional Related Links
AARP Bulletin Retirement Calculator
25 Ways to Cut Costs (March-April 2003)
AARP.org's Financial Planning Channel
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