Boost the odds of a successful retirement by following these steps
Consumer Reports Money Adviser: October 2012
Do you know how much you need to save to ensure that you won’t run out of money during your lifetime? Financial companies’ TV ads often tout “your number”—the amount you’ll need for retirement, which is generally a seven-digit sum. Others use different but equally daunting benchmarks: a yearly income-replacement rate of 70 to 85 percent of your last working year’s salary; 11 times your last year’s salary in a lump sum; or a portfolio that will fund your living expenses on a maximum annual withdrawal rate of 4 percent.
For many people, of course, those goals are unachievable. A 2012 survey by the nonprofit Employee Benefit Research Institute found that 64 percent of retirees and 70 percent of workers had less than $50,000 in savings or investments for retirement, excluding housing values and pensions. And a frightening 28 percent of retirees and 30 percent of current workers said they had less than $1,000 saved.
A nest egg that falls somewhere in between those two extremes will probably work for most people. Your actual needs will depend on an array of variables, some of which you might be able to control—such as your lifestyle, how much debt you carry, and your retirement age—and some that you can’t, like your health, your investment returns, and your life span.
Follow these guidelines to help you plan for a successful retirement:
1. Save more and spend less
In our 2011 retirement survey, 36 percent of retired subscribers to ConsumerReports.org said that not spending beyond their means was one of the best steps they had taken to prepare for retirement. Keeping your expenses in line accomplishes two things: You’ll be able to save more for retirement, and you’ll be able to live on less once you stop working. If you’re looking to ratchet up your savings rate, try to cut back on your discretionary spending. “Take a fresh look for items that are costing you more than you are getting back in pleasure or utility,” says Paul Palazzo, managing director at Altfest Personal Wealth Management in New York City. “That’s different from scrimping.”
Starting too late and saving too little topped the list of retirees’ regrets in our survey. Indeed, starting your savings when you’re young allows you to take on more risk, which can boost your returns, and the compounding of those returns will do a lot of the heavy lifting for you. But if you’re way behind in your savings and need to catch up, you might have to take a more aggressive approach—in both your savings rate and your investments.
The CR Money Lab recently examined the hypothetical case of a 50-year-old man who earns $100,000 a year and has $150,000 in his retirement account, invested in a target-date retirement fund. To accelerate the growth of his portfolio, we moved his investments to a more-aggressive target-date fund—one with a later projected retirement date and thus a higher percentage of stocks in its asset allocation—which increased his projected annual return to 5 percent from 4 percent. We also hiked his annual savings rate from 7 percent to 9 percent. Taking both those measures would increase his projected nest egg at age 67 by more than $136,000 over what he would have amassed without those changes.
2. Set up multiple types of accounts
First up is fully funding your 401(k), at least to the level you need to get your full employer match. Aim for a target of about 15 percent of your salary between your contributions and your employer’s. Then fund an IRA (Roth or traditional) and taxable accounts to hold investments you might not have access to in a 401(k), such as energy, commodities, real-estate investment trusts, or master limited partnerships.
Make your savings automatic by setting up regular direct deposits into your accounts, just as you do with your 401(k) plan. Having both taxable and tax-deferred accounts allows you to invest and draw on your money in a tax-efficient way. Keeping bonds in tax-deferred accounts is often preferable, because otherwise the income they pay out will be immediately taxed as ordinary income.
Stock dividends and long-term capital gains, on the other hand, are taxed at a preferential rate of 15 percent under current tax law, making them generally more suitable than bonds for taxable accounts. When you need to start drawing from your assets, Christine Fahlund, a senior financial planner with T. Rowe Price, generally advises that you take money from your taxable accounts first. That will allow the money in your tax-deferred IRAs and 401(k)s to continue to grow. Once you reach 70 1/2, you’re required to take withdrawals from 401(k) plans and traditional IRAs. Leave your Roth IRAs and Roth 401(k)s for last, since you don’t have to take minimum distributions from them.
3. Maximize Social Security benefits
Every year that you delay collecting Social Security between the ages of 62 and 70 adds 8 percent to your eventual monthly payout—a guaranteed return you won’t get anywhere else. If you’re close to retirement you can probably assume you’ll get the full amount promised to you, but if you’re decades away, financial planners often recommend calculating your potential benefits with a 25 percent discount to account for any possible changes in the program.
Waiting as long as possible to collect Social Security might be the best strategy if you’re single or widowed, but married couples might want to consult a financial planner to learn how they can maximize their benefits.
4. Reduce debt before you retire
Ideally you’ll be debt-free as you enter retirement. Of course, paying off high-rate credit-card debt is a no-brainer. But what about your mortgage? Pay it off and you can improve your cash flow in retirement, and perhaps gain some peace of mind. But if you can refinance with today’s rates as low as 2.75 percent for 15-year mortgages and 3.375 percent for 30-year ones, according to HSH.com data—an argument can be made for holding a mortgage into retirement.
Paying off the loan costs you liquidity; if you need cash later, you may have to borrow again (very possibly at higher rates) or sell your home. Also, keeping the mortgage can provide a hedge against inflation. If interest rates rise, your payment remains constant. Meanwhile, you’re able to invest at higher rates.
5. Consider health-care costs
If you retire before you reach age 65 and your employer doesn’t offer retiree health insurance, you’ll probably get sticker shock when you see the full cost of your health insurance, whether you take the COBRA coverage from your employer or you purchase an individual policy. One practical solution is to set up a health savings account with a high-deductible indemnity plan until you qualify for Medicare, says Bedda D’Angelo, president of Fiduciary Solutions in Durham, N.C.
Once you reach age 65, you’ll be eligible for Medicare, though you’ll have to pay premiums for Part B coverage and for a Part D drug plan. In addition, you might want to buy a private Medicare supplement (Medigap) plan that will pay for expenses not covered by Medicare.
If you become ill or disabled and need long-term care for an extended period of time, don’t expect Medicare to pay for it. You would need to have a long-term-care policy to pay for a nursing home, assisted living, or home health services. If your employer offers long-term-care insurance as an optional benefit it might be worth considering if the premiums are affordable and you qualify for coverage. Individual policies are more customizable for your needs but can be prohibitively expensive, especially if you wait until you’re near retirement to buy one. And even if your premiums are affordable now, they might not be later; the costs of long-term care have risen considerably in recent years.
6. Asset allocation still matters
If all goes well, you might be retired for 20 or 30 years. So you should continue to divide your investments among stocks for growth and inflation protection, and bonds for income, even after you retire. One common rule of thumb, popularized by Vanguard’s founder, John Bogle, is that your bond allocation should equal your age. A variation is the “rule of 110”—subtract your age from 110 and use the remainder as the percentage of stocks you should hold in your portfolio.
“I find individuals saying they’re happy with a bond, an annuity, or a dividend-paying stock generating 3 to 4 percent a year in income,” says Eric Ross, a certified financial planner in Cincinnati. “In today’s inflation environment this is suitable, but if interest rates rise, only the dividend-paying stock will be an appropriate investment.”
Most market prognosticators expect lower returns for stocks and bonds than the historically rosy returns of the 20th century. Volatility is expected to stay high. And right now stocks are paying a higher dividend than the yield you can get with Treasury bonds, making them suitable only as protection, not an investment. So income-oriented bond investors may need to invest more broadly across different bond categories, including corporate, emerging-market, and high-yield bonds.
7. Plan your transition
Retirement planning goes beyond making sure you’ll have enough money to stop working. In our 2011 survey, 14 percent of retired respondents said they regretted not developing friendships that would have lasted beyond their working years, and 9 percent said they wished they had hobbies or interests that would have kept them engaged in retirement. Among the most difficult adjustments for those who had trouble with the transition to retirement were loss of identity without a job (cited by 19 percent) and boredom (15 percent). So before you call it quits, make sure you’re ready for a very different lifestyle.
“Are you retiring from or retiring to?” asks H. Jude Boudreaux, founder of Upperline Financial Planning in New Orleans. “If it’s just to stop going into the office every day and the job that you’re burned out on, you’d better figure out what you’re going to do during retirement—and fast. People who don’t really understand that end up withering away. You’ve got to have interests to pursue and activities to keep your mind sharp and busy.”
Many advisers recommend a phased retirement, where you continue to work part-time for a few years. That transition to retirement could be smoother on your cash flow and better for you psychologically. Of course, some people stop working before they had planned to because they lose their jobs. Unemployment rates for people over 50 are increasing faster than any other age group, and older workers could face a higher risk of longer-term unemployment than younger people.
“I encourage older workers, age 55-plus, to keep learning new skills, to become a subject-matter expert if at all possible,” says Cheryl Sherrard, director of financial planning at Rinehart Wealth Management in Charlotte, N.C. “They need to do even more to keep themselves from being the logical target of staff reductions.”
Finally, to ensure that your savings are adequate, estimate your eventual retirement income—including Social Security, a pension if you have one, and the amount you’ll take from your investment accounts—and try living on that amount before you stop working. If the income stream is adequate for the lifestyle you anticipate, then you’re ready to retire, at least from a financial perspective.
Don't underestimate longevity
More than half of retirees and preretirees underestimate how long they can expect to live, according to a recent report from the Society of Actuaries. About four in 10 underestimate their life expectancy by five or more years. Life spans are increasing, and misjudging yours can throw off your estimates of how much money you’ll need to last throughout your life. The Social Security Administration estimates that among baby boomers born in 1950 and retiring at 65, men have a 20 percent likelihood of reaching age 90 and women have a 32 percent chance. So if you’re married, it’s likely that one of you might live into your 90s.
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