Seventy-five years ago, retirement planning was generally pretty straightforward—you died. There was no “retirement” as we have come to know it as life spans were much shorter than today.
Then, in September 1974, with passage of the Employee Retirement Income Security Act (ERISA), people started actually investing with retirement in mind. Regulations issued and clarified in the early ’80s established defined-contribution plans as the primary retirement vehicles for generally larger employers, instead of the former defined-benefit (pension) plans.
By the way, corporate retirement plans are named after the section of the Internal Revenue Code in which they appear. The best known is the 401(k). It’s used by private-sector employers. Similar salary-deferral retirement plans are authorized for public-sector employees (known as 457 plans) and nonprofit-sector employees (known as 403(b) plans). Benefits and plan restrictions are generally the same for all three types.
Whichever you use, or if you do none of them and rely on other methods to set aside some assets for “later,” it’s good to have some guidelines to help you build that pile up how you want it. Reviewing the following steps will take in less than 10 minutes and can either help give you some insight into what blanks you need to start filling in or confirm how stalwart your strategy is now.
1. Figure out how much income you’ll need over your retired life.
What sort of income will you need each year in retirement? What will be comfortable—for you? What will mean real hardship?
It’s my experience that, in definite contrast to the usual received wisdom of the financial media, retirement income needs don’t drop much, if at all. The spending may go into different categories but it still gets spent. As an example, check out cruise ships with their large numbers of folks using walkers and/or breathing apparatus aboard. They’re definitely still spending.
In retirement, you don’t have to set aside any more money for that purpose. If you expect to pay off your mortgage by then, you’ll no longer have to set aside money for that. Once you’ve eliminated those and similar costs, the best way to calculate the disposable income you’ll need during retirement is simply to look at your disposable income today.
You can always make adjustments as you go. You may find you’re comfortable with less or you may want more. But, when you are dealing with the unknown, it helps to start with something familiar which, in this case, is your current disposable income.
2. Figure out much you will get from outside sources.
This means how much you’ll get from Social Security, as well as how much you’ll take in from any pension plan. If you have rental or other passive income, how much of that will continue and for how long?
Social Security is really an inflation-protected annuity that will last your lifetime and where the insurer, Uncle Sam, won’t run out of cash … really. In the case of a pension, it’s also important to note whether it’s set for payout over your life alone or that of your spouse, as well. Your spouse won’t want any unexpected holes in that cash flow when you sign up for harp lessons.
To determine what your benefits will be, you can go online to www.socialsecurity.gov. It will give you your benefit at age 62, at your personal full retirement age, and at age 70, to help you determine when to begin your payout. For reference, as of 2014, the average retired single worker got about $15,120 a year; the average couple around $24,300.
3. Figure out how much income you’ll need from your investments.
Now that the first two are done, it’s pretty easy to work out how much you’re going to need from your own investments … just subtract No. 1 from No. 2.
This means that a married couple that is now living on $60,000 a year in disposable income, with no pension and potential Social Security benefits of $23,000 a year, is going to need another $37,000 a year from their own resources to maintain their lifestyle.
4. Understand how long your investments will have to last.
In other words, how long you’re likely to live as a retired person. I know of no one who wants to have their money expire before they do. In other words, to save enough for your retirement, you’re going to have to set aside enough money to provide you with a suitable income for several decades. Think 25 years past 65—more likely 30, or more. Here’s why.
According to the Census Bureau folk, the average life expectancy in the U.S. today is about 75 for a man and 80 for a woman. While nice to know, this is pretty useless for retirement math as these life-expectancy figures are measured from birth, not from age 65.
Much more useful are the “cohort survivorship figures.” These are calculated by the U.S. Department of Health. For those of us men who make it to 65 today, 25 percent will go on to live to 90. Among women, it’s 30 percent. And of those ladies who make it to 65, 12 percent, one in eight, will live to 95. Quite a few, about 3 percent, will live to 100. Your family history is a key determinant for this.
5. Don’t forget medical coverage.
While Medicare is available now for those age 65, don’t plan on it covering most of your longer-term needs. Medicare covers only about half of all health-care costs. For the rest, yes, you get to pay that yourself. That means you’ll be on the hook for uncovered services such as long-term health care coverage (Medicare has no such provision) as well as certain meds, dental, hearing and eye care, along with any supplemental insurance costs.
According to a study of retiree health-care costs by Fidelity Investments, a 65-year-old couple retiring this year is estimated to need about $240,000 to cover medical expenses throughout their retirement … in addition to normal living expenses. Most heavy medical usage comes late in retirement.
6. Now, make some estimates.
For example, let’s assume you plan to retire at 65 and need additional income of $10,000 a year from all your investments for up to 30 years.
How much will you need to save? There’s no one-size-fits-all answer.
One option could be an immediate fixed annuity. These are issued by an insurance company and will provide you with a guaranteed income for life. So you know, with any insurance-backed investment, the guarantees are based upon the ability of the particular issuer’s ability to make your payments—a good reason to check the financial stability of those issuers before you invest. For our example, our gentleman retiree could invest $130,000 into such an annuity. A 65-year old woman would pay a little more for the same benefit, as in $140,000, because the insurance company figures she’ll live longer.
So that’s it, right? You just have to save about 13 or 14 times the extra income you need?
Not exactly …
That fixed-rate annuity, as is the case with all fixed-income bonds—regardless of individual bond credit quality—will provide steady income, but neither of these types of investment will protect you from inflation … from the long-term loss of your buying power. And that’s a very big deal. The average annual U.S. inflation rate since 1913, according to InflationData.com, has been 3.22 percent. That doesn’t sound like much but, over 20 or more years, even that modest rate of inflation will hurt you. At that average rate, over the 20-year period, your purchasing power will be cut nearly in half …
Inaccurate conventional wisdom still has it that you should rely heavily on bonds rather than stocks as you get older “to be safe.” That might have made sense when retirements were short and inflation didn’t have as much time to erode savings. Planning for a 30-year retirement, as you should do now, should change the thinking.
A reasonably conservative investment portfolio can help. As a totally generic example of a portfolio, imagine you have inflation-protected Treasury bonds (TIPS) and high-quality blue-chip stocks with records of long-term growth in dividend payments. Although TIPS offer lower returns than usual at the moment, most of the time you would expect a portfolio like this example to earn you a return in line with inflation, plus some additional return over the course of an economic cycle. So, based on those numbers, you’d probably need to set aside about 20 times your required annual income by the time you retire.
In dollars, if you need your portfolio to generate $10,000 a year and last up to 30 years, for example, you’d want to start with about $200,000. If you need your portfolio to generate $50,000 a year, you’d want to start with $1 million.
For those facing a retirement-savings shortage, the strategies for adapting are worth reviewing. They include scaling back your spending, moving somewhere much cheaper (don’t forget state income and estate taxes) as well as delaying your retirement as long as possible. This gives you longer to save, gives your savings longer to grow, reduces the length of time you’ll need to live off your savings and boosts your Social Security income by delaying its start. Even part-time work can help.
Additionally, if you have lots of equity in your personal residence, you can convert that into extra cash either by selling outright or using a cash-out reverse mortgage, which allows you to convert some of the equity into cash. Be careful with the latter as they aren’t free and it generally makes your property ineligible to be passed on.
As you can see, there are no easy answers. But the real problem is that most people still don’t even understand the questions. Now that you do, hopefully, your retirement will be even better!
Michael Maehl is an independent financial adviser and Spokane-based senior vice president of Opus 111 Group LLC, a Seattle-based financial services company. He can be reached at 509.747.3323 or firstname.lastname@example.org.
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