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Issue Date: December 2005 Issue


Retirement Through the Ages

The news on retirement may seem dreary, but with a plan, some help and a little luck, you could be relaxing on a sunny beach (or your dream destination) when it comes time to put work away.


Myra Orenstein

We’ve heard the landslide of bad news about saving for retirement.

Social Security is in jeopardy — “headed toward bankruptcy,” declared President George W. Bush in his 2005 State of the Union address.

Pensions (remember them?) have all but disappeared — a mere 21 percent of workers at all private companies are covered by defined-benefit plans, according to the Bureau of Labor Statistics. And an increase in claims from “significantly underfunded pension plans” has severely strained the government’s stopgap, the Pension Benefit Guaranty Corp., which saw its deficit increased from $11.2 billion to $23.3 billion in fiscal year 2004.

Enron, which used company stock to match employee 401(k) contributions, proved that not all 401(k) plans are created equal.

Health care costs are rising astronomically: In 2004, employer health insurance premiums increased by 11.2 percent — nearly four times the rate of inflation, according to the National Coalition on Health Care.

The stock market seems to have picked up the pieces from the burst bubble, but has yet to pick up much momentum. The S&P 500 was up just 1 percent for 2005 (as of Oct. 31). And many experts are predicting five- to 10-year equity returns to be modest — about 5 percent to 6 percent after inflation.

And, now financial advisers are blunt about the fact that a million-dollar nest egg is not nearly enough, suggesting doubling the amount at least. “My research says that the average retirement age could be pushed back 10 years or more, depending on certain economic circumstances,” Jeremy Siegel, finance professor at the Wharton School of the University of Pennsylvania, told Fortune Magazine earlier this year.

Yet, all is not lost. A quarter of workers polled are “very confident” they’ll have enough money to live comfortably in retirement, according to the 2005 Retirement Confidence Survey. That’s roughly the same number — actually, a slight increase — who were very confident in 1998.

So what do those folks know that we might not? (If you’re reading this story, it’s a good guess that your confidence is little less than rock steady.)

“The reason most people fail with their retirement efforts or in financial markets is because they make investments based on emotions rather than strategy,” says Dennis P. Barba Jr., Ph.D., managing partner Oxford Group of Raymond James & Associates. “The only way to succeed is to determine what you are trying to accomplish.”

Yet only about 40 percent of workers have done a “retirement needs calculation,” the basic planning step to determine the money needed for retirement and how much must be saved to meet that goal.

So we put together some simple strategies to put you on the right path, no matter what your age.

 

The 20s

The Experience: You’ve landed that first job. So what if you’re not making what they promised in college. It’s enough that you’ve got an apartment (and a roommate — or two) and you’re on your own. Sure, you owe about $20,000 for that degree and tacked on another $3,000 in credit card debt. And don’t forget the car payment, bills and those wedding bells in your future.

 

The Advice: “Start early for retirement,” says Bruce A. Jentner, president of Jentner Financial Group. “You have to save 10 percent of your gross.”

And the only way to do that is to set a budget. It’s the best way to balance the financial freedom you’ve earned while still saving some of what you’re earning.

Besides your degree, college has probably taught you to live on meager means. So continue some of those habits: Find a roommate, take the bus to work, cook for yourself rather than eating out. The discipline you learn here will serve you well later in life.

Start chipping away at your debt. Interest rates on student loans are usually low, so start with the highest rate credit cards first.

Create an emergency fund — about three months worth of expenses — in a money market fund or savings account. This will keep the credit card balances down in case something unforeseen comes about.

“I want to know what the person is saving for himself,” says Thomas Hlavaty, a certified public accountant and president of Hlavaty & Associates. So he first looks at a client’s W-2 to see what percentage of income is being invested in a 401(k). “I advise people to max out their retirement plan at work first and to always contribute if it’s a match.”

The message must be sinking in. In 2005, 60 percent of workers age 25 to 35 say they’ve begun saving for retirement compared with 47 percent a decade ago, according to the Retirement Confidence Survey.

More than three-quarters of workers are offered a retirement plan where employers match part of the contribution. For example, a company might match 50 percent of the employee contribution up to 10 percent of her salary.

Because you’re young, time is certainly on your side. “Don’t worry about the fluctuations [in the stock market],” says Jentner. “Regardless of whether the market is up or down, you will be rewarded over time.”

Even with almost four decades until retirement for this age bracket, many advisers suggest diversification that includes some measure of bonds, which guarantee a rate of return (about 4 percent for a 10-year Treasury bond).

“As professionals, we are risk managers,” says Creg Hardy, vice president of portfolio management at Huntington Bank. The longer a person can accept risk, the longer the time that she can accept variability.

That long time horizon means 20-somethings who can accept the market’s ups and downs can be a bit more aggressive in their investments. So Jentner suggests equity-oriented investing rather than moderate income funds.

But what about 401(k) plans? Are they risky? After all, millions were lost when Enron collapsed. “It wasn’t the 401(k) that was the problem. It was Enron,” explains Joseph W. Kraft, senior vice president of Morgan Stanley’s Individual Investor Group. “By law, employees may choose what to invest within their 401(k) plans. In the case of Enron, they chose to invest in the company, which is why [the employees] suffered a financial loss.”

 

The 30s

The Experience: You’ve either moved up or moved on from that first job. And with that increased salary has come more demands and different priorities too. That college lifestyle just isn’t working anymore. You’d like a place of your own or one where you can start a family. You’re probably not the only one you have to consider when planning for the future. You’re likely thinking about child care, life insurance and paying for school.

 

The Advice: Remember all the good habits you started in your 20s? (No, not that partying-four-nights-a-week habit, the good habits.) Well, keep it up. And learn to adjust. As your priorities shift, you’ll likely need to alter you budget, savings habits and financial goals to stay on track.

Extend your emergency fund to six months of expenses to cover anything unforeseen such as job loss, disability or illness. And, especially if you’re married, be sure you have life insurance to cover any tragedy.

Now might be the time to buy a house. “If you can buy a house, it’s a better decision than anything else. It’s a working investment,” says Randy Bateman, chief investment officer at Huntington Bank. “It’s one investment that’s working for you. Real estate values traditionally trend upward. It’s a storehouse of value.”

And Cleveland, unlike some parts of the country, offers real estate that’s not overpriced. “Everyone should buy a house when it’s the appropriate time for them,” says Kraft. “Continuing to rent is continuing to allow money to be thrown away. This is a great way to build equity.”

Yet Barba cautions about the latest fad: the interest-only mortgage. Now making a comeback, the initial payments on an interest-only mortgage repay only the interest on the loan, not the loan principal. When the mortgage term is complete, the original capital borrowed is still owed.

“One of the greatest assets we have in Northeast Ohio is that we can generally have our houses paid off,” he says. “This is a dangerous tool.”

Don’t forget though that owning a home means more than just mortgage payments. You’ll need to factor in insurance costs, property taxes and repair bills.

And what about that 401(k) plan? The advice is clear. Maximize it.

“Now you have learned from your 20s. Now you have a better idea,” Bateman says. “You may be more aggressive because of the knowledge and you might recognize the need for diversification.”

And for those who have postponed saving until their 30s, the experts say don’t fret. “If you haven’t started until now, it’s definitely not too late,” says Jentner. “You’re making more money. Maximize the employee contribution on the 401(k) plan. Take advantage of the matching funds.”

And next year, employees may have the option to put some of their savings in a Roth 401(k). The opposite of current 401(k) plans, the Roth 401(k) requires employees pay taxes on earnings before investing, but is withdrawn tax-free in retirement.

In addition, more than a quarter of workers in the 35-to-44 bracket have put money in an IRA outside their company’s plan, according to the Retirement Confidence Survey.

Consider a Roth IRA. Although annual contributions of up to $3,000 or 10 percent of your income (whichever is less) may not be deducted from your federal income tax, the Roth has worthwhile benefits: You don’t have to stop making contributions at a certain age; don’t have to start taking money out at an early age and don’t get taxed on withdrawals in retirement.

“The time has come to consult with a professional adviser,” says Rodney W. Vargo, president and CEO of Falls Bank. He recommends diversifying with mutual funds, but consider the taxes, load (a charge for selling shares) and expenses of the funds. “Look at funds that are not necessarily the ones that your adviser represents,” he says. “Have your accountant take a look at them. Look at the tolerance and the risk.”

Oh, and by the way, if that next job meant going out on your own, there’s an Individual 401(k) plan for people who are self-employed with no employees.

Known as an Individual(k) or Solo(k) plan, these options allow sole proprietors or small-business operators to put more money away for retirement and benefit greatly in terms of personal and business taxes.

Contributions can’t exceed $14,000 or 100 percent of pay with a total salary deferal and employer maximum of $42,000. The employer contribution is limited to 25 percent or 20 percent for self-employeed.

The self-employed should also look into a SEP IRA in which investments of up to 25 percent of net income, not exceeding $42,000, may be stashed away into a retirement account. A Simple Employee Pension Individual Retirement Account has no real administration costs and are a great way to save for those who are self-employed with no employees. And, SEP funds may be invested in just about anything.

If you have kids, start socking money away — even if it doesn’t seem like much — for college. Let compounding be your friend. And try not to look at tuition as an expense but as an investment. Consider that the average salary for a male age 25 to 35 with a college degree is 65 percent more than one with only a high school diploma (and 71 percent more for women of the same age), according to the U.S. Census Bureau.

Kraft suggests parents look into a 529 Plan, a savings program earmarked specifically for college savings, to help fund their children’s education. You remain in control of the account (not the child whose name it’s in), the investment grows tax-deferred and distributions to pay for the beneficiary’s college costs come out federally tax-free.

 

The 40s and 50s

The Experience: Kids. College. Home. Health. Chaos. A little bit of this and a little bit of that is likely swirling about during this time. Most professionals lumped these two age categories together. You’re likely earning the largest salary of your career, but with some families facing private college tuition costs of more than $42,000 a year, the concept of paying for anything other than college may seem unrealistic.

 

The Advice: You’ve got some tough choices in front of you: Put money away for the kids or save for yourself.

Hlavaty concludes that most people gravitate toward investing in their children’s college education not because they don’t believe in investing in their retirement, but because retirement is almost an abstract concept to them. Seeing children through college is very tangible.

That’s why many advisers suggest re-emphasizing your retirement goals.

“You cannot help your children at the expense of your retirement. Children can contribute toward their own education,” Jentner says.

Kraft echoes his sentiments. “There are many self-made millionaires who put themselves through school,” he says. “It is not necessarily a burden you should put on yourself.”

Barba plans to put his three children through college and suggests meeting with a professional who can calculate odds of success under different scenarios while allowing for changes in life circumstances.

Still, he admits that if a couple in their 40s has two children and is just beginning to plan for college, “They have an issue.”

As for the retirement income, Kraft suggests some changes. For those who have changed jobs and have 401(k) plans from three to five different places, he says, “Consolidate them. Roll them over into a private IRA or bring them with you to your current 401(k). Continue to monitor your statements.”

But, that’s not the only change he is suggesting. Kraft says that now is the time to shift from mutual fund portfolios to professionally managed portfolios and to hire a money manager to manage stocks and bonds.

“Sit down and run projections with professionals,” says Jentner. “Zero in and see if there are enough savings. Don’t make your assumptions too aggressive. Don’t assume that you will get a 14 percent to 15 percent return in order to retire.”

And consider, too, that you might have to come up with more money than you had planned to retire. Because on top of the expenses you had anticipated, now you are potentially facing a lack of health care coverage.

“Many think that they are covered by corporations or the government,” says Kraft, “but with companies closing and others like GM reducing their benefit packages, health care coverage has suddenly become a huge unknown.”

His advice? “Look into long-term care insurance,” says Kraft. “Do this as early as possible. If one spouse requires care, the [financial] numbers change so dramatically it could impoverish the other spouse. A long-term care plan must be in place.”

 

The 60s

The Experience: Retirement is upon you. Or is it? Almost a third of workers 55 and older expect to retire some time past age 65, according to the Retirement Confidence Survey. In fact, 58 percent of that same age group expects to work in retirement. To most consumers, the magic number needed for retirement is $1 million. To most experts, that number needs to increase two- or threefold.

 

The Advice: The 60s are the antithesis of the 20s. While it was perfectly fine to consider online trading in those earlier years since money could be recouped if bad investments were made, now most experts believe that there is no more time to make such a recovery.

There are considerations to be sure. Some people aren’t in a position to retire, even though the magical age has arrived. Hlavaty sees a lot of this. And, although he admits people certainly envision spending time with their grandchildren somewhere down the road, they aren’t quite ready to retire and aren’t ready to sacrifice by taking lesser jobs at big box retail stores. To estimate how much is realistically required to retire, he suggests they create a spreadsheet outlining all of their expenses, including expenditures such as dining out and vacations, and multiplying the amount times 110 percent.

“Who wants to sit in a corner and do nothing during their retirement? Who wants to tell their grandchildren they can’t afford to buy them anything?” he asks. “That’s not what retirement is all about.”

So, we’re back to the question of how to get there. According to Jentner, if you worked hard on your plan all along, you’re “well on your way to investing, have more discretionary cash flow and have investments allocated to prepare for retirement.” Putting money into CDs is “the wrong move,” he says. “Keep it in stock funds.”

But other advisers suggest just the opposite approach. “Focus on preservation of capital,” Vargo says. “You can’t make a recovery now on a bad investment. Look at government treasuries or municipal bonds. Invest in bank CDs. Consider safety and principal first.”

And then there’s Bateman, who believes that the conservative investor will sell his equities and invest in bonds, but acknowledges that “most aren’t doing that.” His advice? “Look into options.”

Barba’s approach is timeless. He thinks that investments should be made based on what your goals are during different stages of your life. He estimates that the average retired couple in Northeast Ohio needs $5,000 to $6,000 a month after taxes to have a comfortable retirement. He claims that if they were strategic in their planning, they should be fine.

It’s obvious that it’s easiest to retire if you were born wealthy. If, like most of us, you weren’t born into that income bracket, you’d better start saving now. For whether you take a conservative or a more aggressive approach, the one thing all of these experts agree on is that it takes a plan.

(Arooj Ashraf contributed research to this report.)


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