Do-It-Yourself Retirement
Ira Carnahan. Forbes. New York: Jun 6, 2005.Vol.175, Iss. 12; pg. 092
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Abstract (Document Summary)
No matter what happens to President George W. Bush's proposal to cut Social Security benefits for
the better off, the age of the own-your-own, plan-your-own, get-real retirement is here. A single
worker earning $90,000, retiring at 65 today, will find Social Security replaces 30% of his salary,
down from 41% for a comparable high earner retiring in 1980. The President's suggested changes
would cut the benefit to 19% of salary by 2035. Traditional pensions, in which an employer takes the
investment risk and guarantees a payment, are in decline, too. And the stock market's recent
performance has punctured the fantasy that upper-middle-class Americans can retire at 55 to a life
of golf, sailing and world travel--if only they choose the right broker. So here's the good news:
There's more that individuals can do and are doing to make the numbers work for them. Folks are
postponing retirement or are planning to work part time after retiring. They're tapping into their home
equity or moving to cheaper digs. Research even suggests that, in terms of savings, those in their
50s are further along than is commonly believed.
Full Text (2037 words)
(Copyright Forbes Inc. )
Americans are taking charge of their own retirements. Fortunately, there's a tool kit on the Web to
help them do it.
No matter what happens to president George W. Bush's proposal to cut Social Security benefits for
the better off, the age of the own-your-own, plan-your-own, get-real retirement is here. A single
worker earning $90,000, retiring at 65 today, will find Social Security replaces 30% of his salary,
down from 41% for a comparable high earner retiring in 1980. The President's suggested changes
would cut the benefit to 19% of salary by 2035. Traditional pensions, in which an employer takes the
investment risk and guarantees a payment, are in decline, too. And the stock market's recent
performance has punctured the fantasy that upper-middle-class Americans can retire at 55 to a life
of golf, sailing and world travel--if only they choose the right broker.
So here's the good news: There's more that individuals can do and are doing to make the numbers
work for them. Folks are postponing retirement or are planning to work part time after retiring ( see
"Retire? Not So Fast" ). They're tapping into their home equity or moving to cheaper digs. Research
even suggests that, in terms of savings, those in their 50s are further along than is commonly
believed.
How prepared are you? As the box on page 94 shows, a slew of sophisticated do-it-yourself
retirement planning tools are now available on the Web at little or no cost to help you gauge your
prospects and calibrate the tradeoffs you may have to make.
Ross Griffin, a retired petroleum engineer, used Fidelity Investments' Retirement Income Planner a
few years back to calculate how much he and his wife could spend each year and how they ought to
invest. It showed Griffin, a resident of Hawaii at the time, that he wouldn't have as much as he
wanted to live on. So he and his wife sold their Hawaii home and are building a new one in their
native Texas. Thanks to the 1997 tax cuts, the gains on their Hawaii house were all tax free. After
paying for the new house in Bonham, Tex., they had an extra half-million to invest, which they put
into a mix of bond and income-oriented stock funds. Their granddaughter is nearby. Who needs
Hawaii?
The most useful calculators often give you the odds of making your financial goals. The Fidelity
calculator says that the Griffins' investments and expenses give them an 87% shot of having their
money last for another 30 years. "I'm real comfortable with this model," says Griffin, 62. "It gives you
some peace of mind that the money that we have will be sufficient."
Can you really plan for retirement, yourself, over the Internet? Doesn't something so important call
for a pro?
Hiring a financial planner can be a wise move if you're too busy to plan, hate numbers, have an
unusually complicated situation or need a nagging nanny to get you to save. If you want help with
the numbers and investment choices but not necessarily ongoing hand-holding, consider the
planning services offered by T. Rowe Price and Vanguard (see FORBES, Dec. 13, 2004). For only
$500 to $1,000--less if you have a big balance--you can get individual advice over the phone and a
detailed written plan, generated with more elaborate software than is generally available over the
Web.
But remember, a lot of what a good planner does involves getting a client to focus on important
questions whose answers can dramatically alter the results all those calculators spit out.
How much will you need to retire? That depends on the age at which you plan to hang it up; how
many years you're likely to live after retirement; how boldly you're willing to invest during retirement;
whether you plan to work part time; if you're willing to move to a cheaper house or tap your equity
with a reverse mortgage; whether you're determined to leave your kids an inheritance; what risk of
outliving your money you consider acceptable--and so on.
Even if you use a professional planner or intend to hire one, playing with the best online calculators
will help you analyze the tradeoffs. Say you're 40, earn $100,000 now and want your 401(k) and
other personal savings to replace 80% of income. If you retire at 65 you'll need a grand total of $2.1
million in 2030 dollars. That means, assuming you have $100,000 saved now, socking away 13% of
your income, estimates Vanguard's online retirement calculator, using midrange assumptions for
asset allocation, investment returns and life expectancy. If you postpone retirement until 70,
however, you'll have to save only 6%. And if you want to retire at 60? Dream on--you'll have to save
23% of your income each year.
As for how many years you'll have left after 65, the answer is probably longer than you think. A 65year-old man in good health has a 50% chance of living to 85 and a 25% chance of reaching 92. A
65-year-old woman has a 50-50 chance of making it to 88 and a 25% chance of reaching 94.
Unless you're an insurance actuary, or use a calculator, you may not think about what it means to
fund for two lives. If a husband and wife are both 65 and healthy, there's a 25% chance at least one
will live to 97 or beyond.
Of course, life expectancies vary with individual and family history. To get a personalized prediction,
try the online calculator from Northwestern Mutual Life called the Longevity Game. (To find it, go to
www.nmfn.com and search "longevity" or go to www.forbes.com/extra, where you'll find links to all
the calculators in this story.) You answer questions about your diet, health, height, weight, family
history and the like, then the calculator comes up with your life expectancy. Note, though, that for
each additional year you live, the age that you're expected to reach will increase, as well. So while a
40-year-old man with average weight, blood pressure and good habits can expect to live to 81, a
65-year-old with the same characteristics is likely to make it to 85.
How to Invest. Once you have an idea how long you are likely to be around, the next question is
how to invest so that you'll have the best chance of making it through retirement without becoming a
pauper. One common mistake: investing too conservatively during retirement. If you put 20% in
stocks, 50% in bonds and 30% in cash, and withdraw 5% the first year, adding to that amount to
keep pace with inflation each year, the odds of making your nest egg last 30 years are a mere 10%.
If you invest by taking on a bit more risk--with 50% in stocks, 40% in bonds and 10% in cash--your
odds rise to 60%. These are Fidelity's numbers, and they are based on historical stock market
returns--which may be a tad too optimistic, given that stocks at the moment are trading at
abnormally high multiples of their earnings.
Getting too adventuresome in your asset allocation, paradoxically, can raise your probability of
running out of money. While a stock-rich portfolio has a greater chance of having a very good
return, it also has a greater chance of having a disastrously bad one. To improve greatly on that
60% chance of dying solvent, lower your withdrawal rate.
T. Rowe Price's calculations show the importance of keeping withdrawals down. Start spending 5%
of a portfolio that's 60% in stocks, 30% in bonds and 10% in cash, and keep withdrawals in pace
with inflation. The chance your money lasts 30 years is 70%; lower the starting withdrawal to 4%
and your odds of making it 30 years rise to 90%.
Withdrawals. One of the unpleasant truths of withdrawal-rate mathematics is that the safe rate is
often much lower than the average return on your investments. Say you expect a portfolio to earn
9% a year. What's wrong with drawing down 7%? Your chance of making it 30 years without
running out of cash would only be 46%, according to Fidelity. That's because when you're gradually
liquidating a portfolio, it's not just your average of returns that matters but also their timing. Suffer
several poor years early in your retirement, when you have the most invested, and you might lose
so much early on that strong returns later, when you have little money left, wouldn't do much good.
A simple retirement planning calculator that plugs in an average return and doesn't take this timing
risk into account will leave you thinking you're more secure than you are. A better approach is a
statistical method known as Monte Carlo simulation, which accounts for the mix of returns and the
probability of different patterns. (The moniker draws a parallel between probability theory and
roulette wheels.) Most of the tools recommended in our table use Monte Carlo simulation.
Spending. Once you have a handle on your investment returns, the next question is how much
you're likely to spend each year during retirement. The standard financial planner answer: 70% to
80% of preretirement income, adjusted for inflation. That's a sensible figure, on average. You
shouldn't need as much money as you did before you retired and not just because you won't have
commuting costs. With no salary, you won't pay payroll taxes (for Social Security, Medicare). And to
the extent you are spending down your taxable savings first, you'll have a smaller income tax bill.
But don't expect to spend the same amount every year you're retired. In his book, The Prosperous
Retirement, financial planner Michael Stein suggests there are three stages of retirement spending:
the active phase, through age 75, the transition phase, from 75 to 85, and the passive phase, after
85. Spending starts high, and then declines as retirees get older (though end-of-life medical costs
can push expenses back up). Academic research also supports this view. Retirees at 75 spend an
average 20% less than retirees at 65, according to a 1999 study in the Journal of Financial
Planning. For a careful assessment of how much you're likely to spend in retirement, try Fidelity's
Retirement Income Planner, with its optional detailed questionnaire.
Limits of calculators. While calculators are great, don't be a slave to them. Humans adjust their
behavior; calculators can't.
Calculators base their projections on your circumstances and expectations today. But those can
change. Your spending may take a dive because you are especially parsimonious, so you find you'll
need to take out less than you thought. Perhaps the markets slump and you decide to offset this by
cutting back on travel and dining out. Or you ramp up your part-time work hours.
Minneapolis financial planner Jonathan Guyton looked at what would have happened if you'd retired
in 1973, wanted to make your money last 40 years, rebalanced annually and applied a rule like the
following: If your portfolio's value at the end of the year is less than its beginning value, don't take
any inflation increase the next year and don't award yourself a makeup increase later.
His hypothetical 1973 retiree could (with hindsight) have started out taking 5.4% from a 65% equity
portfolio rather than 4.4%. However, beginning in 1982, after the high-inflation, low- return period of
the late 1970s, this spender's withdrawals ended up smaller, in dollar terms, than they would have
been without the rule.
Risk that the money runs out. What may be the toughest question of all: How much risk are you
willing to take that you'll outlive your money? Running a 50% risk would obviously be foolish, but
demanding too much certainty you'll be secure--say, 99%--may not make sense, either. Assume
you're 65 and have $1.5 million invested in a moderate mix of 40% stocks, 40% bonds and 20%
cash. If you demand 99% certainty you won't run out of money during retirement, you'll have to start
your withdrawals at a chintzy $59,400, says T. Rowe Price's calculator. Accept a 10% risk and you
can withdraw $68,400.
A better bet if you're really that worried about running out of savings might be to invest some of it in
a low-cost immediate annuity and invest the rest more boldly.