How To Afford A Long, Happy Retirement
Procrastination.
It’s a word that most of us know all too well. While there are times when
holding back can pay off, planning for your retirement is NOT one of them.
There’s only one side to waiting and that’s the downside.
So in the 20 or so minutes we have together today, I’m going to play two
roles. First, the role of advocate for your future financial security. I hope by
the time we’re done, I will have made my case convincingly enough for you
to understand why you have to START NOW to plan and save for
retirement. It’s NEVER too early. But, while early is certainly preferable,
it’s also NEVER too late.
Second, I will play the role of adviser. My goal is to pinpoint strategies that
will help make the retirement of your hopes, the retirement of your reality.
Why do you have to take charge of your retirement? After all, you’ve been
paying into Social Security for just about as long as you’ve been working.
Let me give you a few hard-to-ignore reasons to start saving for your
retirement now.
• Experts estimate that you will need 2/3 to 3/4 of your current income
to lock in financial stability for your post-retirement years. On
average, Social Security will only supply 40% or less of the income
you’ll need in retirement.
• You are likely to live a minimum of 20 or more years after you retire.
That’s good news – provided you have the money to afford this
longevity.
• If you start saving in your 20’s or 30’s, you can possibly be a
millionaire by the time you reach retirement age.
• Even a slight increase in contributions to your retirement savings plan
- 1% or 2% - can reap huge benefits 15 or 20 years down the road.
[NOTE: “pensions” are not funded by employee contributions]
• If you stay the course, you are likely to maintain or improve your
current standard of living in retirement.
Whether you’re a glass-is-half-full person, or a glass-is-half-empty one, the
facts and figures I just outlined hopefully have started you thinking about
retirement saving and planning. But, as we all know, it’s really easy to fall
into the “New Year’s resolution syndrome.” You know how it works. You
get all fired up and then a few days or a few weeks later your resolve
dissolves and you’re back to square one – or worse.
The strategies I am about to outline will fight that natural, but dangerous,
tendency because they will make it easy for you to stay on target and will
also – pretty early on in the process – provide measurable results. In other
words, you’ll have in your corner EASE and PROOF, two major
psychological incentives for sticking with it.
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For the balance of our time together, I am going to focus on the following 3step program for successful retirement planning and saving:
STEP 1: Pinpoint Your Major Sources of Retirement Income
STEP 2: Take a Realistic Look at Your Retirement Costs and Goals
STEP 3: Close the Gap Between Income and Goals
STEP 1:
Pinpoint Your Major Sources of Retirement Income
In this step you will basically inventory all of your anticipated sources of
retirement income. As we walk through each of them, consider which ones
you have, which ones you don’t, and which ones you should consider
adding.
Let’s start with the one most Americans depend on – Social Security.
Social Security is a compulsory federal government insurance program
that, in addition to retirement income, provides basic financial support for
you and your family during disability and for your survivors following your
death.
Each year, about two to three months before your birthday, you receive a
statement from the Social Security Administration detailing the facts and
figures surrounding your contributions and anticipated retirement benefits.
Review and keep this document. It’s a vital piece of information for your
retirement planning. Especially relevant is the comparison of what benefits
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you can expect at various retirement ages. The longer you work, up until
age 70, the greater your benefits.
You will need to consider these numbers to realistically assess when you
can actually retire. For example, you should consider the ramifications of
taking your Social Security benefits early and reinvesting that income in
another vehicle that gives you a higher return than the increased benefits
you could receive by waiting. In addition, you need to analyze the tax
implications of receiving Social Security benefits while you are still working.
These are the kinds of questions that can be addressed in detail by a CPA
or other financial planner.
You can obtain a copy of your Social Security Statement by contacting
the Social Security Administration, either on their Website, www.sss.gov, or
by phoning them at 800-772-1213. The Website also contains some very
helpful information on all aspects of retirement. It’s worth a look.
One final note on Social Security. The system was never intended to
provide complete financial independence at retirement by itself. Rather,
Social Security is supposed to serve as a foundation for a comprehensive
retirement plan, supplementing other sources of income.
Another major source of retirement income is an Employer Pension Plan.
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If you have a pension plan, you need to look at its provisions carefully and
make sure you understand them fully. The most important thing to keep in
mind is that your pension may be significantly reduced, or completely
eliminated, if you are not with the company long enough to be fully vested.
Retiring even a few months too early (or leaving for another position in
advance of vesting) could cost you tens of thousands of dollars over the
course of your retirement.
For example, if your employer’s pension plan specifies that you must be
with the company seven years before you become fully vested, and you’ve
worked there only five, it may be wise to sit tight for another two years.
Also, don’t forget that the amount of your pension is often calculated using
your final salary, so if you get raises in that period, you are also adding to
your potential retirement income.
Employee Contribution Plans, with the most common being a 401(k)
plan, are a highly-effective approach to putting money away for retirement.
If your employer makes matching contributions, all the better. In addition to
accruing retirement income, there are a number of other advantages to
401(k)s and other plans:
• Your contributions are not subject to tax. If you put $5000 into a
401(k) and earned $50,000 that year, your taxable compensation
would be $45,000.
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• Employers often offer a variety of investment options, so you can find
the investment vehicle or vehicles that best suit your goals and your
temperament.
• Some plans allow you to borrow against your 401(k).
• Should you leave your current employer, you can roll your 401(k)
over into another tax-deferred retirement plan such as an IRA, or
Individual Retirement Account.
But far and away the best feature of employee contribution plans is that you
build your retirement nest egg using pre-tax dollars that grow tax free until
you withdraw them.
IRAs are also tax-advantaged retirement vehicles that you can easily
establish with your broker or banker. There are two types of IRAs –
traditional IRAs and Roth IRAs. A traditional IRA contribution can be fully
deductible, partially deductible, or totally non-deductible. This depends on
whether you or your spouse has retirement coverage with your employer
and on the amount of your adjusted gross income. Distributions from
traditional IRAs are generally fully taxable and if made prior to age 59-½,
are generally subject to a 10 percent penalty. Annual minimum
distributions must begin when you reach age 70-½.
Contributions to a Roth IRA are not deductible. However, distributions from
a Roth IRA are generally tax-free if taken after (1) five years from the year
of the contribution and (2) age 59-½. Unlike a traditional IRA, no annual
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minimum distributions are required after age 70-½. As a result, a Roth IRA
can continue to grow tax-free. For 2004, the combined contribution limit for
both traditional and Roth IRAs is $3,000 ($3,500 for individuals age 50 or
older). For 2005, the contribution limit is increased to $4,000 for individuals
under age 50, and $4,500 for individuals age 50 or older. Consulting a
CPA or other financial adviser to learn more about which IRA is best for
you could be a critical step in your retirement planning.
More and more experts agree that, in order to afford retirement, you will
also need to have private investments to supplement other sources of
income.
Here again, advice from an objective party who does not have an interest in
promoting a particular investment can be invaluable. Many have been
turning to their CPAs for that kind of advice. I’ll talk more about specific
investment vehicles when we get to Step 3: How to Close the Gap.
Finally, as you assess where you will be getting retirement income, you
may want to consider a second career. More and more Americans are
doing that. Some out of necessity. Some because they feel they want to
pursue a passion. Whatever your reasons for a retirement career, you
should include it in your retirement scenario. And not just the projected
income. You also need to look at the tax consequences. Will it affect your
Social Security? Will it kick you up into a higher tax bracket? Will a parttime job or career generate enough income or will you have to consider
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working full time? These are the types of questions you need to be asking
now.
You now have an idea where your retirement income will be coming from.
Let’s move on to:
STEP 2:
Take A Realistic Look At Retirement Costs And Goals.
The operative word here is REALISTIC. You need to be honest with
yourself NOW so you are protected from unpleasant surprises when
entering retirement.
Here are some questions to consider that will help you get a good picture of
your retirement expenses and financial responsibilities. And keep in mind
that you are likely to live in retirement for 20 years or more.
• Will you keep or sell your present home? Move? Upgrade? Acquire
a second home?
• Will you be carrying a mortgage?
• Will you want to duplicate your current lifestyle? If so what are your
annual expenses?
• Will you be paying to educate children and/or grandchildren during
retirement?
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• Do you plan to make gifts (annual) to your family?
• Will you be contributing to the support of aged parents?
• Which of your medical expenses will be covered – Prescription?
Dental? Eye care? How would changes in your coverage affect your
finances?
• Will you purchase Medicare Part B? Or will you have to purchase
“Medigap” insurance?
• Do you plan to travel? How often? Where?
• What will your hobbies cost (for example, golf, tennis, memberships)?
• What expenses will you eliminate, such as a wardrobe for work or
transportation?
• What benefits will you lose? A company car? Frequent flyer miles?
• If you plan to embark on a second job or career, what expenses
accompany that decision?
While you don’t need to, and at this point can’t, calculate expenses to the
last penny, you should sit down with a calculator and come as close as you
can to listing all major anticipated expenses.
In addition to asking yourself those questions I just outlined, and more
importantly, answering them honestly, there’s another factor you need to
take into account as you project your retirement expenses…and that is
inflation.
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Based on the past ten years, experts say you should figure on an inflation
rate of 3 to 4% a year. How does that translate into what it will cost you to
retire? Let me give you an example. If you retire at age 65 with income of
$50,000 per year, 20 years later the purchasing power of that $50,000 has
been cut by about 45%. That’s presuming the relatively low inflation rate of
3% per year. In other words, to maintain the same lifestyle that $50,000 in
income gave you when you retired, you would need about $90,000
annually in 20 years.
Now, the news is not all bad. Most pension plans and even Social Security
factor in a cost of living increase to account for inflation, but it is not likely to
be enough. You get a better picture now, I hope, of why being on a fixed
income as a retiree can be devastating if you don’t plan for inflation.
So far you’ve calculated your anticipated sources of income, and you’ve
looked at your expenses. The remaining step is:
STEP 3:
Close The Gap Between Your Projected Income And Your
Retirement Goals
Now we turn plans into action. Ideas into reality. If you are like the majority
of Americans, you will discover that there is a gap between your retirement
goals and the money you’ll need to support them.
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Now’s the time to do something about it. Let me address those of you who
may honestly believe you have good reasons not to do something NOW. If
any of these reasons sound familiar, hold on, because I’m about to
discredit them.
• I’m too young to worry about retirement.
• It’s too late to get started.
• I don’t have enough money to put away.
• There are other expenses we have to worry about.
I have one point that will attack all of these arguments: I call it the Power of
100. By that I mean there is amazing power in putting away $100 a month
towards your retirement, doing it without fail, and doing it whether you’re 30
or 60.
Let’s look at how powerful that $100 really is. After 5 years earning 6%,
you’ll have $6,977. After 20 years, $46,204. After 30 years, $100,452. If
you can find a mix of investments that earn you 8%, you’ll have $7,348
after 5 years; $34,604 after 15 and $149,036 after 30. Now, if you can set
aside more than $100 a month, the savings will be even greater.
You see my point? It is NEVER too early and NEVER too late. What’s
more, you would not have to look very hard to find around $3.25 a day to
put away for your retirement. $3.25 a day is all it takes to set aside
$100.00 a month. That’s about the cost of a large, designer coffee.
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I’d like to spend a moment now talking about the kinds of investments to
consider. As we discussed earlier, individual investments are often pivotal
in closing the retirement income gap.
Whether you make your retirement investment decisions on your own or
get professional assistance, there are a number of considerations you
should keep in mind:
• Your current age;
• Your desired retirement age;
• Your tolerance for risk;
• Your liquidity requirements; and
• Tax implications now and at retirement.
Once you’ve analyzed those criteria, you can map out a retirement
investment strategy that will work for you both now and in the future. Let’s
take a quick tour through the types of retirement investments you might
want to consider – both tax advantaged and not.
First, the tax advantaged: U. S. Treasuries, as they are called, are the
safest securities around. They are backed by the “full faith and credit” of
the United Sates, so the risk is practically nil. But these investments are
not safe from the impact of inflation. In fact, long-term studies show that
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the real, inflation-adjusted returns are close to zero. Nevertheless,
Treasury securities are considered to be a key component in a wellrounded portfolio.
Treasuries may be purchased directly from Federal Reserve Banks or the
U.S. Treasury, or indirectly through a mutual fund. The income is exempt
from state income taxes.
Municipal bonds, issued by states and cities, may also be purchased
directly or through a mutual fund. They are exempt from federal and state
tax in the state of issue. For those in higher tax brackets, they can be
especially attractive.
Annuities, investment contracts sold by insurance companies, are also taxadvantaged. The government sees them as a safe and convenient way to
build retirement savings while contributing to a more stable and secure
society. Generally, earned income on the annuity escapes taxes until the
annuity is paid out, either in a lump sum or installments. Premiums are not
deductible, but the good news is that, unlike IRAs, you are not limited to a
set annual contribution.
Now let’s jump to taxable investments. These investments should be
included in your personal retirement assets for a number of reasons: (1)
they often carry larger after-tax returns; (2) you have a greater degree of
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control in buying, monitoring, adjusting and selling them; and (3) there are
no withdrawal penalties, should withdrawals be necessary.
A detailed discussion of taxable investments is beyond the time and scope
of our time together today. However, I hope that a discussion of the more
promising ones will serve to motivate you to investigate further.
Certificates of Deposit or CDs are fixed-income investments with higher
interest rates than saving accounts. Maturities range from 30 days to
several years and they are insured, so risk is minimal. However they do
follow the old paradigm: “the lower the risk, the lower the gain.” And at this
point in time, CDs come nowhere near keeping up with inflation.
Corporate bonds also generate a fixed income, but they usually have
higher returns than CDs, and not surprisingly, a bit greater risk. Corporate
stocks usually offer the greatest hope of significant returns over the long
haul, especially when considering stocks that offer BOTH dividends and the
potential for increases in share price. The best way for an individual to buy
stocks is through mutual funds. Mutual funds provide immediate
diversification for even the smallest portfolio and you can take advantage of
the knowledge and skills of an investment professional whose job depends
on the fund’s success. Of course, there is risk. The market goes up and
down. Funds managers are fallible. However, the good news is that there
are so many funds – and so many kinds of funds – that with a little patience
and guidance from an objective professional, such as a CPA, you can find
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the right mix to match your investment goals and ensure that you don’t
have all your eggs in one basket.
As you investigate your various investment options, here are some
common pitfalls to be careful of:
• Get rich quick schemes. If you are an older investor, you could be
especially vulnerable in the hope of making up for lost time.
• Over-caution. Remember, your investments need to keep ahead of
inflation. Just putting money in the bank will not do the trick.
• Not enough diversification. You need a variety of investment vehicles
to protect yourself from the idiosyncrasies of a single industry, mutual
fund or broker.
• Tapping into your retirement investments. Your retirement
investments should be sacred. They are for one purpose and one
purpose only. If you start to tap into them, you are literally sabotaging
your future. Of course, you do need an emergency rainy day fund,
but your retirement investments are NOT it.
To sum up, there are five things you can do easily, quickly and effectively
to protect yourself in retirement.
1. Put aside $100 extra a month. As it grows, consider how you will
make it work harder for you.
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2. Diversify. Be sure your investment strategy includes a mix of income
builders for retirement which might include: government securities,
mutual funds, bank accounts, CDs and annuities.
3. Take advantage of anything and everything your company offers to
help you save for retirement.
4. Use tax advantaged vehicles such as IRAs, annuities and municipal
bonds to help you increase your income BOTH now and later.
5. FINALLY, start right now.
Thank you. I’ll be happy to take any questions now.
© AICPA 2005
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