December 2006 Issue
Even for those who are late to the game, there are ways to invest for retirement.
When it comes to saving for retirement, it's never too soon to start. While retirement may seem like a long way off to twentysomethings, salting away dollars at a young age allows even small accounts to gain the significant benefit of compound interest.
Nevertheless, experts say that many Americans wait until they are in their 40s or 50s to start planning for their retirement years. The consequence: Less than 30 percent of Americans aged 55 and over have total savings of more than $100,000 (not including the value of their house), according to a survey by the Employee Benefit Research Institute. For those who will receive income from an employer-sponsored pension plan, $100,000 in savings might provide a comfortable retirement. But without pension income, $100,000 won't go far, even with Social Security benefits.
The survey respondents listed a wide range of reasons for their lax retirement planning. In some cases, the basic costs of living and the burden of financing their children's college tuition left little extra for savings. Others experienced setbacks such as illness, divorce or unemployment.
Whatever the reason, there's good news for baby boomers who have underfunded their retirement nest eggs. If you're willing to adjust your lifestyle and your expectations for retirement, there are financial catch-up strategies that can provide security for your golden years.
The first step for late savers is to do a retirement needs calculation, says Jon Dauphine, the director of economic security strategy for the American Association of Retired Persons. "Research shows that many people save blindly," he explains. "They think they have enough put away for retirement, but when they do an actual calculation, it forces them to think about what they really need."
Noting that you should plan on retiring with 80 percent to 90 percent of your pre-retirement income, Dauphine suggests using one of the many Web-based calculators to determine how much you'll need to sock away. The American Savings Education Council (ASEC) offers a retirement calculator at its site, www.asec.org. Don't forget to use your annual Social Security statement to estimate how much that will contribute.
"If people don't take the time to calculate their retirement needs and start putting aside money, they may find that they have to work much longer than they wanted to," Dauphine says. "But even if they plan on working until they are 80, they may have a disability or get laid off, and things can be real tough."
With more and more corporations doing away with traditional defined- benefit pension plans, the responsibility of saving for retirement has shifted to workers. "But when it comes to thinking about retiring, there's a lot of denial going on, especially among younger baby boomers," Dauphine says. "They may have had parents who worked for a large corporation and had a traditional pension plan to augment their Social Security. It tends to lull the boomers into complacency about thinking of their own retirement funding. But if they're not putting away enough money, they are going to be disadvantaged compared to their peers who have saved adequately."
The increasing cost of health care has become a key factor in retirement planning, says Dauphine. Because medical co-pays and deductibles are rising, baby boomers should consider putting away an additional $150,000 just to cover health expenses, he notes.
If you're fiftysomething and playing catch-up with your retirement savings, Dauphine has the following tips for you:
Maximize tax-deferred accounts.
Once you've reached the age of 50, you're allowed to make "catch-up" contributions to your IRA and 401(k) plan. For example, at age 49 you can put up to $15,000 in your 401(k) this year; but at 50 and older, you can put an additional $5,000 away, for a total of $20,000.
For IRAs, the 2006 maximum tax-deferred contribution is $4,000. But if you're 50 plus, you can put in an extra $1,000 for a total of $5,000. The catch-up provision also applies to 403(b) and 457(b) plans.
For many people, it may be wise to consider some financial belt-tightening in order to contribute maximum amounts to retirement plans. "One thing that folks need to realize is that there are strategies you can do to save more, but there are also strategies to not spend as much," Dauphine says. "With so much of the responsibility of retirement funding transferring from the employers to us, we really need to think about how much we're consuming and how much we need to save," Dauphine says. "As a colleague of mine says, â€˜Live for today, but save for tomorrow.'"
Tailor your investment plan.
As we get older and approach retirement, the common wisdom is to reduce the risk profile of our investments, shifting money from higher-risk stocks into lower-risk (and lower-yielding) fixed-income investments, such as bonds and CDs. "But now that people are living longer, they should have exposure to the stock market so that their investment portfolio keeps pace with inflation," Dauphine says.
WHAT DOES WHAT
When selecting an advisor, it helps to understand the industry designations and buzzwords. Here's a list to help you understand the alphabet soup of credentials. The designations that are typically the most respected - and require the most preparation and knowledge - are the CFA, CFP, ChFC, CPA and PFS.
CFA: Chartered financial analysts must pass a test on investment analysis, economics, portfolio theory, accounting, corporate finance and other topics
CFP: Certified financial planners must meet experience and education requirements and pass a 10-hour exam.
CFS: Certified fund specialists have completed a 60-hour self-study course and passed an examination on mutual fund investing.
ChFC: Chartered financial consultants are typically insurance agents who have passed college-level courses in financial planning.
CPA: Certified public accountants are tax specialists who must have a college degree, pass a rigorous national exam and keep current on changes in tax law.
PFS: Personal financial specialists are CPAs who have met education and experience requirements and passed a comprehensive exam on financial planning.
RIA: Registered investment advisors are individuals who have registered with the Securities and Exchange Commission.
Kevin Jacques, who teaches business administration at Baldwin-Wallace College in Berea, says that even retirees should consider keeping a portion of their money in stocks. "If you retire and put all of your money in bonds or CDs and you live to be 80, you're actually taking a large amount of inflation risk, says Jacques, who holds the College's Boynton D. Murch Chair in Finance. "Inflation has averaged 3 percent per year, historically. At that rate, if your retirement account is invested only in bonds or CDs, your money can lose half of its purchasing power over the course of 25 years."
Think about purchasing long-term-care insurance.
Because of the surging cost of health care, long-term-care insurance can be an important part of retirement planning. But only for some people, says Bernie Garrah Jr., president of the Cleveland Society of Financial Service Professionals. "We're living longer, so our need for medical care is increasing," says Garrah, a consultant with Skylight Financial Group in Cleveland. "Long-term care insurance can be one way of paying for that care. But someone who has a large amount of money saved up or a great pension may have the potential to self-insure their long-term care needs." If you're considering long-term care insurance, it makes sense to purchase a policy sooner rather than later, adds Garrah, noting that premiums are typically lower for younger people.
Carefully consider when you'll retire.
"Don't exit the workforce until you're really sure you want to and are financially ready," says Dauphine. "If you should have to reenter the employment market, you'll find that it's tougher to find a job when you're older that pays as well as your previous job." He offers two more reasons for maintaining your job: With each additional year that you work, you'll have more money to put in your 401(k). And by staying employed, you'll postpone tapping into your retirement funds.
Choose a good financial adviser.
For people who don't have a financial background, retirement planning can be perplexing. Because tax laws, savings options and financial products are continually changing, it makes sense to seek the help of a professional. To find a good advisor, talk to neighbors and friends for references and make sure you interview two or three, says Dauphine. "You really want to do your homework when you're deciding on an advisor," he notes, adding that people should consider hiring a Certified Financial Planner. ("CFPs have to live up to a professional code," he says.)
Garrah, who is a ChFC (Chartered Financial Consultant) and a CLU (Chartered Life Underwriter) says that advisors should have some form of professional accreditation. "That shows a commitment on the part of the advisor in maintaining their knowledge base and increasing it," he says. "But I would stay away from an advisor who says they can solve all of your problems, such as doing your tax return, investing all of your money, selling you any insurance product you need and preparing your estate plan. If someone is a jack-of-all-trades, then they are the master of none. The financial industry changes so much that it's hard to stay on top of developments in all areas and still give the best advice. You want to find someone who is a specialist."
An advisor should disclose whether he or she works on a fee-based or commission system, adds Dauphine. He suggests steering clear of "double-dipping" advisors who propose taking an hourly fee for their work as well as earning commissions from selling insurance and investment products.
If you're planning to interview a prospective financial advisor, Garrah suggests asking these questions:
- How many years of experience do you have?
- What are your licenses and credentials?
- Do you work in a team environment? Will there be other professionals helping you to manage my account and offering input?
- What is your investment philosophy?
Garrah adds that it's important that clients feel comfortable with their advisor. "Don't let someone rush you into making an investment," he says. "If someone is getting pushy, you have to question why they are in a hurry. A good advisor will give you enough information so that you are comfortable with his or her recommendation."
The folowing are organizations that can point investors in the right direction.
If you're interested in finding a financial advisor but aren't sure where or how to begin, here are some resources that can help:
American Institute of Certified Public Accountants
(personal financial planning division),
Financial Planning Association,
National Assn. of Personal Financial Advisors,
The following regulatory agencies can also provide helpful information:
The National Association of Securities Dealers provides information on disciplinary histories of brokerage representatives and broker-dealers. It also offers general information on avoiding financial fraud. For details, visit www.nasdr.com.
The Certified Financial Planner Board of Standards provides information on financial planners' CFP designation and disciplinary history. For more information, call 303/830-7500 or visit www.cfp-board.org.