Retirement Income Blog

In economic downturns everyone tends to tighten their budgets, and that includes retirees. In fact you may find you’re actually saving in retirement after paying your regular expenses. So where should you put this ‘extra’ savings as a retiree?

You may tend to just put it into your retirement savings into a bank account. But that makes your money vulnerable to inflation and unable to participate in market upturns. Its earnings are also taxed yearly - you may as well put it under the mattress.

Better to make it work toward ensuring more for you in the future. At 65 you statistically have some 20 years of remaining life expectancy. Long before that time elapses, both inflation and economic upturns will affect your holdings.

Presuming that you’ve stashed anywhere from 1 to 2 years of easy-to-access emergency money, you should put your ‘extra’ retirement savings into investments of a longer time horizon. Here, you’re looking for equity growth – both to offset the effects of inflation and further capitalize on the eventual rebound of the economy and the stock market.

Be sure to diversify your retirement savings among a variety of equity portfolios. Although you may invest some in funds that cater to large capitalization stocks, you should try to include real estate investments, international stocks, emerging markets, and smaller U.S. stocks.

These investments will reside in your ‘taxable’ accounts since they come from investment earnings and not work earnings. And as equity-based investments, their annual earnings should be small, since you’re investing for ‘growth in principal’. They may not ‘move’ for a while, but remember, you’ve already proven you don’t need this money. 

Consider this money outside your normal portfolio arranged according to your risk profile and income requirements. This way you can afford to risk a small portion of retirement savings and wait sufficient time for it to bloom.

For the most conservative investors, consider index-linked CDs.  These are FDIC insured CDs that pay interest based on increases in the stock market.  If the market falls, you original principal is guaranteed.  If the market rises, your index-linked CD increases in value.  Similar to this alternative, are equity-indexed annuities.  The same principals hold.  If the market declines, the issuing insurance company guarantees your principal.  If the market advances, your annuity balance participates in the gain.  Consult a retirement advisor to learn about your options for saving in retirement.

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Let’s first state three fundamental principles and then add the details.

1.      Start retirement with sufficient retirement savings

2.      Protect your retirement savings from erosion due to taxes and inflation

3.      Never lose money

Start with your desired retirement income and expenses.  Then, you can use a retirement income calculator to determine how much retirement savings you will need. You need to know how large of a nest egg is required for a comfortable retirement.  Most people don’t like to do this rigorous exercise of charting your expenses and income over time.  If you won’t do it, then hire a retirement planner who will.  I highly recommend the retirement planning software from J&L planners as it allows you to account for detailed changes in your income and expenses year by year.  Only by doing the math do you know how much you need and when you are able to retire. 

Next, you need to take advantage of as much tax shelter as possible.  For most retirees, that means using your unsheltered money first (e.g. your non-IRA, non-401k funds) .  You want to let your tax sheltered money grow as long as possible.  The caveat here is the uncertainty of future tax rates. Future income tax rates may be higher than today. You can have a retirement planner calculate for you the tax rate at which it is better to use your sheltered funds first.  In fact, understand that the plans you make at the beginning of retirement can change because of changes in tax rates or other variables.  That’s why smart retirees will update their retirement plan every 24 months.

Last, you need to be sure your principal never declines.  That would seem impossible based on the advice in the retirement-Income.net web site that recommends you keep 50% of your funds in stocks and everyone knows stocks go up as well as down.  BUT, you will never rely on these stocks for retirement income.  Your money will always be in at least 2 baskets—your liquidity basket from which you make withdrawals for your living expenses and your growth basket which replenishes your liquidity basket at long intervals.  You will never take funds from your growth basket to live on and the long intervals create a very high probability that you will only have gains in your growth basket between transfers to your liquidity basket.  Consider for example that over the last 80 years, when stocks have been left alone for 10 year time intervals, they gained in value 97% of the time.

Of course, in terms of protecting your retirement savings, there may be other asset protection measures such as trust and estate planning that you do for your heirs.

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The “baby boomer” generation are those people 45 and 62 years of age (as of 2008). This generation has saved on the average retirement savings of $38,000, excluding pensions, homes, and social security. However, “baby boomers” with qualified retirement plans has an average retirement savings of $88,000. The $88,000 of average retirement savings will generate an annual retirement income of about $5,000 yearly. Not many people would be satisfied with this level of retirement income. To get an exact amount, based on your age and retirement savings, you can use the retirement income calculator. But there is ample evidence that these retirement plan accounts are mismanaged with approximately half invested in under-earning money market funds rather than long term growth investments.  Its clear not many baby boomers will retire rich.
Source: http://chaz11.blogspot.com/2008/05/baby-boomer-retirement-dilemma-how-much.html

Here is additional data on average retirement savings and attitudes. Allstate has conducted a Retirement Reality Check annually. The survey measures Americans’ attitudes toward, and savings for, retirement. In the 2006 version, respondents were asked, “If saving for retirement were like driving on the highway, where would you be?”

By far, the majority of respondents– 48% — said they are “in the middle lane, keeping up.” More confidence was shown by 20%, who said they are “in the fast lane, passing others.” And everyone else was rather timid. “On the on ramp, still getting started” came in at 14%; “in the slow lane, watching others go by,” notched 13%; and “lost and looking for a map” held strong at 5%. Obviously, retirement is one area where many of us are perfectly content thinking of ourselves as average and the average retirement savings sounds to be pretty dismal. The dismal facts mean that most babay boomers will need to annuitize their nest egg and will have nothing to leave to their children (use the fixed annuity calculator for estimates).

It’s estimated that the average projected postretirement income replacement needed among employees of large U.S. employers is 126 percent of final pay, a level only about 19 percent of employees are expected to satisfy, according to a Hewitt Associates report released July 1. If we assume that the average person earns $40,000 annually, they would need about $50,000 in retirement income, requiring an average retirement savings of $833,000 (not taking into account any social security income).

In fact, according to the report, Total Retirement Income at Large Companies: the Real Deal 2008, about 67 percent of the more than 1.8 million employees of 72 large U.S. employers tracked in the study are expected to have accumulated less than 80 percent of their projected needs at age 65. Despite the gloomy projections, the report’s authors concluded that employees can make a big difference in their retirement readiness by making small changes in their savings rates, investing smarter, paying lower fees, and delaying their retirement – all great actions to increase the average retirement savings in America.
I think in particular the last point is what we are going to see more and more of: individuals working well into their 70’s just to pay their bills and survive. Unless savings rates make a big change, average retirement savings by retirement date will be too low.
Source: http://www.typepad.com/t/trackback/89778/31259398

Economist and humorist Ben Stein set out to answer the question, “Why won’t the baby boomers save?” According to Stein, the average baby boomer needs to save about $400,000 to have sufficient interest income to make up the difference between Social Security and what he or she needs for retirement.
Yet the average retirement savings of baby boomers has saved only $50,000—or $110,000 if you
include equity in their homes. He called this a crisis in the making.

Humorously exploring the question of how we got to this point, Stein suggested a number of possible causes for a low average retirement savings. First, he suggested, baby boomers have “always had it too good.”

Never having lived through economic hard times, they lack the discipline to save. He also proposed
a Freudian explanation: the false sense that mommy and daddy—or the government—will always
bail them out if they get in trouble. A third possibility drew on the theories of behavioral psychologist
B.F. Skinner: saving offers no immediate gratification, while spending provides immediate positive reinforcement such as a flat-panel plasma TV set or a new car. The final theory suggested that baby boomers felt compelled “to obey the media consumer spending machine.”

Whatever the cause, Stein concluded, many baby boomers in retirement will have to cut their
standard of living drastically, while others will simply run out of money. The baby boomers may
actually have saved more than the previous generation of Americans, but because fewer of them have DB pension plans, they are worse off.  In other words, because baby boomers must save on their own whereas their parents largely had company retirement plans, this generation’s average retirement savings rate is lower.

No matter who you listen to and what statistics are used, the average retirement savings of baby boomers is inadequate.

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