Friday, May 17, 2013

Have You Been Listening? Retirement is Broken.

If you aren’t aware that our retirement financing system in this country is broken, then you haven’t been paying attention. People have been shouting it from the rooftops for a long time now.

Google “retirement shortfall” and you’ll find a boatload of articles on the subject beginning a decade ago or even earlier. This shouldn’t come as a surprise to anyone at this late date.

How do we know it’s broken? Because most households will need to save at least $200,000 to maintain their pre-retirement standard of living after leaving the workforce and according to the Employee Benefits Research Institute (EBRI), only about 10% of workers will retire with that much. Almost one-half of Baby Boomers and Gen Xers were determined to be at risk of not having sufficient retirement income to cover even basic expenses and uninsured health care costs.

Lest you think this is a Baby Boomer problem, EBRI studies show that younger “cohorts” are even worse off.

Why haven’t people saved enough?  There are no doubt many reasons, but in general the problem is that out current “system” for retirement funding demands far more from most families than they can possibly save, investing skills that most don’t have, and a whole lot of luck.

Teresa Ghilarducci explained the problems quite well in “Our Ridiculous Approach to Retirement.” Wall Street money manager and former neurologist, William Bernstein put it this way in a Money magazine interview in September 2012:

“I did a little thought experiment in which I calculated how many years it took people starting work in different years to make their number. I realized that the cohort that started working during the worst of economic times is the one that did the best. The last cohort that actually was able to make their number started their careers in 1980, and they made their number in 19 years. And the graph ends in 1980, because no cohort that started work after 1980 actually made the number. “

In February 2011, the Wall Street Journal reported, “the 401(k) generation is beginning to retire, and it isn't a pretty sight.”

And in case you thought Social Security would bail you out, the New York Times ran a story on the prospects of living off the benefits alone.

It isn’t pretty, either.

Our retirement system is in deep trouble. It doesn’t work. And if you are still avoiding the issue, it isn’t because the media have been trying to keep it a secret. As two-time Pulitzer Prize-winning editorial cartoonist and columnist David Horsey recently put it, Time to Wake from the American Dream and Face Retirement Reality.

I’m not trying to scare you. . . well, maybe I am. If you’re still young I hope I scare you into saving every penny you can for retirement. As Bernstein says, “Save as much as you can as early as you can and don’t ever stop.” And who knows, conservative politicians have been trying to undo Social Security since it became law in 1935 and maybe one day they will.

If you’re closer to retirement, then scaring you isn’t going to help. There are things you can do, though.

Read my series, Inadequate Retirement Account (IRA), for ways to make the best of your situation.

Friday, May 3, 2013

Inadequate Retirement Account (IRA): Investing After You Retire

Note: This is the sixth and final installment of a series of posts with advice for the 90%-plus of American households that haven’t been able to save enough for retirement. The first post was Inadequate Retirement Account (IRA).

My feelings about post-retirement investment strategies (and for the decade prior to retiring, actually) for households who haven’t saved enough are based on four principles:

1.        If you weren’t able to save enough and invest successfully enough for retirement over three decades that featured the greatest bull market in history — while you were earning an income and not withdrawing from your portfolio — then it is unlikely that your previously unsuccessful investing skills are going to come to your rescue now.

If you found it difficult to accumulate wealth while you were working and adding savings to your portfolio constantly, you’ll find it tremendously harder to grow wealth with no additional savings coming in and constant withdrawals (spending) going out. To add to the pain, most economists forecast lower stock market growth ahead.

Over the past thirty years, you were in a sailboat with a strong, accommodating breeze. After retirement, you’re sailing into the wind and taking on water. There’s a world of difference.

2.        You should never, at any age, invest money in the stock market that you cannot afford to live without, because you may well end up having to.

You can lose money when you’re young and accumulating wealth without it having an impact on your standard of living. Losing wealth after you retire often means a permanent reduction in your standard of living. This is money you cannot afford to lose.

3.        William Bernstein says that after you win the retirement savings game, you should stop playing. I would add that once it becomes obvious that you can’t win, you should stop losing.

It takes a lot of stock market growth to improve your standard of living. One dollar of income per year for thirty years costs around $22. If you have minimal retirement savings, doubling that amount in the stock market probably won’t have a big impact on your standard of living, but losing half of it may.

The Bernstein recommendation is that you not risk losing your already-adequate retirement portfolio in a market crash just before you retire, as many households did in the 2007-2009 market crash.

4.        Retirees should first secure income to cover their non-discretionary spending needs, then set aside an emergency fund, and only then should they consider investing in the stock market.

Many economists recommend a “Floor and Upside” strategy, also known as the “Theory of Life-Cycle Saving and Investing”. In part, that theory recommends that you secure your non-discretionary retirement spending with safe investments (like government bonds) before investing what’s left over in riskier assets like the stock market.

In other words, when you go to Las Vegas, set aside enough cash for dinner and a plane ticket home and don’t bet from that stash. (Economists do, I confess, state this more eloquently.)

Retirees with inadequate savings, by definition, don’t have enough assets to secure a “floor” of spending that would let them live like they did before retiring, let alone having some left over to take to the casino.

When I consider my four principles, I conclude that retirees in this group should not invest any sizable portion of their wealth in stocks.

If you decide that you simply must bet on a better standard of living in the stock market — and I hope you don’t — then limit stocks to 40% or 50% of your portfolio at most and invest in low cost index funds. At least give yourself a fighting chance.

Ultimately then, my advice for households that have inadequate savings for retirement is:

·       Invest little or none of your savings in stocks after retirement
·       Begin investing less in the market about ten years before you retire
·       Make sure you have the equivalent of a couple of years of expenses saved in liquid assets for emergencies
·       Lastly, invest any additional savings in TIPs bonds and/or lifetime fixed annuities to generate a floor of secure income as best you can.

I realize that there are no attractive alternatives for safe income in the current environment, and that includes fixed annuities and TIPs bonds, but that won’t last forever. You have two choices in the meanwhile: take more risk or accept about zero percent interest for a while. Since zero gain is better than a loss, I’d wait. Keep your money in money market funds or short duration government bond funds until rates go back up.

So ends my six-part series of posts of retirement advice for the 90%-plus of American households who have been unable to adequately save for retirement. If you have lots of savings, then you have lots of options, but that’s usually the way things work, isn’t it?

That doesn’t mean there’s nothing you can do if you haven’t saved enough. In fact, it makes your decisions more critical. In a nutshell:

·       Work longer
·       Spend less
·       Manage your home equity and mortgage
·       Maximize your Social Security benefits, and
·       Don’t expect the market to save you.

How much difference can these decisions make? I ran a scenario through E$Planner Basic that consisted of a single male, age 60, who earns $50,000 a year and contributes 6% to his 401(k). His company matches 3%. He could retire at age 63 with a $12,708 per year standard of living. He could increase that amount 31% to $16,644 if he could work to age 66.

He could increase his standard of living 83% to $23,220 per year if he could work to age 70, but not many workers will be able to hold onto their job that long.

As someone commented on my last post, finding a competent, fee-only financial planner to help might be a great investment unless you're really good at these kinds of calculations. We're talking about tens or hundreds of thousands of dollars over your lifetime and you really need to get the decisions right the first time.

One last piece of advice: don’t beat yourself up if you haven’t been able to save the hundreds of thousands of dollars needed to maintain your standard of living after you retire. Fewer than one out of ten American families did.

Just make the best of it.

Thursday, May 2, 2013

Inadequate Retirement Account (IRA): Claiming Social Security

Note: This is the fifth installment of a series of posts with advice for the 90%-plus American households that haven’t been able to save enough for retirement. The first post was Inadequate Retirement Account (IRA).

If you have lots of money saved for retirement, then my advice to you for claiming Social Security benefits would be pretty straightforward — delay claiming your benefits until you are 70 if you are single or are married and have a larger benefit than your spouse, and delay claiming until your full retirement age if you have a smaller benefit than your spouse. But, this is a series of posts for people who haven’t saved enough for retirement and that’s more complicated.

If you had lots saved for retirement, you could retire and live off your savings while you waited for your Social Security benefits to grow about 8% for every year you postponed claiming. That’s a deal that’s too good to pass up if you can get it.

Without huge savings, postponing claiming benefits probably requires working longer and, as I explained in my post Inadequate Retirement Account (IRA): Working Longer, that decision isn’t always up to you. Half of recent retirees report that they were forced to retire earlier than they had planned by unforeseen layoffs, closings, health problems or a need to care for family members.

With inadequate retirement savings, chances are very good that you will need to claim your benefits long before you turn 70, but I still recommend that you postpone as long as you can hold out.

I know that many people believe they should collect Social Security benefits at the earliest age (62), but that isn’t a wise decision for healthy people. Usually the basis for this belief is that Social Security benefits might be taken away at any time so you need to grab them while you can, but those arguments aren’t convincing. 

Conservatives have been trying unsuccessfully to kill the program since it was created in 1935. When George W. Bush tried to privatize part of it in 2005, in his words, “I did more than touch the third rail. I hugged it.” There is no political will to end the program and even proposed changes have always considered grandfathering for current participants.

The second argument for claiming early is that the break-even age is around 80. If you don’t live that long, you will receive less money by claiming later. I've heard many people say, "Heck, I probably won't live to 80, so I should take the money now."

I have no idea how those people know when they're going to die.

On the other hand, if you claim early and live longer than about age 80, you will receive far less in benefits. Since healthy people have no idea how long they will live, the best approach is to take the worst-case scenario (one or both spouses living a very long time) off the table by claiming as late as possible.

If claiming your benefits at the earliest possible age whether you absolutely need them or not will help you to sleep at night, go for it. But be forewarned that it isn’t the best bet from a financial risk-reward perspective. Many elderly widows will tell you that having their husband claim benefits at the earliest age possible was the worst financial mistake of their life.

T. Rowe Price has an online calculator that lets you play with a few different scenarios to find the best age to claim benefits for you (and your spouse, if married). I used it to calculate cumulative lifetime benefits for a married couple of the same age. The husband expects $2,300 a month in benefits at full retirement age and the wife expects $1,940 in monthly benefits at full retirement age.

If both spouses claim at the earliest age (62), and the husband lives to age 83 and the wife to 95, their cumulative lifetime benefits total $1,050,000.

If both spouses claim at the latest age (70), and the husband lives to age 83 and the wife to 95, their cumulative lifetime benefits total 28% more, or $1,346,000. 

The wife’s survivors benefit would increase from $20,700 per year if benefits are claimed at age 62 to $36,450 per year if claimed at age 70 — a whopping 76% more!
(Now you see why those widows are complaining.)

Postponing Social Security benefits as long as possible is a very powerful way to maximize your retirement income, and one of the few available ways if you have limited retirement savings.

Of course, maximizing Social Security benefits can be far more complicated than this example, and more complex than the T. Rowe Price website tool can handle. For example, the optimizers told me that my wife should claim and suspend benefits at age 66 and I should simultaneously claim spousal benefits. Two years later, my wife should claim her own benefit. Two years after that, I should file for my own benefit. As you can see, optimizing benefits can be very complicated. You’ll probably need help.

The company that provides the E$Planner software I mentioned in previous posts in this series also provides a package entitled Maximize My Social Security. While the T. Rowe Price tool is free, Maximize My Social Security currently costs $40. An alternative is to work with a financial planner, but that will likely cost more than the software. Reuters describes a number of other sources of help in this article, including AARP’s free tool.

My recommendations for claiming Social Security, which apply equally to those who have saved enough for retirement and those who have not, are first to not claim benefits at age 62 if you can live without them. And second, use one of the tools mentioned above or contact a financial planner to make sure you will get the maximum benefits to which you are entitled.

That leaves us one topic, investing, to conclude this series of posts on retiring with inadequate retirement savings.