How much of your retirement
planning is based on wishful thinking?
It's a question more people
need to ask themselves as they approach later life. Developing a
successful retirement plan is both an art and a science: sketching out how
you wish to spend your time after leaving the office, and estimating what
your income and expenses might be. Some information is relatively easy to
find; Uncle Sam, for instance, sends you a letter each year that forecasts
the size of your Social Security check in retirement.
But some answers -- about nest
eggs, taxes and long-term care -- are harder to come by. And that's where
people can end up deceiving themselves.
"We're not exactly a
nation of savers," says Rande Spiegelman, vice president-financial
planning at the
Schwab
Center
for Investment Research, a division of Charles Schwab Corp. Thus, "we
are in denial, to a certain extent, about retirement planning," Mr.
Spiegelman says. "Maybe we need a reality check."
We asked financial planners,
educators and economists across the country to share with us some of the
most risky assumptions -- or outright lies -- that people are crafting as
they approach retirement. The thinking usually goes something like this:
"I might not be in the best shape when it comes to planning for later
life, but that's OK because..."
"I'm going to work
in retirement."
The idea of working in later
life is one of the most prominent features of what's frequently called the
"changing face of retirement." A number of surveys have shown
that about two-thirds to three-quarters of baby boomers expect to work for
pay after retiring. It certainly sounds good; staying active as we age can
promote mental and physical health. And the added income, obviously, could
help patch any cracks in your nest egg.
The problem is that you might
not be able to work in retirement. You might develop health
problems; you might not find the kind of work you want, or jobs in your
area could be in short supply. Indeed, many workers in their 50s and 60s
are having a tough time keeping the jobs they have -- never mind finding
new jobs in retirement. A study published this year by McKinsey & Co.,
a consulting firm, found that 40% of surveyed retirees had to stop working
earlier than planned, a consequence primarily of layoffs and poor health.
Predicting what boomers
actually will do as they age is always a chancy exercise. But one way to
gauge expectations about working in retirement is to look at the
experiences of people who have already collected their gold watch. A
survey published earlier this year by the Employee Benefit Research
Institute in
Washington
found that just 27% of surveyed retirees had ever worked for pay while in
retirement. A similar study published in September by the
Pew
Research
Center
, also in
Washington
, found that only 12% of current retirees are collecting a salary.
REALITY CHECK: For the
moment, "there's a big disconnect between what people say they
will do, or might do, versus what people are doing," says Cary Funk,
senior project director at the Pew Center.
Yes, that could change: The
sheer size of the baby-boom generation could mean that more boomers, in
contrast to their parents, will end up working in retirement. But if
you're counting on a paycheck in your 60s and 70s to help compensate for
inadequate retirement savings, you could be in for a nasty surprise.
"My home is my
safety net."
To listen to many people in
the 50-plus crowd, they have little to worry about when it comes to
financing their retirement. That's because they can always turn to the
equity in their homes.
A recent study by Spectrem
Group, a consulting firm in
Chicago
, found that almost two-thirds of affluent baby boomers (with investable
assets of at least $500,000) intend to finance their retirement by selling
their homes. That should come as no surprise; housing prices in many
locales have skyrocketed in recent years. (The median value of the primary
residence among Americans age 55 to 64 rose to $200,000 in 2004 from
$139,000 in 2001, according to the Federal Reserve.)
The home-as-piggy-bank
strategy, though, may not be as easy or attractive as it first appears.
Most people have two options:
trade down to a smaller, less-expensive home, or borrow against their
equity. The first option, in theory, will result in lower annual expenses
and a nice addition to your nest egg (if you walk away with a profit).
Most Americans, though, wish to remain in their homes and communities as
they age. Selling might sound good today, if you're several years from
retirement. But when the time comes, will you actually want to pack up and
move? And will you be able to adjust to a smaller residence?
Borrowing against your home,
meanwhile, could be tricky. If interest rates rise in coming years, the
value of your property could fall, meaning you may not be able to pull as
much money from your home as you wish. Reverse mortgages are attracting
more borrowers, but fees are high, and many loans are capped. (Depending
on your age and where you live, a $300,000 home might yield $115,000).
REALITY CHECK: "A
home is not a panacea for shortfalls in retirement savings," says
Andrew Eschtruth, an associate director at the Center for Retirement
Research at
Boston
College
. At best, "you can tap only a portion of your equity," he says.
If you decide to trade down,
the sooner the better. Given that many retirements today will last 20
years or more, it's never too early to reduce expenses and shore up
savings. If you plan to apply for a reverse mortgage, think of those funds
as a last resort -- to help pay for medical bills or long-term care -- and
not as money for groceries or vacations.
"I can live on 70%
or 80% of my pre-retirement income."
It's among the most frequently
heard maxims in retirement planning -- and among the most misleading.
Ask yourself: Will you be able
to live the life you want in retirement on 20% to 30% less income than you
have right now? The key phrase in that question is: "the life you
want." Beyond generalities ("I plan to travel more"), most
people don't think about how they want to spend their time in retirement,
and thus have no idea how much income or what size nest egg they will need
to support themselves in later life.
Yes, some expenses -- like
commuting and wardrobe costs -- will drop off after we leave the office.
But many costs will increase in later life -- for travel, home improvement
and, most important, health care. All of which means you could be spending
just as much, if not more, in retirement as when you were working.
(There is one group of people
who can safely follow the 80% guideline: "If you're saving 20% of
your paycheck, then the 80% rule works fine," says Mr. Spiegelman at
Schwab. "But most people aren't saving anything close to that.")
The most telling evidence
regarding income needs in retirement comes from current retirees. Fully
55% of surveyed retirees, according to research published earlier this
year by the Employee Benefit Research Institute, said they were living in
retirement on 95% or more of their pre-retirement income.
REALITY CHECK: Adolph
Neidermeyer, professor of accounting in West Virginia University's College
of Business and Economics, who has studied income needs in retirement,
says the most important step would-be retirees can take is to put pencil
to paper.
"There needs to be a
detailed projection of spending in retirement," Dr. Neidermeyer says.
"It has to be documented. And it should take place as early as
possible -- ideally, by your mid-50s."
"My taxes will go
down in retirement."
They might. But chances are
good you'll end up in the same tax bracket, if not a higher one, once you
leave the office.
The explanation is tied to the
likely source of your income in retirement. With fewer employers today
offering pensions, many people in later life will turn to their 401(k)s
and individual retirement accounts for the bulk of their money. Any
dollars withdrawn from these accounts (with the exception of Roth IRAs and
Roth 401(k)s) are taxed as ordinary income, which means you could be
paying as much as 35% to Uncle Sam.
In short, "if you need as
much money in retirement as when you were working, you could end up in the
same tax bracket," says Barry Kaplan, a certified financial planner
with Cambridge Southern Financial Advisors in
Atlanta
. The numbers "don't go down as significantly as people think they
will."
Other factors may conspire to
keep taxes in retirement higher than you imagined. If you pay off your
mortgage before retiring -- normally a prudent move -- you may find that
you no longer can itemize deductions on your income-tax return, Mr. Kaplan
notes. As much as 85% of your Social Security benefits could be taxable.
After age 70½, you're required to withdraw funds from your retirement
accounts, generating still more taxable income. And in many areas,
property taxes may continue climbing.
REALITY CHECK: We
always hear about the importance of diversifying our investments. But it's
just as important to think about diversity in terms of taxes -- having
several different accounts you can tap for retirement income, says Clark
Randall, a certified financial planner with Lincoln Financial Advisors in
Dallas
.
"Putting all your
money in a traditional IRA or a 401(k) is risky," Mr. Randall says.
"You could end up a 'tax prisoner' in retirement -- stuck with one
source of income." That's why it's important, he explains, to invest
in Roth IRAs and Roth 401(k)s, among other products, to help minimize the
tax bite in later life.
"I'm comfortable
with debt."
Older adults today, unlike
previous generations, are carrying unusually high levels of debt --
juggling mortgages, credit-card balances and installment loans. According
to new research by Dr. Neidermeyer in West Virginia, 45% of people in
their 60s were still carrying a mortgage in 2000, up from 34% of that age
group in 1980, and 20% were carrying a second mortgage in 2000, up from
just 7% in 1980.
The problem: When medical
bills kick in during later life, as they are wont to do, you could end up
carrying the equivalent of yet another mortgage in retirement, says
Charles J. Farrell, a partner at Dorman Farrell LLC, a financial
consulting firm in
Medina
,
Ohio
.
According to Mr. Farrell's
calculations, a couple retiring today could easily incur annual
health-care costs of about $7,000. That includes about $2,400 for Medicare
Part B premiums; almost $800 for Medicare Part D; almost $2,800 for a
supplemental Medicare policy; and about $1,000 in out-of-pocket costs (for
basic prescriptions and doctor visits). Toss in premiums for long-term
care insurance, and the total could hit $9,500 to $10,000 a year.
That would seem to be a major
incentive to pay off your mortgage (and most other debt) before you begin
living on a fixed income. But most people don't recognize the costs
associated with health care in later life, or how cash flow in retirement
can be disrupted.
"The timing [of your
retirement] is so important," Mr. Farrell says. "If you retired
in 2000 -- just before the markets fell -- and you were carrying a lot of
debt, that really put you behind the eight ball."
REALITY CHECK: One way
to begin preparing for health-care costs in retirement is to open a health
savings account. This tool allows people with high-deductible health plans
to save pretax dollars -- and eventually withdraw the money tax-free -- to
pay for Medicare Part B premiums, qualified long-term care premiums and
out-of-pocket medical bills, among other expenses.
"My spouse is
taking care of everything."
In many households, one person
pays the bills, manages the money and oversees planning for retirement.
And just as often, that person's spouse is more than content to remain
financially detached.
If that describes your
relationship, ignorance is not necessarily bliss.
The risks of one person
holding the reins should be obvious: If the spouse handling the retirement
finances becomes incapacitated or dies -- or if you and your spouse
divorce -- the person who's been left in the dark could face retirement
with little or no savings and no idea how to make up the shortfall. But
many couples are approaching later life in just that fashion. Frequently,
the victims are women.
"In general, women still
aren't adequately prepared for their own retirement," says Emily
Sanders, president and chief executive of Sanders Financial Management
Inc., an advisory firm in Norcross, Ga. "They tend to put off
thinking about it because they're so busy taking care of other people --
first the children, and then elderly relatives."
A common mistake, Ms. Sanders
says, arises in divorce cases, where a wife will agree to give up pension
benefits in exchange for keeping the house. "They don't want to
uproot the kids," she explains. But "they don't realize that
they're robbing their own retirement."
REALITY CHECK: Beyond
the basics (knowing where documents like wills and powers of attorney are
kept), both spouses should be aware of: the size and location of all
retirement accounts, investments and insurance policies; what funds are
being directed to retirement accounts and other investments; whether
beneficiary forms have been filled out for all accounts and whose names
are on those forms; any and all debt; and how much money might be
available from Social Security.
"I'm going to get
an inheritance."
Yes, you might. But chances
are good it will be smaller than you think.
The numbers certainly sound
impressive: Paul G. Schervish, director of
Boston
College
's Center on Wealth and Philanthropy, estimates that as much as $41
trillion could be passed down through estates in the
U.S.
during the next five decades. But then there's the fine print. About
two-thirds of the amount transferred will be concentrated among the
wealthiest 7% of estates. ("It's top-heavy, as all wealth is,"
Dr. Schervish says.) And a good chunk of the money will go to taxes,
settlement costs and charity.
Those factors will reduce the
amount of money that boomers may inherit during the next several decades
to about $7.5 trillion. The whittling, though, doesn't stop there.
Boomers' parents are living longer, and much of their money will go to
annuities, health costs and long-term care expenses. In short, the odds of
your seeing a windfall are slim.
A study published earlier this
year by AARP, based on the Federal Reserve's most recent Survey of
Consumer Finances, found that only 15% of boomers today anticipate
receiving an inheritance. Among those boomer households that had received
an inheritance by 2004, the median value was $49,000.
REALITY CHECK: If you
do receive an inheritance, the amount will likely be less than six
figures. "That might help remodel your home or get your kids through
college," Dr. Schervish says. "But for the vast majority of
people, it won't solve their retirement issues."
"I'm going to get a
pension -- and it's safe."
It's one of the more
mystifying assumptions in retirement planning: the firm belief among many
workers that they will receive a pension check in retirement -- even
though hundreds of pension plans nationwide are underfunded, and growing
numbers of companies are freezing or eliminating benefits.
Research published earlier
this year by the Employee Benefit Research Institute found that 61% of
surveyed workers anticipate receiving money from a pension in retirement.
But only 40% of working couples currently are covered by such plans. And
even though more and more companies, including giants like General Motors
Corp., International Business Machines Corp. and Verizon Communications
Inc., are cutting or freezing benefits, almost 70% of workers in the same
survey said they were very confident or somewhat confident about their
financial prospects in later life.
Today, insured pension plans
nationwide are underfunded by about $350 billion, according to the Pension
Benefit Guaranty Corp. (The federal organization guarantees the payment of
basic pension benefits -- if the pension is insured -- up to an annual cap
currently set at $47,659.) If you're approaching retirement and have the
option of taking a lump sum from your pension or a monthly check, the
latter choice could be a risky decision if your company's pension plan is
ailing.
REALITY CHECK: Arthur
Conat, executive director at accountants Ernst & Young, says workers
need to take a "much more active role in their own retirement"
and ask several questions about their pension plans: How financially sound
is my employer? How well-funded is my plan? If my plan is not well-funded,
is my ability to earn additional pension benefits going to be restricted?
And if I plan to take a lump sum, will my plan's funding levels affect my
ability to take that money?
If you're lucky enough to be
covered by a pension, you can find out how to check on the health of your
plan at the Pension Benefit Guaranty Corp. Web site, www.pbgc.gov.
"I won't need
long-term care."
Actually, this is one
assumption where the odds are slightly in your favor. Many Americans won't
face large bills for extended care in later life. But those who do could
end up exhausting their retirement savings.
A study published earlier this
year in the health journal Inquiry by Lewin Group (a consulting firm in
Falls Church
,
Va.
) and professors at
Pennsylvania
State
University
and
Georgetown
University
projects that 65% of all people age 65 will at some point in the future
spend some time in their homes requiring long-term care. The good news:
Family members will provide much of that assistance. The not-so-good news:
Some 35% of 65-year-olds eventually will spend time in a nursing home,
with 5% staying more than five years.
And who will pay for that
care? About 45% of expenses, will be paid out of pocket, the authors
estimate. (Government programs and private insurance will pick up the
balance.) The average person would need to set aside $21,000 at age 65 to
pay those future bills, but 6% of patients will need to invest more than
$100,000 at age 65 to pay for future care.
REALITY CHECK: Every
family should make the possibility of needing long-term care a part of
their retirement planning. One possible solution -- long-term care
insurance -- is pricey and complicated. That said, some insurers are
starting to simplify policies, and more companies are giving employees the
option of buying long-term care insurance at the office.
"If your net worth is
less than $3 million, you need to consider long-term care insurance,"
says Ms. Sanders in
Georgia
. Even for estates larger than that, she adds, such policies "can
offer peace of mind."
