How Much Do You Need to Retire?

By Kerry Hannon
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Jeffrey Jacobi, a Katy, Texas, air conditioning contractor, plans to retire soon. Or he did. He’s not so sure now, given the current economic crisis. The 66-year-old has been steadily socking away enough savings to let him and his wife enjoy the equivalent of 100 percent of their salary over three decades of retirement. But even so, he wonders, will it be adequate? “Until now, I was feeling pretty confident that I had done a good job preparing for our retirement, but now I’m worried that it’s not going to be enough,” he said. “Our retirement portfolio is down nearly 30 percent in the last month. With the Wall Street bailout, everything is so uncertain. And now they’re talking about a recession that could last anywhere from three to eight years.”

Jacobi is not alone. Call it the new retirement math. As recently as 2006, most financial planners routinely advised clients to put away around 70 percent of their final year’s pay for each year the life expectancy charts predicted they would live as a retiree. But even before the recent credit crunch and fears of a global recession hit, a new consensus was building, with many advisers and retirement experts tossing out figures closer to 110 percent and up.

According to a recent Ernst & Young report, middle-income Americans entering retirement now with savings equal to 59 to 71 percent of their preretirement wages will have to reduce their standard of living by an average of 24 percent to minimize the likelihood of outliving their financial assets. Those Americans seven years out from retirement are even less prepared, and the study estimates that they will have to reduce their standard of living by even more, an average of 37 percent.

“Many Americans envision a retirement where their lifestyle continues much as before,” said Tom Neubig of Ernst & Young. “Our work shows that this is often not a realistic expectation and that, with the current state of savings and potentially very long life expectancies, many retirees will have to cut back far more on expenditures than they expected.”

For people who don’t want to risk living on 70 percent of their current income, “the agonizing issue,” said Susan Stewart, president of Charter Financial Group in Bethesda, Md., “is that many have to save more, spend less and work longer before they retire.”

That’s the situation Jacobi finds himself in. He and his wife, Carole, a 61-year-old accountant, have been living well below their means for years. “We’ve never been big spenders and have worked hard to save enough to retire without worry,” he said. Plus, they have successfully paid off the mortgage on their home and hold the title to Jacobi’s workshop. Even better, Jeff thinks he can rent his shop out for a couple of thousand dollars a month. Sweet cash flow. “But you never know, it’s possible we could have another 30 years of living ahead of us. And any way you look at the economic picture now, it’s not going to be good.”

The Jacobis’ new savings target: 105 percent of their current annual earnings, multiplied by 30 years.

That’s a whopping amount to fathom, but it’s not as much as it first appears. The couple figure their current yearly living expenses clock in around $57,000, and their current retirement plan projections, combined with Social Security payouts, cover only that plus some wiggle room to enjoy some travel and address rising health care costs. So although Jacobi could have chosen to retire this year, he’s going to hang in there another three years, until 2011, just to be sure he will have enough.

“I don’t want them to fail in retirement, and so I’m extremely conservative and have created a realistic plan for them,” said financial planner Marc Schindler of Pivot Point Advisors in Bellaire, Texas, who has been guiding the couple through the process.

Planning early retirement?

Those eyeing an early getaway in their 50s will need even bigger nest eggs. Stewart had one client, a 54-year-old mid-level health care company manager living near San Francisco, who was earning around $60,000 a year until a year ago. In March she arrived at Stewart’s office, via a friend’s recommendation, in distress. She had decided to retire early with the blessing of a former financial planner. She had roughly $400,000 stockpiled in her 401(k) and $300,000 in equity built up in her home. The planner advised her to roll all the 401(k) proceeds into an IRA that was structured so she could begin taking periodic annual distributions without the 10 percent penalty.

So she did. She reasoned she could do that until it ran out, then maybe she’d be old enough to collect Social Security and tap into the equity in her home via a reverse mortgage. But it soon became clear that her portfolio was too small to support her.

Falling markets had slammed the woman’s retirement account. “I simply told her she had to go back to work, even at the cosmetics counter at Macy’s, where she could get some health insurance at least,” Stewart recalls. “Not what she had expected to hear, but I’m not a magician. To retire early today, you need to have substantial savings, enough so that the fluctuation in the stock market by 25 percent won’t cause you any material suffering beyond the mental angst it induces.”

In the good old days, living on 70 or 80 percent of current annual earnings was a reasonable figure for many because the cost of living was expected to decline for the majority of retirees. Children were grown; taxes were reduced; transportation costs to and from work and other job-related expenses were erased. Moreover, retirees were likely to sell the family home and move to smaller quarters in a part of the country with a lower cost of living. Sure, they might do some traveling initially, but with age and declining health, the assumption was that travel, too, would level off. And for many, it all held true.

A new financial world

But the times, they are a-changin’—at a perilous speed. The new financial world of retirement that boomers are facing is drastically different from yesterday’s, and it is rapidly roiling every facet of a retiree’s life planning. Some of the factors at work:

• We’re living longer. New medicines and technology have ratcheted up life expectancies. Most people may be facing two or three decades of retirement, and so the basic cost of living rises in tandem with an extended life span.

• Inflation is rising. Multiply your extended retirement years by increasing inflation—this year, nearly double-digit—and paying your basic living expenses on a fixed income looks harder and harder. In July, for example, the annual increase in overall finished goods (producer price index) was 9.8 percent, the biggest 12-month jump since the early 1980s, according to Bureau of Labor Statistics industry data. No one knows how long this might last, but “at that level, inflation will erode our savings very quickly,” Jacobi says.

• Pensions are declining. Workers are increasingly leaving the workforce without the cushion of a defined benefit plan, in which an employer provides a specific income for retired employees, either as a lump sum, as a pension or as a lifetime annuity. A mere 20 percent of U.S. private industry workers participate in such plans now, down from 80 percent in 1985, according to the Bureau of Labor Statistics. Instead, they rely on their own savings in a tax-deferred 401(k) plan, matched only partially by employer funds. Retirement funds like 401(k)s and IRAs are also typically invested in stock and bond funds, which are subject to the fluctuations of financial markets. In recent months, that has been terrible news for retirement portfolios, which have been reduced by 30 percent or more in some cases.

• Home equity is harder to tap. House values have taken a drubbing in many parts of the country. And even if yours hasn’t, selling might be harder, as mortgage lenders have tightened up their lending requirements for would-be buyers. Stewart says some “brag that they aren’t worried about their retirement savings, because they have a million dollars waiting for them in the value of their home.” But she warns them that they need to be prepared for the possibility that it might not be easy to pull that money out of their house when the time comes.

• Medical care costs are out of control. This is the biggest, most frightening unknown. While the good news is that we are living longer, the bad news is, it is costing a lot more to do so. Retiree health benefits have been slashed at many corporations and a growing number of employers are eliminating health care coverage for future retirees altogether. Barely one-third of all workers now expect to have access to employment-based health insurance in retirement, down from 42 percent as recently as 2007, according to the most recent survey by the nonprofit Employee Benefit Research Institute (EBRI).

“These results show the impact of rising health care costs is widespread and growing,” said Dallas Salisbury, president of EBRI. In addition, more than half of Americans with health insurance coverage (55 percent) reported an increase in the costs they are responsible for paying under their plan in the past year, the survey found.

At the same time, medical expenses themselves are climbing rapidly. For instance, long-term costs associated with illnesses such as Alzheimer’s have the potential to wipe out retirement savings. Medicare insurance covers less and less. A single, healthy man currently age 65 will likely need $331,000 in savings to cover health insurance premiums and out-of-pocket expenses in retirement, according to a new computer simulation analysis by EBRI. A couple in the same age range will need $635,000. And those figures do not include long-term care insurance if that is needed.

Save, save, save

It is little wonder, then, that advisers like Schindler are pressing their clients to save as fast and furiously as they can. But how much is enough? What percentage, or multiple, of your final salary do you need to have saved to provide enough income to last throughout retirement at something close to your current lifestyle?

There is no easy answer anymore. It all comes down to each individual’s circumstances, and, in many ways, outlook on life. There are the easier variables—your spending, retirement age, asset allocation, health insurance plan—and there are the tougher ones, such as how long you will live. What are your health risks? (Is cancer prevalent in your family? Heart disease?) Are you really willing to forgo traveling and eating out or buying new clothes? Do you want to leave money for your grandchildren? Are you willing to work if you find there really isn’t going to be enough to live on? How comfortable are you with risk—the odds that at a robust 85, the value of your investments will shrink in a roller-coaster market swing? Those are personal questions that literally no one else can answer for you.

“The number is different for every individual, which is part of the challenge,” EBRI’s Salisbury said. “This is no longer a one-size-fits-all calculation.”

And that’s why it’s more important than ever to force yourself to take a hard look at your retirement plan. Regrettably, about half of workers say they or their spouse have not even tried to calculate how much money they need for a comfortable retirement, according to EBRI’s 2008 Retirement Confidence Survey. Take off your dreamer’s hat and be realistic, Stewart urges clients. “Focus on your current financial assets, not future assets, such as funds from the sale of a home or boat. Figure on annual returns in the 4 to 6 percent realm, not 10 or 15 percent. This is the time to be ultraconservative in your financial planning. Always presume the cost of living is going to go up in retirement, never down. You won’t regret it,” she counsels. “Overfunding for consumption is your least painful option these days.”

Surely no one wants to wind up a pauper at 80, but before you get all panicky about the hard numbers, take a deep breath—you should consider some of the cosmic questions, too, says Lee Eisenberg, author of The Number: A Completely Different Way to Think About the Rest of Your Life. He suggests that people go beyond the basics of food, shelter and health care and really think about what they want to be and do as retirees. “Ask yourself, what am I going to need money for? What kind of life do I want to live that will bring satisfaction and a sense of meaning?” Eisenberg said. “People have to wrestle with what really matters in their life before they will know how much money they will need. It’s not about a couple of clicks on a calculator and boom you’re done. Your current lifestyle might not be your best lifestyle.”

If you’re nearing retirement and feeling unprepared, don’t fret. Here are some steps you can take:

Face the numbers. Gather up your financial records: your current 401(k) and bank statements, your estimated Social Security benefit and your projected pension payout, if your company still offers one. Next, visit AARP’sretirement calculator, or a mutual fund site such as Vanguard or Fidelity and tap into theirs. You could also confer with a fee-only financial adviser. Get referrals for planners near you through the National Association of Personal Financial Advisors, the Garrett Planning Network, or use the search tool at the Financial Planning Association.
Play catch-up. You can set aside a maximum of $15,500 in your 401(k) in 2008—and add a “catch-up” for another $5,000 if you’re 50 or older. And most employers make matching contributions, typically 50 percent to the first 6 percent of your salary. That’s free money you shouldn’t forgo.

The standard IRA contribution limit for 2008 is $5,000. Taxpayers who are 50 years or older at the end of the current year (2008) can make an extra $1,000 contribution for a total of $6,000.

Extend your stay. If you’re concerned about coming up short, working for an extra two to three years would substantially improve the retirement security of most workers, according to the Center for Retirement Researchat Boston College. The upside: Your employer picks up the tab for your high-priced health benefits for a while longer, while you continue to sock away money in your retirement accounts. Moreover, you have fewer years in retirement to draw down your savings.

Delay Social Security benefits. Let’s say, for example, you qualify for full benefits of $1,901 a month at your normal retirement age of 66, but you decide to begin collecting your benefits at 62. Your retirement benefits will be reduced for the rest of your life—to $1,433 a month, because you’ll be collecting a smaller benefit for a longer period of time. However, if you postpone collecting benefits, you will receive an 8 percent credit for every year beyond your normal retirement age until you reach 70, when your maximum benefit would be about $2,509 a month—a $1,076 difference that will last your lifetime. To run your personalized numbers, go to the Social Security Administration’s online calculator.

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