The good news is that there are some markers, checkpoints on the racecourse so to speak, that folks can use to figure out whether they are close to the finish line. It's not exhaustive, but here are five of the more important markers.
1. The financial capital-to-living expenses ratio
How much money do you have set aside? You'll need, all in, at least 15.7 times your pay in your nest egg to fund your living expenses in retirement, according Hewitt Associates' Retirement Income Adequacy at Large Companies: The Real Deal 2010 study.
Happily, part of that 15.7 will come from the net present value of your stream of Social Security benefits, which Hewitt estimated to be 4.7. Thus, you'll need only at least 11 times your pay set aside in your defined contribution plan or other accounts earmarked for retirement. And, the "number" goes down a bit more if you have a defined benefit plan. That counts for 2.1 times pay on average. So, if you have a defined benefit plan, you'll need just nine times your pay to fund your retirement.
One bright spot about Hewitt's number of 15.7 is this: It reflects an explicit assumption that employees will bear the cost of post-retirement medical care, and that medical costs will increase at a rate greater than general inflation. Speaking of expenses, most experts say getting a handle on all your expenses, not just health-care costs, is a must-do for your checklist. Read Hewitt's study here.
Other firms, meanwhile, put the number at 10 times your salary. According to a Lincoln Financial Group study, would-be retirees should aim to have at least 10 times their income at a typical retirement age. There is, however, a caveat. "While the 10X score can help people gain perspective on the need for retirement planning, it's important to note that this is a baseline number and should only be used as a conversation starter," said Chuck Cornelio, president of the defined contribution business for Lincoln Financial Group.
Cornelio said savers should discuss their 10 times pay number with a financial adviser to determine whether this number fits their savings needs, or should be adjusted based on their individual circumstances.
Read the Lincoln Financial Life Stages Study here.
By the way, don't feel embarrassed if you haven't hit the 10X or 15.7X number. Hewitt said most employees, at least at large firms, were on track to replace just 85% of their predicted retirement income needs. So, if you have designs on hitting the number, read the Lincoln study, which also contains some tips from those who have set aside 10X pay on saving.
If you're behind the eight-ball and don't have time to read those tips, consider this quick rule of thumb. Russell Investments recommends that each year a defined contribution plan participant should be saving a percentage of salary equal to 30% of his or her final income replacement rate, net of Social Security income. Read Russell Investments' What's the Right Savings Rate report.
2. Could you withdraw just 2% per year and maintain your lifestyle?
Many financial advisers say you can safely withdraw 4% on an inflation-adjusted basis from your retirement accounts over the course of your lifetime (or least 30 or so years of retirement) without fear of running out of money. Well, a study published in the Journal of Financial Planning disputes that rule of thumb and is creating lots of debate and discussion among financial professionals.
According to Wade Pfau, Ph.D., an associate professor of economics at the National Graduate Institute for Policy Studies in Japan, the percent that you can safely withdraw and not outlive your financial capital is probably much closer to 2% than 4%.
The reason being this: There's a new normal. The current dividend-price ratio or dividend yield and the ratio of current stock price to average real earnings over the previous 10 years, what is often referred to as the PE10 or CAPE, don't bode well for future stock market returns. And that means retirees will likely need a new "maximum safe withdrawal rate" that's lower than the 4% that was used when market valuations were lower and dividend yields were higher. "Although the 4% rule could possibly work out for recent retirees, it certainly cannot be considered safe in light of the unprecedented market conditions of recent years," Pfau wrote.
Read Pfau's paper, "Can We Predict The Sustainable Withdrawal Rate for New Retirees?" here.
By the way, one reason why you might want to dial down the withdrawal rate has to do with longevity risk, or the risk of outliving your assets. "While many people base their longevity on the average life expectancy, there is a possibility that they will live well into their 90s," said Sandra Timmermann, the director of the MetLife Mature Market Institute. "The 85-plus population is the fastest growing age segment in terms of percentage." See MetLife's Retirement Readiness Workbook here.
By having a too-aggressive withdrawal rate, one runs the risk of perhaps not running out of money, but certainly having to reduce their standard of living should they live past average life expectancy. "Flexibility in taking the income stream — say in black swan-type markets — is also an important conversation," said Thomas L. Howard, a certified financial planner with Harris Bank.
3. Can you still work?
It might seem like a contradiction, but do you have the skills, knowledge, experience and health to keep working past age 65? If not, you might explore how to get re-employed or stay employed. For some, that might mean going back to school. For others, especially those who don't have a clue about what to do in their retirement years, it might mean reading "What Color Is Your Parachute? For Retirement!" and going to such websites as RetirementJobs.com and RetiredBrains.com.
And don't think that you'll be the only person working during your retirement years. The data suggest that many folks ages 65 to 70 are still working, generating about 40% of their total income from 1099 and W-2 employment.
John F. Hochschwender, a certified financial planner with RTD Financial Advisers, had these thoughts and questions: "Is there a second career that you have always wanted to do? The question is: Can you make that happen now and would they get enough income from a career that may pay less money but be more rewarding? We have had many clients that have continued to work in new professions or in their current profession with fewer hours well into their 70s and were very happy doing it. By continuing to work part-time they also have more 'fun' money."
4. What will you do?
Hochschwender also said it's wise to start with the end in mind — your goals. "Do you have clear vision of your life in your 60s, 70s and 80s?" he asked. "Where do you want to live and what do you want to do? Many times we have discussions over multiple years until a potential retiree has enough of a vision to make it happen."
Yes, many folks retire without having given much thought to what they might do with all their free time. According to some studies, many retirees spend their time gardening, travelling and spending time with family and friends. If you don't have a good sense of how you will spend your free time, now would be a good to add this to your scorecard and check it off.
For his part, Will Prest of Transamerica Retirement Management said, it's important that you are being emotionally ready to leave work and all your social and time management ties there. "Think through how this transition will affect you," said Prest.
Others agree. "Have a retirement plan for your lifestyle," said Timmermann. "What will inspire you to look forward to every day?"
Part of this exercise means getting a sense of who you are, what you are about and what you want to leave as your legacy — and not just the financial one. "Values dictate working, hobbies," said Howard. "Meaning and vitality in life are important considerations for me in planning my and other's retirement."
5. Social Security, Medicare and employee benefits
Far too many people retire without a thorough understanding of Social Security, Medicare and their employee benefit package. For her part, Timmermann suggests that you calculate Social Security payments and the worthiness of deferring them until age 70 to get the maximum amount. "People should be aware that their payout will be reduced based on their income," she said. And, look at what Medicare covers, calculating the costs of Medicare supplement insurance and consider other costs that Medicare won't cover, such as dental care, eye care and long-term care.
Speaking of health care, check what if anything your employer provides, especially if you retire before becoming eligible for Medicare. "Will you need to replace health-care coverage now covered by an employer until Medicare kicks in?" Timmermann asked.
Consider also the value of working longer so that you can delay Social Security. That does three things: it helps you build more assets in your retirement accounts, it increases the amount you'll get from Social Security, and it shortens the length of time that you'll need to draw down your assets.
Lastly, plan for the unexpected. "Plan for the contingency that if one spouse or partner dies, the Social Security payout for the deceased spouse will be discontinued," said Timmermann. And don't forget to factor in long-term care needs.
No comments:
Post a Comment