3. Live Well and Pay the Bills
When you were young, you wanted to live forever.
Now you’re afraid you just might.
—Wachovia Securities advertisement
As a boomer professional, you are likely counting on pension, savings, and health programs from your employer to sustain you in your retirement, whenever that occurs. Combined with your personal savings and social security, you reasonably expect retirement to be an enjoyable and secure phase of your life.
However, boomers often underestimate their financial needs and overestimate their prospective retirement resources. Research and experience suggest that you need to take a fresh look at your financial situation and plans so that you can live well and pay the bills for decades in your future.
This chapter provides information that will help you think about your retirement income requirements, your prospective retirement income and assets, and gaps that you may need to bridge either through working, saving and investing more, or by adjusting your spending. Viewpoints typically expressed by boomer professionals highlight several sections, followed by factual information that will prompt your thinking about choices you need to make. This information may be astonishing news for you. Or you may have heard of these trends but did not fully consider their implications for your personal financial planning.
“I am targeting income of 80% of my pre-retirement income to support my needs once I retire.” Actually, you may find that your boomer lifestyle will require more disposable income than less. If retirement is your chance to enjoy the good life, you should target higher income.
Your first question should be, “How much income do I need to live well for the rest of my life?” The answer depends on your specific needs and the standard of living you seek to maintain. When you retire, your lifestyle and associated spending patterns may change. To answer the question, you could start from scratch and project what you anticipate your living expenses will be when you retire. Will you be living in the same city or same house? Look at what you are spending today and project to the future what you expect you will spend in retirement. Typical spending categories are the following:
• Health care insurance and out-of pocket medical and health care expenses
• Housing (rent or mortgage, taxes, maintenance, insurance, and so on)
• Food
• Personal care
• Transportation (car payments, insurance, maintenance, other transportation)
• Care of family members (elderly parents, children, and so on)
• Travel
• Entertainment and hobbies
• Charitable gifts
• Fee and tuition for education and lifelong learning
• Other expenses and miscellaneous contingencies
These categories are listed approximately in order of importance—or degree to which they are basic, fixed expenses versus variable, discretionary expenses. These estimates can give you the starting point in creating a budget to guide your spending when you retire, and will give you a reference point in evaluating the adequacy of your retirement income and assets. Health care is important in boomers’ minds because of the rising costs and the potential need for health care or long-term care.
You may think that your life will be simpler and less costly after retirement or if you work less. Certain living expenses may be lower or eliminated, such as commuting, business clothing, non-reimbursed travel and entertainment expenses, income taxes, life insurance premiums, and savings. Boomers’ parents tended to reduce their costs of living upon retirement. They kept the same car, television, hi-fi, and other things they had for 20 or more years. Most expected to cut back on vacations, travel, and major purchases. Consequently, the conventional wisdom they conveyed is that you should plan on retirement spending to be equivalent to 70% to 80% of your pre-retirement levels.
You may not want to change your consumer habits when you retire. Boomers, especially professionals, have demonstrated a tendency to spend freely and enjoy the good life they have been accustomed to. Many feel that this is their time to “let loose” and enjoy life more because they cannot anticipate how long they will live. Rather than thinking about leaving money for children or charities that they supported in the past, many are prepared to focus on themselves. Boomers are a consumer generation like none before it. Also, you may be active, with high living expenses well into your seventies, far longer than your parents imagined.
It is reasonable to expect that you will spend more, rather than less in retirement. Early in your retirement, you may satisfy pent-up desires for traveling, remodeling, relocating, buying a boat, or other activities that involve new expenses. And even small but frequent spending habits are significant. Remember the “latte” factor: If you buy a Starbuck’s latte every day, over the years it adds up to thousands of dollars!
Given what we’re learning from boomers who have already retired, a target of 100 to 125% of your income may be a more realistic goal for your retirement, particularly in your early retirement years. As you grow weary of discretionary or costly leisurely activities and choose to “settle down” into a quieter retirement routine, your expenses may decline. But this may not happen until you are age 75 or later.
My suggestion is to assume that you’ll need a 100% replacement rate. If you end up having more than you actually need, you’ll be in better shape.
—Olivia Mitchell, Professor and Director, Pension Research Council, Wharton School, University of Pennsylvania
Are you willing to change your lifestyle and future plans in order to reduce costs? Are you ready to downsize? Your financial planning needs to be based on your lifestyle and needs. If you know where you will be living in retirement and have a plan for what you will be doing, you can adjust your plans for annual spending. Focus first on what is important to you and what your expenses will be. Then you can adjust your plans to match the income you have available.
Joanne, for example, realized that a large portion of what she was spending was related to keeping up with what her friends were doing. In addition, she entertained work colleagues at her home and often treated her employees to meals in appreciation for their efforts. She realized that such discretionary spending, when totaled, represented a significant amount of money which she could not afford to lay out once retired. Although she remains in touch with former colleagues and coworkers, she now hosts potlucks instead of footing the bill herself. In addition, she no longer has to keep up with the Joneses because they also retired and discovered that they also have less ability to spend at will.
You may face a complicating factor that is becoming very common for boomers: the three-generation “sandwich.” Frank is supporting a 90-year-old mother still living in her own home, while also caring for a son in high school and two daughters in college. “How am I supposed to be putting money away, when we’re doing all this? For many boomers, the sandwich drains resources at just the time that retirement assets should be accumulating most rapidly—in the years during which earnings usually peak. Today, nearly 50% of people in their sixties have at least one parent who is still alive, versus 7% or fewer a century ago. The cost of residing in a senior living facility ranges from $5,000 to $10,000 per month. It is far less costly to support seniors living in their home. Also many elder services are now available in communities to enable, indeed encourage, seniors to remain in their homes as long as possible.
Additionally, nearly half of all families today have a child older than age 18 living at home at one time or another. For some boomers this is attractive, keeping the family close and involved. Others consider this to be a good reason to downsize and move to a condominium. There are clearly advantages and disadvantages for parents, just as there are for the adult children.
“Until we get national health care reform, it looks like we’ll have to pay more and more on our own.” Health care will be a significant factor for many boomers. Costs have risen significantly and continue to rise.
While many boomers may be covered by company-paid health care benefits after they leave employment, this benefit may not continue. An AARP study showed that 40% of large employers provided retiree health benefits in 1993; however, by 2001 this had fallen to 23%. Further, boomers who shift to part-time or contract work often find themselves without employer plans and are on their own.
Many people are concerned about paying for medical care and outliving their savings/retirement funds. Watson Wyatt projected that future retirees will shoulder substantially more, if not all, of the costs of their health care in retirement. The firm estimates that the level of employer financial support will drop to less than 10% of total retiree medical expense by the year 2031. Instead, companies are working to focus retiree coverage on Medicare programs.
Medicare is becoming the primary health care insurance plan for most boomers. Compared to privately subscribed insurance, it is cost effective because it is subsidized by the government. Yet premiums for Medicare, supplemental insurance coverage, and Part D drug program coverage are all rising and are projected to continue to rise. Further, the Part D drug program has a big “doughnut hole” coverage gap, in which individuals must pay 100% of their drug costs until they meet a preset limit. This adds to personal costs, especially if the gap is hit every year.
Fidelity Investments has predicted that a 65-year old husband and wife would need $200,000 in savings or retirement income to cover medical costs in retirement, assuming they live to age 82 and 85, respectively. This includes premiums for Medicare’s doctor and drug coverage (Parts B and D), co-payments, deductibles, other expenses not covered, and out-of pocket drug costs. The estimate does not include long-term care, over-the-counter medicine, or most dental work.
To ease the burden of increased costs on employees and help them prepare for retirement, many companies and insurers have instituted health savings accounts (HSAs) for employees. These health plans combine a low-cost, high-deductible insurance policy with a tax-free savings account.
“I am not sure I really need long-term care insurance. I get conflicting messages.” Given increased longevity, some boomers are considering whether they should purchase long-term care insurance.
While only about 4% of people age 65 and older are in long-term care facilities, statistics suggest that 25% to 50% of elderly people will need some form of long-term care. Because Medicare does not cover such care, many boomers ask whether they will have the money to pay for health care when they can no longer live independently. Although this is a long-term worry, some purchase long-term care insurance policies that cover home care, assisted living, or nursing-home care. Those who are covered today draw on their policies for about four years, on average.
Until recently, long-term care policies were expensive and complicated and left the insured exposed to big costs (payments per day were far less than actual nursing home costs). Today, costs of long-term care range from $50,000 a year for home care to $75,000 or more for care in facilities. Insurers now offer simplified policies that include inflation protection, guarantees against premium increases, and easier application processes. An annual insurance premium of $3,000 or more may be a prudent investment for many individuals who want to avoid a risk of high long-term care expenses for themselves or for aging parents. On the other hand, younger persons may be reluctant to make payments for years with uncertainty as to the realized value or payoff; the money might better be invested over the years. If a person signs up when he is age 55 older, the policies are more costly and applicants may not qualify due to health conditions. A detailed guide for buyers of long-term care insurance is available from the National Association of Insurance Commissioners (NAIC, 2003). You may also visit the website of the Family Caregiver Alliance in San Francisco for information (www.caregiver.org).
Policies are best suited for people with net assets in the range of $500,000 and $2 million who may want to protect assets for their children. If you have sufficient retirement assets ($2 million or more), you might be better off self-insuring for your long-term care by paying costs out of your retirement assets.
If you are worried that you might outlive your assets, you might consider a new alternative: longevity insurance. Essentially a deferred annuity, a lump sum payment of $50,000 at age 55 may yield income of $44,000 a year starting at age 85, should you live so long.
The longer you continue working and postpone retirement, the better off you will be financially. Working an additional five or ten years makes a significant difference in the level of accumulated assets. It means you are contributing to savings, letting your invested savings grow, and most importantly, you are not drawing them down. In many cases, your social security and pension benefits will be greater if you defer receiving them. If it is clear that you do not have sufficient retirement income or assets, you will be pressed to continue working. Even if you feel that you have ample assets, retirement will likely be more attractive when it is blended with working, earning, traveling, and new pursuits.
Mary has worked at her company for 22 years, and considers it a “second home” with friends and interesting challenges. At age 58, she is in “no rush to retire.” At 60, she has the option to retire with a pension, but she plans to wait until she is at least 65, because the pension will be larger, she’ll have more cash in her 401(k), and simply “it’s a great place to be.”
Chuck, on the other hand, has been an independent consultant for twelve years, since leaving IBM when it closed his business division. Although traveling is getting difficult to tolerate, the clients and projects are gratifying. The income goes up and down, but the variable work means he has time for him and his wife to spend with their children and grandchildren. “I don’t see myself taking down my shingle. I’ll keep on consulting as long as the phone rings. Every buck I earn is a buck I don’t have to take out of my savings.”
In addition to earnings, you may rely on three traditional sources of retirement income: social security, pension, and personal savings (including direct savings and IRA/401(k) plans). Boomers indicate that they will rely more on social security benefits and traditional pensions than do younger, next-generation workers. Younger workers are less likely to count on pensions and are turning to personal investments in stocks, bonds, and mutual funds, including those in their company-sponsored retirement savings plans. Many employer pension programs are being eliminated, frozen, or supplemented by defined contribution retirement plans such as 401(k) accounts. Only half of all workers in America are covered by any type of retirement plan at work. Although many boomers can still expect to receive income from traditional pensions, others are counting on savings plans, but may have not enough assets to ensure sufficient retirement income.
If you are an older boomer, you may be more secure than younger boomers and future generations because you have accumulated substantial pension benefits, have saved and invested during the long period of steady stock market appreciation, and have benefited from the value appreciation of your home and other properties. In contrast, younger boomers face changing circumstances and uncertainty of investment returns.
The following sections detail some possible sources of income for your retirement years.
The early boomers, people who are going to retire in the next five years, they’ll be okay. The problem is going to be with the young side of the boomers, people in their early fifties now. They’re not going to be okay.
—Alicia Munnell, Director, Boston College
“I expect Social Security benefits will pay out for me—I’m not affected by the changes that have been made.” Actually, rising eligibility age and the taxing of benefits are greatly reducing take-home income. And long-term, who knows what changes will be adopted?
Social Security is important for today’s retirees. However, it will be a less important source of income for each successive generation. Social Security benefits are under pressure, with program changes being made and the future viability of program benefits being debated as a political issue. The benefits from Social Security have been reduced by more restrictive rules. Social Security benefit payments before age 65 (62–65) are offset by earned income. After age 65, the age for full retirement benefits eligibility has been raised from 65 to 67. Up to 85% of benefit payments are now taxable, if the individual has a specified level of other income. Rising Medicare premiums also take a larger bite from Social Security checks.
“My company pension will provide me with a solid income to cover my basic needs.” Actually, many defined benefit plans are being frozen, discontinued, or amended. They are no longer as secure as they once were. If you’re within sight of receiving an assured pension, you are fortunate.
Some boomers, particularly those who spent a long career with a single employer, can expect a guaranteed income based on the years of service and final years’ salary. Other boomers will receive pension payments from one or more employers where they worked long enough to become vested. At the same time, many boomers will receive no pension because they did not stay at any employer long enough to earn vested benefits. This lack of accumulated benefits is a great concern to the most mobile of boomer professionals. What is your situation?
Lynn, for example, taught at a state university for ten years after she earned her Ph.D. Then she worked on large government-funded projects, moved on to several large companies to head up training and development, and finally returned to another university. Her only earned pension benefits were from her university service early in her career. The bulk of her retirement assets is accumulated personal savings and 401(k) savings from subsequent employers. For this very reason, employees who change jobs frequently prefer a plan such as the 401(k) in which balances are portable.
Pensions will continue to be important for employees fortunate to participate in them. Despite news of pension terminations, financial problems, and other problems, boomers are “ahead of the curve” and can likely rely on these benefits.
—Bill Novelli, Chairman of AARP, 2006, p. 27.
“I have always put some of my salary into a 401(k) program.” Actually, you will have substantial retirement assets only if you have contributed for a long time and maximized your employer’s matching contributions. Experts advise that you put away 15–18% of your income into savings during your whole career—advice rarely taken. However, it is never too late to save. Working and saving for a few more years can significantly boost your retirement assets.
A Merrill Lynch retirement survey found persons who are saving say they are putting away an average of only 12% of their income. Overall, Americans have a net negative rate of savings, after considering accumulating credit card debt, mortgages, and household spending in excess of current income. However, this fails to take into consideration the appreciation in their homes and investments.
Employers are shifting away from pensions toward defined-contribution plans such as 401(k)s, which provide savings incentives and tax advantages but are controlled by the employees. Employees find account-based programs attractive because they are easy to understand and allow them to watch their retirement dollars grow over time. Actually, many contemporary American and foreign companies have grown without pension plans, including Dell, Starbucks, and Home Depot. Employees have grown used to the idea of putting some of their earnings away, usually matched by an employer contribution.
401(k) plans allow employees to put away part of their paycheck tax-free until retirement. They were not intended to provide retirement for all employees, but in just two decades such savings accounts have become widespread and the apparent successor to pensions. Unlike pension payments, your future income from a 401(k) is uncertain. The growth of the fund depends on the investment performance and the mix of investments. Your choices among investment options will affect your account size over the years and the income it will provide to you in retirement. Also, you will need to carefully manage withdrawals from your savings accounts to make the funds last long enough, but with not so much caution that you need to live too frugally or in unnecessary discomfort.
Because participation in a 401(k) plan is voluntary, millions of workers have chosen to put in less than is allowed or nothing at all. This puts their retirement security at risk, especially when there is no pension. Federal legislation in 2006 permitted higher contribution limits, larger “catch-up” contributions by workers age 50 and older, savers’ credits for low and middle income households, and use of Roth 401(k)s. Roth plans, created by law in 2001, enable workers to save after-tax dollars and then withdraw those contributions plus their earnings, tax free in retirement.
Younger, next-generation workers who participate fully in a 401(k) or similar plan over many years can build their accounts to provide half or two-thirds of their retirement income by the time they near retirement. If investments perform well, a 401(k) plan may actually accumulate more assets for retirement than a traditional pension might provide. With Social Security and other personal savings, this may add up to a comfortable retirement income. Yet younger boomers are caught in the middle, without many years to accumulate funds, and unable to catch up by contributing more each year. They are often at their peak spending years (because of children, parents, housing, and so on) and so they face a difficult challenge.
For a decent standard of living (not just 80% replacement), workers would have to save, on average, more than 25% of their compensation each and every year, which, of course, is not a feasible situation. And this assumes that Social Security, Medicare, and Medicaid programs continue status quo.
—Jack VanDerhei, Employee Benefit Research Institute (PBS, 2006)
“My biggest retirement investment is in my home. It has increased significantly in value.” The reality is that you have to live some place. Many boomers say they want to continue to live in their current home in retirement. If you do this, you will find it difficult to draw retirement assets out of your equity. You can get a second mortgage or a reverse mortgage but these options have high costs and risks.
Overall, your housing costs may be lower if you sell your home and buy something far less costly or rent. This may be a good idea if you have a large home and are ready to downsize. Larger homes require more upkeep. The recent trend towards larger homes is counter to the emerging “aging in place” concept. A lot of people have large homes, but only live in a small part of them. There will likely be a flood of boomers selling their homes in suburbia and buying one-level homes or condominiums in cities or communities that are more senior-friendly. If you choose to sell, be sure you actually free up funds to generate retirement income; many boomers simply buy another property that is just as expensive. Taking on more expenses, higher taxes, or a new mortgage is not the idea; the idea is to downscale.
A majority of boomers indicate they would like to remain in their home as they grow older. You may tap the equity of your home when you are 62 or older through a reverse mortgage. Through a reverse mortgage, you may borrow against the equity in your home, and the loan plus accumulated interest is repaid to the lender when you die or sell your home.
A household could receive about half of the value of its home through a reverse mortgage. In the U.S., a growing number of lenders now offer this product and, as a result, the loans are becoming less complex and the fees less costly. However, be sure to take note of one of the drawbacks to reverse mortgages. There is the high fee a homeowner must pay, as much as 8% of the home value, which goes for government mortgage insurance, points for the lender, and closing costs. And the interest accumulates rapidly. As a result, these are most useful for persons who want to remain in their homes in their old age, after age 80 or 85.
“I figure my retirement funds will get a boost when my mother passes away.” Although an easy way to financial security is through substantial inheritance, you can’t count on it. An AARP analysis of actual data through 2004 indicates that the overwhelming majority (80%) of boomers had yet to receive an inheritance. Among boomer families who received an inheritance by 2004, the median value was $64,000 (in 2005 dollars).
Transfers from parents or grandparents can make a big difference in building wealth and influencing your decision to work or retire. Only 14.9% of boomers expected to receive an inheritance in the future, suggesting that inheritance will remain an elusive and likely small contributor to assets for retirement.
“As I get older, I am shifting into more conservative, lower risk investments.” It has been standard advice for persons to lower their investment risk as they grow older. Actually, to build up your desired retirement “nest egg” and to keep up with inflation, you should keep much of your assets in a growth mode. You should talk with a financial advisor to determine your investment mix as you develop a strategy to preserve and grow your assets.
Do you feel you make smart investment decisions? Many employees, responsible for making their own investment choices, have left their money in low-yielding money-market funds, the usual default option in 401(k) plans. Older workers often held too much money in such funds or in their company’s own stock. These choices limited the potential growth of funds needed to provide retirement income.
What degree of risk are you willing to take to ensure that your resources are sustained and will continue to grow faster than inflation? You may choose a mix of securities or stock and bond mutual funds that matches your objectives (and willingness to take risk). You may be drawn to life-cycle portfolios or funds. The mix of securities matches the “life cycle” of each investor—changing with different age brackets as investors age. In this way, greater risk (and return) is taken early in one’s career (for example, equities and real estate), while less risk (and guaranteed return) is taken near and after retirement (for example, inflation-linked bonds and cash).
It used to be that younger investors were advised to have 80% equities and 20% fixed income securities, while older people were advised to have the reverse. However, this formula is changing, and you may find it necessary to invest more aggressively to achieve higher growth and a larger return to “catch up” in building assets for retirement if your funds are not adequate or if there has been a market downturn that hit the investment portfolio hard. Despite the volatility of the financial markets, investments in equities have generally yielded the best overall, long-term return and growth for individual investors.
“I like the idea of a steady, regular income, but I also worry about keeping it up with inflation.” If you have a strong need for a secure, predictable flow of income, another option is to put your retirement money into an income annuity. An annuity is a contract, or policy, between you and an insurance company. You pay a lump sum or a series of premiums that the company invests. In return, the company agrees to make regular payments to you over a specific period of years (for example, 25 years) or for the rest of your life, beginning either immediately or at a future date. This investment vehicle is popular because it serves to avoid the uncertainty of the financial markets; however, they are likely not give you as much income and certainly do not grow your assets invested. Some annuities also offer a payment to your beneficiaries if you die before the agreement expires.
Annuities are packaged financial products that inherently are complex and costly; they are profitable for the seller but entail risks for the buyer. If you have an annuity with a fixed term (defined number of years), you may outlive the income stream (joint and survivor options are recommended by many advisors). Inflation may eat up much of the value of a fixed annuity—large monthly payments may not be as attractive as payments that will be adjusted for inflation over time.
Some people opt for variable annuities or equity index annuities that provide returns based on changing values in the stock market but without stock ownership risks. For these annuities, disadvantages may include the variability, the caps on gains that may be realized, sales charges of up to 5%, high ongoing maintenance and administrative fees, and high withdrawal fees. In many cases, they are less tax efficient than regular mutual funds.
“I feel pretty good. I never dreamed my home and savings would be worth so much. I’m a millionaire!” Actually, the costs of living mean that this is no longer a status of assured wealth and income. Given inflation, a million today is like $500,000 twenty years ago or $100,000 in the 1950s, based on changes in the Consumer Price Index. Today about five million families have $1 million or more in assets, including their home equity and all savings.
If 5% of retirement assets are withdrawn each year in retirement, the resulting annual income is $50,000. For many boomers to sustain their lifestyle, they would need to withdraw more. This most likely means dipping into the capital as they grow older, gambling that they will not outlive their money. And as boomers look forward to living longer active lives, the risk increases.
How much money will you need to provide sufficient retirement income? Financial advisors suggest this logical analysis:
1. Estimate the total annual living costs you anticipate in retirement.
2. Deduct the annual income that you will receive regularly from pensions, Social Security, and annuities to estimate the net additional annual investment income you will need.
3. Multiply the net income requirements by 20. The result is the amount of financial assets required for a secure retirement.
This means that estimated net annual retirement income (income above and beyond Social Security and pension income) of $60,000 would require assets of $1.2 million. A net retirement income of $100,000 would require assets of approximately $2 million. These assets may reside in personal savings, IRAs, 401(k) accounts, and other investments. Assets may also lie in the equity of a home, which could be tapped as income-generating assets by selling the home and renting or buying a less costly home. In many cases, payouts from these sources are taxable, so that needs to be taken into account as well.
Is the multiplier of 20 too high? Some advisors have suggested multipliers of 10 or 12 times expected net income requirements. However, the higher multiplier reflects likely increases in health care expenses, longer life expectancy, and the risks of lower appreciation of assets in the years ahead related to economic uncertainty. You can pick the multiplier you consider reasonable for purposes of looking ahead.
Longevity is the big reason to consider a high multiplier. You must be wary of outlasting your nest egg. If you were to retire at age 65, you might plan your withdrawals based on a 15–20 year retirement period (based on a life expectancy of around 83). However, life expectancy is an average; about half of all boomers your age will live longer than age 83. Your life expectancy also increases as you grow older. Many boomers will live to age 90, 100, or older. Investment advisors are now talking about providing retirement income for 25–30 years. Additional information on estimating your life expectancy is provided in Chapter 4, “Stay Healthy and Active.”
Here is an example. George, age 57, is a project manager in a consulting engineering firm. He earns $125,000 and is looking to retire within a few years. He would like about $100,000 income plus his Social Security benefits (whenever he starts receiving them). Because he has changed jobs frequently in his career, he has no vested pension income. At the income replacement rate of 80% and an asset/income multiplier of 12 (the conservative, traditional assumptions), he needs to have a minimum of $960,000 in savings and other assets for a secure retirement. George has about $600,000 in his 401(k) accounts and other investment funds, plus he has a “mostly paid for” home. George has done well professionally and financially. If he works and saves a few more years, he will be in even better shape financially. However, if he uses the income replacement rate of 100% (not even the suggested 125%), and the income multiple of 20 (assuming greater longevity), he needs to have a minimum of $2 million in assets. This is quite a difference and would require George to do some serious rethinking.
Jeff and Mary are typical of many boomer professional households. They have about $500,000 in retirement assets. They are among 14 million households with this amount or more, largely saved from earnings, often from dual incomes. Jeff is a company attorney and Mary teaches grade school. She is a participant in a teacher pension plan; he is vested in a pension, but only has 14 years of credited service. In their mid-fifties, they plan to keep on working and saving for retirement.
Bill and Janet, however, have accumulated less net wealth largely because they had less income from which to draw savings. He is a computer programmer, working as an independent contractor; Janet is a part-time nurse. She did not work for the years they raised their two children, who are now adults. They are among 25 million families with household assets of $100,000 up to $300,000 who will need to plan very carefully. Many boomer professional and technical persons are in this situation—that is, with hardly enough assets for retirement. Compounding the difficulty of saving, some of these families experienced financial losses, chronic illness, or needs for financial support to family members. There always seemed to be expenses that took priority over saving, even in IRAs. Many boomer families have dual incomes, but even together, they worry that they have not set aside enough money for retirement.
There are some families that have ample assets. Jack and Sue Phillips owned a small retail chain that they grew from a single store that Sue’s parents owned. Their equity in the business, assets they inherited, and property investments all helped to build assets exceeding $10 million. They are not concerned about assets or retirement income—in fact, their concerns are when to sell the business and retire and what they will do then.
A saying is that, “To be rich is to not have to worry about the costs of everyday living.” A survey by Spectrem Group in Chicago asked households that have invested assets (excluding home and possessions) how much it takes to be rich. Only 22% said $1 million is enough money to be rich. Nearly half said $5 million or more. 25% said $25 or more, and 8% said $100 million. In comparison, U.S. Trust, the private banking arm of Bank of America, considers wealthy clients to be those who have $6 million or more in assets or annual income over $325,000. “Ultra-affluent clients” have assets of $20 million or more.
Overall, the top five percent of households in the U.S. have a net worth of $1.4 million or more. The top one percent of households hold one third of all wealth ownership. In some cases, their wealth was acquired through super-high earned incomes (CEOs, investment bankers, venture capitalists, actors, authors, sports figures, and so on). However, their assets were more typically acquired through entrepreneurial business activities, fortuitous investments, or through inheritance.
The core message of this book is that you should recognize that your needs may likely exceed your wealth; hence you may need to explore options for continuing some type of paid work, increasing your savings, or changing your expectations for retirement and your future lifestyle.
To do this, you need to assess your needs and assets. If you face a shortfall, you will need to adjust your savings and investing behavior, scale back planned living costs in retirement, defer your retirement and extend your working career, or redefine the concept of retirement to include working. Do you think you can achieve your savings targets during the balance of your career? Are you counting on another housing boom to boost the value of your home? Are you anticipating that inflation will increase your assets despite the fact that your retirement expenses will also increase with inflation?
A Merrill Lynch survey found that 64% of respondents do not have a financial plan identifying the amount of assets needed for retirement and how to build those assets. On the other hand, those with a plan to build assets for retirement also have a plan to convert these assets to a steady stream of income throughout retirement. Respondents who say they have such a plan tended to have larger incomes, higher household assets, and more education.
Retirement financial planning has become important to boomers. The industry of financial advisors, commingled with marketers of retirement income products and services, has grown larger and more sophisticated in recent decades. Financial advisors are eager to provide advice on the best courses of action. Meeting regularly with your advisor, especially when a change occurs in your life that may have financial implications is a good idea.
A survey by U.S. Trust found that the essential attributes clients seek in financial advisors are that they are trustworthy, understand the client’s situation, and keep the client informed. The advisors considered to be most trustworthy were CPAs or accounting firms, private banks, and investment management firms compensated by fees, not by commissions. Rated lower were mutual fund companies, insurance companies, and stockbrokers or brokerage firms.
Financial advisors are important because in all likelihood you have not studied investment planning and management in depth. A Certified Financial Planner (CFP) must take a two-to-three year training program and pass a ten-hour exam. Investments and investment strategies are a major focus in their studies and work, but their expertise goes further. They provide a broad-based approach to retirement, education, taxes, insurance, estates, and other life issues. CFPs can help you plan and manage all facets of your financial life. The knowledge requirements to become a CFP are extensive: Visit www.cfp.net for an overview of topics covered in examinations and other certification requirements.
Certified Financial Analysts (CFA) go in-depth into investment research and analysis. Individuals with four years’ experience as a financial advisor (usually a CFP) take the training, which takes four years, followed by three six-hour tests. They learn the inner workings and valuation of stocks, bonds, hedge funds, derivatives, and other exotic investments. A CFA can look at financial statements and provide an informed opinion. The CFA course curriculum builds an understanding of what drives valuation, different markets, and investment returns. Individuals who achieve the designation typically manage institutional money and mutual funds or become involved with corporate finance. Many insurance companies and financial institutions offer web-based tools, advice, and general information to attract and serve boomers as customers. Some of the analytic models provided on the Internet or used by financial advisors take into account a number of variables, including prospective investment returns, interest rates, and inflation, as well as the projected draw upon funds for annual living costs.
Many retirement planning books and websites exist that will guide you through a series of worksheets that ask questions about expected expenses and sources of income. Visit almost any bookstore or search at www.amazon.com. Associations such as AARP; financial service firms such as Fidelity Investments or Merrill Lynch; and media websites such as Smart Money and Money all have sections devoted to retirement financial analysis, which require you to set a target income requirement. You might also visit the popular “motley fool” website at www.fool.com. You can find a variety of web links for resources at www.analyzenow.com.
Relying on web-based tools, any of the many excellent books on retirement and financial planning, and perhaps a financial advisor, you can evaluate your needs and adopt the right plans for living well and paying the bills.
When we are still feeling great, while we have our marbles and our health, this is the time to think about how we want the next 30, 35 years to go. We have to get ourselves out of denial and take a look at the fact that nobody is going to get out of here alive.
—Ciji Ware, Rightsizing Your Life