Meltdown retirement lessons: Investment ignorance is expensive, so is retirement

Lesson: The best-laid retirement plans melt down

DES MOINES, Iowa — Planning for retirement has never been as complicated — or as important — as it is now.

Last year’s financial meltdown was the second stock market disaster of the decade. Millions of baby boomers saw their savings wither, just when they were eyeing retirement.

The collapse of the stock market had much less impact on people in their 20s and 30s. They had less to lose and have plenty of time to recover. For many others, though, the decline in 401(k)s and other investment accounts will force them to make difficult choices. Many will work longer than they expected. Others will forget about buying a second home in retirement or traveling as much as they had planned.

David Rothberg, 56, an ophthalmologist in Palm Harbor, Fla., once planned to retire when he reached 55. When the dot-com bubble burst in 2000, he lost more than half his savings, and pushed back retirement to the age of 60. Then came the market crash last year. His new target is 62, six years from now.

The crash and its effect on baby boomers highlight the risks that came with the revolution in how people finance their retirement.

For decades, a company pension was the key to the good life. With a defined-benefit pension, workers contribute nothing and receive a guaranteed monthly payment, or a lump sum at the start of retirement. Since 1980, pensions have been gradually replaced by 401(k)s. These are tax-deferred savings plans in which workers, and sometimes employers, make contributions and the retirement payoff depends how well the money was invested.

The number of families with only a company-provided pension fell from 40 percent to 17 percent from 1992 to 2007, according to one study. Those with a 401(k)-type savings plan reached nearly 80 percent from 32 percent.

“We’ve moved so much of the burden of saving onto the individual worker,” says Blaine Aikin, CEO of Fiduciary360, which offers advice on overseeing retirement plans. “We also expect them to be able to manage it in a situation where even the professionals were baffled.”

For years, personal finance experts have urged people to take a more active role in managing their retirement investments. The meltdown has made it even more critical. Financial planners say the rules haven’t changed. They just need to be applied — whether you’re starting your first job or counting the days until retirement.

The ultimate question is how much do you need to save?

For starters, think about how you plan to live. Do you want to enjoy more time with family, or dart around the globe on exotic journeys?

Either way, you’ll need to budget for it because inflation stops for no one. Although the inflation rate is running less than 1 percent annually right now, the long-term average since 1913 is about 3.5 percent.

A general rule is that you need at least 75 percent of your gross income in the years just before retirement. There are several reasons why you need less than 100 percent:

— Income taxes are lower after retirement. There are extra deductions for those over age 65, some retirement income may be tax free and, with less income, you’ll probably be in a lower tax bracket.

— Saving for retirement is no longer necessary.

— Social Security taxes disappear.

— Clothing and commuting costs will drop. Often, a person’s mortgage is paid off by retirement. But health care costs will climb. People over age 65 spend roughly 30 percent of their income on health care, according to the AARP Public Policy Institute.

The exact amount you will need also depends on several factors, chief among them your income level and your gender. A study last year by Aon Consulting and Georgia State University provides one of the most complete looks at the issue.

In one scenario, someone with a gross income of $60,000, retiring at 65, would need $47,000, or 78 percent, to maintain the same standard of living. The reduction reflects expected changes in taxes and work-related expenses. The $47,000 could come from a mix of savings, Social Security and employer benefits.

The percentage needed is higher on either end of the salary scale. Those making $40,000 or less will need at least 85 percent of their income in retirement. Lower-paid employees save the least and, while working, pay the least in taxes as a percentage of income. So they spend more of their gross income while working and need a high percentage to maintain their lifestyle in retirement.

People earning $150,000 or more should plan to replace 84 percent or more of their income. They face relatively heavier taxes, in part, because the bulk of their Social Security benefits are taxable. Savings also need to be more substantial because Social Security makes up a smaller percentage of their necessary retirement income.

Those examples don’t include spending on Medicare or supplemental insurance, which would increase costs by thousands of dollars.

The bottom line is that men will need to have 4 to 6.8 times their annual salary in the bank, separate from Social Security. Women should aim to have 4.5 to 7.5 because they tend to live longer, according to the study.

So based on a multiple of 5.2, the man earning $60,000 would need $312,000. Based on a multiple of 5.7, a woman at the same income level should have $342,000.

But is that enough to ensure that you won’t run out of money?

To protect against outliving your savings, a common rule is to withdraw about 4 percent of the account in the first year and increase that amount each year by 3 percent for inflation.

Your income will be supplemented by Social Security, too. This year, the average Social Security benefit is $1,153 a month.

One good way to look at retirement spending is to separate the necessities from the nonessentials and save for them separately, says Jean Setzfand, director of financial security for AARP.

Make sure the necessities, such as housing, transportation, food and health care costs are paid for through a guaranteed income stream, such as Social Security or a pension fund, if you have one, she says.

The optional expenses, such as entertainment and travel, should be paid out of invested savings, the value of which may fluctuate. This method gives you much more security meeting your basic needs. If your investments do well, you can spend more on nonessentials.

When the market falls, however, it cuts to the bottom line for retirees and those close to retiring.

People between the ages of 55 and 64 saw 20 percent of their retirement savings evaporate during the meltdown, though a six-month rally in the stock market and continued contributions have restored much of that. Still, the average 401(k) account balance for this age group was down 2.6 percent on Sept. 1 from the same date a year ago.

The volatile stock market has forced many people to pay more attention to what’s in their 401(k).

In February, five months into the meltdown and a month before the stock market hit bottom, nearly a quarter of 401(k) participants 56-65 had at least 90 percent of their money in stocks, according to research by the nonprofit Employee Benefits Research Institute.

The good news is that 75 percent had less. But the first group and many in the second had ignored one of the basic rules of retirement planning: Adjust your investments the closer you get to retirement. To retain some earnings potential, a safe figure for those within a few years of retirement may be 20 to 30 percent in stocks with the rest in cash and bonds.

Bill Crothers, 64, of Lancaster, S.C., retired in 2006 after selling his environmental consulting business. His new job is hanging on to his retirement savings.

“This was a wake up call,” he says. “People ought to do more research into what the alternatives are in their 401(k) rather than just buying their own company stock or just taking someone’s word for it.”

The question for many is how to restore some of the losses. A study by asset management firm T.Rowe Price indicates that a person with a salary of $100,000 can increase retirement income from investments by as much as 28 percent by postponing retirement from 62 to 65.

Another option to increase retirement income is to delay claiming Social Security benefits. Each year you keep working, the monthly check would increase by about 8 percent.

In the short term, people should contribute as much as they can to their 401(k). For those under 50, the maximum this year is $16,500. Those 50 and older can put in another $5,500.

Still, research suggests that you have to be prepared in case your plans get derailed. Various life situations, including an aging parent, health problems or a job loss, might prevent you from working as long as you want. Although the median retirement age was 62 in the recent EBRI study, nearly half the retirees said they left work sooner than they had planned.

“People are not always in control of that decision,” says Barrie Christman, vice president of individual investor services at Principal Financial Group Inc., a leading 401(k) provider.