Practicing Significance

Glorifying God by fulfilling your own unique purposes through the never-ending

action of acquiring, using, and sharing diverse resources.

Financial Issues for Retirees

“You can’t talk yourself out of problems you have behaved yourself into.”   Bonnie Smith

“Do not confuse possible with reasonable.”   Unknown

“We have met the enemy and he is us.”   Pogo

“Good judgment comes from experience.  Experience comes from bad judgment.”    Unknown 

Introduction

A myriad of special financial issues face retirees.  Many of the other Practicing Significance lessons address certain financial issues common to all of us, such as personal finance, estate planning, and gifting.  This lesson addresses some of the major financial issues concerned solely with retirement.  It should aid people currently retired and alert those who may retire someday.   A common lament is not planning for retirement soon enough, but it is never too late to institute new plans and make better financial decisions.

For all but the most affluent retirees, maximizing income and tightly controlling expenses is mandatory.  The lesson on Personal Finance specifically addresses many issues which need to be addressed by retirees, and it is recommended that you review that lesson.  However, there are many other thoughts and issues that also need to be addressed. 

Expectations

According to a survey in 2005, the expectations of potential retirees may not reflect reality.

· Only half of Americans are currently on track to reach their retirement savings goals. Yet, nearly 70% believe they will somehow reach their goals before retirement.

· Approximately half of American workers believe they will prolong careers past age 65 to make up for financial problems. Historically, only a quarter of Americans are able to keep their careers after age 65. Employment is most often terminated because of health problems or company layoffs.

· A large majority of American workers greatly overestimate the benefits they will receive from Social Security.

· Less than half of American workers have tried to calculate the amount of savings they will need to retire.

· Over half of Americans do not believe they can afford their long-term health costs.

Our best financial protection for retirement is to have appropriate expectations, make realistic plans, and take bold actions.

No Big Problems

A common characteristic of retirees is that they have little room to recover from big financial problems.  Due to age, health, energy, training, and family constraints most retirees will have great difficulty recovering from even one big financial problem.  In this respect, age is an enemy.  The older we get, the harder is it to recover.  Unfortunately, some of these problems are caused years before retirement and some other problems are unavoidable.  Further, some critical decisions are irrevocable, yet seem to be impossibly complex with the critical factors out of your control. Yet, if certain steps are taken soon enough, the financial damage from these problems can be mitigated.   Some common big problems include:

1. Long-term health problem or disability of retiree or a spouse.  Your grandmother’s saying that “an ounce of prevention is worth a pound of cure” is certainly applicable to this problem.  Many of these insurmountable problems could have been prevented by having regular doctor’s visits, taking the right medicines, driving safely, not walking on ice, and a multitude of other actions.  I cannot stress too much that avoidance of health problems should actively be pursued.  Nonetheless, many health problems are unavoidable.  The plethora of these maladies is overwhelming and their financial devastation can be unending.  Some common preventions and actions include:

a. Have health care insurance even if it is high deductible, and having long-term care insurance. (see Other Insurance lesson).

b. Live in a health-friendly environment prior to a major problem.  Moving into a one-story house or apartment, or a retirement complex while you are still healthy could be very important.

c. Become very familiar with all the government programs which are available and the restrictions involved with the programs.

2. Having insufficient financial resources.  This is the most common of all retirement financial problems and the source of the most common fear…Will I outlive my money? Unfortunately, this is likely to happen to most retirees. In 2005, only 26% of all workers reported having more than $100,000 in savings and investments. With inflation, especially with expenditures in the areas most common to retirees, it seems to be virtually impossible to have enough financial resources to retire.  This problem has been exacerbated by so many companies and states having problems funding their pension plans, or even having no pension plan at all.  It is now a common story to hear about pension payouts being severely reduced and 401-K accounts becoming “101-K” accounts because of investing losses. At the end of 2002, the average 401-K balance for the potential retiree age group of 50-59 was only $88,000. On top of all of this, interest rates and dividend levels can reach rates too low to be of any importance.  The good news and bad news that comes with all of this is…you still need to plan to live to be 100 years old.  Some actions include:

a. Thoroughly understand the payouts and risks of your pension fund, if you are lucky enough to have one.

b. Maximize contributions to your individual retirement account (IRA, 401-K, etc.) at the earliest possible age.  Understand the rules and restrictions for making withdrawals from these accounts.

c. Retire later than you want. The average age for retirement in 2004 was 61. There will probably be a significant difference in your financial wellbeing if you retire at 65 years of age instead of 60 years of age.  The potential joy of early retirement may be very costly in terms of future financial problems.  The average life expectancy for someone that reaches age 65 is 18 more years. Unfortunately, even if you want a job, it may be difficult to get one. Two-thirds of retirees expect to work after retirement, yet only one-third do. Most employers don’t age discriminate on purpose, they just want the best job for the least cost. Keep your job skills current and relevant, and establish a history of experience, good health, and reliability.

d. Have a part-time job.  The additional income from a part-time job may be enough to get you over financial difficulties and with the right attitude may even help your social life, reduce your expenses, and increase your life expectancy. Many companies are actively seeking to hire older employees. One place to start looking for employment is through AARP at www.aarp.org/scsep. New studies indicate you will live longer and be happier if you are productive after retirement.

e. One interesting idea (not necessarily recommended for everyone however) is a reverse mortgage.  With most reverse mortgages, you take a loan against your house which doesn’t have to be repaid until death.  Loan amounts are tied to interest rates, age, and home values. This loan comes to you as a lump sum, monthly payments, or as credit lines. Although these loans were originally designed as loans of last resort, they are (unfortunately) now being used to fund vacations or other non-essential expenditures. Since there are significant down-sides to this strategy, (including high upfront costs, high origination fees, and disqualification for some government programs) check with the AARP at www.aarp.org/revmort  and with the National Reverse Mortgage Lenders Association at 800-264-4466, www.reversemortgage.org, or www.reverse.org.

f. Don’t succumb to the temptations of consumer or credit card debt. In 2001, over 20% of seniors considered credit card debt a severe burden, and the debt levels of seniors was rising dramatically.

3. Making poor investment decisions.  For retirees, it cannot be overstated that risk is a paramount issue.  Most of us think it is untenable to live with low interest rates or dividend yields, but living with those is merely unpleasant when compared to losing a significant amount of capital from making bad investments.  As shown in the Investing lesson, common ways to mitigate bad investments include:

a. diversifying into many different investments

b. investing primarily in those things in which you cannot lose a significant portion of your investment

i. This doesn’t necessarily limit you to CD’s.  Investments in insured bonds and other lower risk instruments are available.

ii. If you invest in stocks, always use a stop-loss-limit at 10-15% below the investment cost to force you to sell before taking too big of a loss.

iii. Work with wise counselors and/or financial advisors. However, you must try to limit the costs of advisors since these costs may be 20% of your investment income.

4. Depleting your financial resources on family members.   This is one of the hardest problems to face.  Who doesn’t want to help their children or parents when they are in need?  Yet, if adequate caution is not taken, a bad health or financial problem of one family member may cause a real hardship on other family members, including you.

5. Housing/living decisions are often the major financial decisions which people make.  Whether to keep a house, move into assisting living, or a nursing hope often drives many other decisions.  It has become very popular to “down-size” houses because space isn’t needed. Unfortunately many people find they underestimate the costs involved and overestimate any cost savings.

6. Starting with debt or spending too much. Statistics show this is a growing problem. If you are not out of debt and living within a budget years before retirement, you are likely going to live in precarious financial circumstances for the rest of your life. It is imperative to do these two things now.

7. Spending too much on leisure and recreation. Whether it’s moving to a retirement community, buying an RV or boat, having a second home or some other method, many people trap themselves in a situation where they are trapped into spending too much time or money on leisure and recreation. Getting out of these traps can be expensive, time-consuming, and embarrassing.

8. Many retirees desire to move to another state. Before doing so, you should understand differences in tax rates for: income, real estate, and estate taxes. Moving to a state with no income tax may not be so inviting if its other taxes are high. Some websites to use include: www.taxfoundation.org, www.taxsites.com, and www.taxadmin.org.   

How Much Money Do I Need to Retire?

“How much money do I need to retire?” is probably the most commonly asked question from potential retirement candidates. Unfortunately, only 40% of retirees have tried to calculate the answer. When I worked for a major oil company, I knew people who spent an inordinate amount of time thinking about this question in the hopes they could retire at the earliest possible moment.   The most concise answer to the question is another question, “How much money are you going to spend?”  Referring back to the Personal Finance lesson, review you current expenses, and try to project how they would change in a retirement situation.  Many people have the belief that they will drastically reduce their expenditures upon retirement, but it is much more likely that you will want to continue the same standard of living you currently have, and maybe even start traveling or eating out more.  Surveys show that most people will need almost 80% of their pre-retirement income to maintain their standard of living after leaving their job.  However, only 18% of retirees expect to need that much.  In the end, most people do not reduce their expenditures nearly as much as they expected.  It is a common error to forget the effects of income taxes, and many people forget to add in the devastating effects of inflation. 

In order to plan over a long period of time for expenditures and inflation, you may want to consider using some of the financial plans available for personal computers or use one available through a financial advisor.  Notice that in these programs, as in real life, small changes in the input assumptions (such as the inflation rate, life expectancy, or your initial base expenditures) can have large effects over a long period of time. Three programs available on the Internet are: www.troweprice.com, www.early-retirement.org, and www.fool.com.   

Unlike the federal government, you will need to make sure that your retirement income is sufficient over a long period of time to meet your inflation-adjusted expenditures.  Your retirement income will likely come from a combination of sources.  The following are typical sources of income for retirees:

· Social Security.  Social Security is the primary income source for nearly two-thirds of retirees. Unfortunately, social security payments are rather sparse when compared to our desired standards of living.  (In 2004, payments averaged $950 per month per person.) The amount of Social Security payment you will receive depends primarily on the amount of Social Security taxes you or your spouse paid during working years and at what age you apply for benefits. In 2004, nearly half of works retired at age 62, the earliest possible age, and took reduced benefits to do so. In order to get more information call the Social Security Administration at 800-772-1213 and ask for a form SSA-7004 or download it from their web site www.ssa.gov.

· Earned income from a full or part-time job.  Many of us find that employment provides both a social outlet and an important income source.  Don’t forget that your income will be taxed and will possibly trigger a severe tax on your Social Security income.  In addition, the rules for this are very complex and depend on your age. Find out all income tax effects prior to taking a part-time job.

· Investments.  See lesson on Investing.  There are many possible answers on how much of your investment portfolio you can spend every year.  One point of view is that you should enjoy yourself instead of scrimping or saving, and just hope things work out. I take a conservative view and think it should be no more than 2-3% per year.  In other words, if you have $500,000 invested, you should spend no more than $15,000 per year from this income source.  If your portfolio grows or shrinks, the expenditure from investments should grow or shrink accordingly. [Note:  I get to this number based on the belief that you should plan to live to be 100 and need to overcome inflation.  If you can get a before-tax yield of 7% over a long period of time you are doing well.  This is equivalent to an after-tax yield of about 5%.   I believe that inflation for seniors will average at least 2-3%, so there is only 2-3% left to spend.  This is much more conservative than most financial planners who would say you could spend 4-6%.]  This should allow you to make needed corrections and still not out-live your investments.  As you get closer to 100 years old, feel free to increase to a higher percentage.  Many people expect that their investments will provide the vast majority of their retirement income.  For these people, I recommend they not retire until they have 33 to 50 times as much invested as they plan to spend a year.  In other words, if you desire to spend $30,000 per year from your investments, you need $1.0-$1.5 million in working investments (not net worth or gross assets since some assets, like a house, do not provide income).

· Annuities.  See lesson on Life Insurance and Annuities.

· Pensions and Retirement Accounts.  These include classic pension funds from a corporation or government, defined contribution plans such as 401(k), 403(b) and 457, and the IRA, SEP-IRA, and Roth IRA plans.  The rules for contributing and withdrawing are complex and vary from plan to plan.  It is a good idea to maximize contributions to your retirement accounts from a young age, and learn about the intricacies of the plans as soon as possible.  Remember the rules may change from time to time.  Like Social Security, many Americans will be disappointed in the amounts available to them from these sources upon retirement, especially since many of these will be taxed at ordinary income rates. 

Conclusion

Planning for the financial aspects of retirement can no longer be done adequately with a pad of paper.  When retirement is seriously being considered, you would probably be wise to work with a fee-only financial advisor who specializes in retirement issues to make sure you have covered all of the bases (refer to the Practicing Significance lesson Financial Advisors).  Remember, it becomes increasingly difficult to recover from financial errors after retirement.

Additional Resources

Schwab, Charles You’re 50, Now What?

Burkett, Larry and Blue, Ron Wealth to Last

Crown Financial Ministries www.crown.org

DISCLAIMER:  The content presented herein is presented as general information and is not intended to be a comprehensive overview of all of your financial options.  Nor is it meant to imply any endorsement of any type of financial plan, product or service.  Investing and spending money is a complicated and serious process that is constantly affected by conditions in the marketplace and changes in tax law and government policies.  There is no guarantee than an investment product bought today will perform the same from year to year.  You should research your choices as thoroughly as possible and, when in doubt, to consult a trusted professional advisor.