15 Expert Lessons for Retirement Planning (Collection)

Moshe A. Milevsky

Trent A. Hamm

Liz Pulliam Weston

Bonnie Kirchner

Jane White

Frank Armstrong

Paul Brown

James Walker

Linda H. Lewis

Steve Weisman

Plan for Managing Your Retirement Risk

Moshe A. Milevsky, Ph.D.

Professor Richard Thaler from the University of Chicago and Professor Shlomo Benartzi from UCLA have devoted a substantial part of their careers to studying the financial mistakes and monetary blunders that people make in their daily lives. Apparently even smart people are not immune. These two researchers are leaders in the nascent field of behavioral finance, which argues that consumers are not cold, calculating machines that optimize their decisions in a rigorous mathematical fashion, but instead they adopt simple general rules for financial decision making, which often leads them far astray.

One of the most egregious behavioral “sins” these two researchers have identified is the tendency of too many Americans to allocate too much of their 401(k) plan—and even their own investments—to company stock. Apparently, more than five million Americans have over 60% of their retirement savings invested in their own company stock. Note that this is well after the notorious cases of Enron or WorldCom, where employees discovered the ruinous risks of such a myopic strategy. Even more surprising, ongoing surveys and focus groups conducted with these same employees indicate that they simply do not view this behavior as problematic. They think it is normal and healthy to invest in “things they know” because they can keep an eye on their investments. This optimism stands in contrast to the fact there is absolutely no evidence that employees have any superior ability to outguess the market or the experts regarding the performance of the stocks they hold and the companies they work for.

Many of the five million Americans who are engaging in this risky practice might be dead wrong. They are improperly investing their human capital and financial capital in the same economic basket, and their retirement might be at risk. Indeed, the evidence suggests that we have a long way to go before individuals truly consider the risk and return characteristics of their human capital and invest their financial capital in a way that balances their comprehensive risks. Hopefully, this book will help along this path. Remember, your 401(k) is a number, not a pension. It is up to you to manage and grow your nest egg so that it can eventually be converted and allocated into a pension.

Retirement Income Planning Is the Goal

At the university where I am a faculty member, I teach a popular 12-week course on personal financial planning to third- and fourth-year undergraduate students. During the semester, I try to cover the entire life cycle of financial issues, from cradle to grave. In the first few weeks, I spend quite a bit of class time on basic topics such as financial budgeting, managing credit card debt, coping with student loans, and so on. I usually get pretty full attendance and engaged interest during these early lectures. In fact, sometimes I get even more than full attendance from non-registered, yet interested students, who want to learn whether leasing is in fact better than buying a car, or whether ETFs are better or worse than index funds for the cost-conscious do-it-yourself investor. They are surprised when I preach that debt can be good. They absolutely resonate with my message that human capital is valuable and should be treated as an asset class to be hedged and insured. In fact, even the topic of life insurance appears interesting to them, perhaps due to some morbid curiosity.

Then, somewhere towards the latter part of the semester, as things are winding down around week number eight or nine, I get to the topic of pensions and retirement income planning. Here I tell them about pension annuities, as well as some of the demographic trends in aging. And, as much as it pains me to admit this, the attendance isn’t great for that lecture. I’m lucky if I get 60% of my enrolled students, and many of those who do bother to show up spend much of the time text-messaging, pod-casting, and whatever else they can do to pass the time. The following week, which is devoted to estate planning, is even worse. In fact—and I’m only half joking here—if you have some extra altruistic energy on your hands and want to take on a challenge, try spending time with a bunch of teenagers explaining the minutia of calculating Social Security payments early on a Monday morning, no less.

And to be honest, I can’t say I blame them. These kids are just not interested in retirement income planning. It is 40 years ahead of its time for them. To many of them that might as well be infinity. They are concerned with finding their dream job, getting rid of their student loan debt, and hopefully accumulating some savings. Even the topic of buying a home is distant to them. The pension is outside their realm of experience.

Yet, when I have the occasional chance to interact with students’ parents and grandparents, the situation is very different. When I mention that I also teach and do research on pensions and retirement income planning, I feel like the only doctor at an evening cocktail party. Everyone wants free advice.

In fact, the personal interest in pension matters extends to my academic colleagues at the University. Around the age of retirement all members of our pension plan must decide whether to take a lump-sum settlement and invest and manage it themselves, or whether to keep the money in the plan and instead receive a monthly income. Many of these professors have heard that I might “know something” about this issue and I get a steady stream of biology, chemistry, and engineering professors visiting my office for a consultation around the time of their big decision. They are wondering whether they should take the money and run, hoping to get a better deal themselves. (Interestingly, I don’t get many humanities professors. I’m not sure why.)

But yet, the topic of pensions is more than just a matter of demographic interest. When I pose the question to my undergraduate students—which retirement arrangement would you rather have, defined benefit (DB) or defined contribution (DC)?—most of them select the DC plan. Some of them justify their decision with some fairly persuasive arguments. They point out that they will likely be working for a number of different employers over the course of their life. Some of them will be spending time in different countries, or at least industries. Few, if any, believe (or even dream) they will be working for one company over the course of 30 years. They therefore need retirement savings with mobility and flexibility. Alas, a defined benefit plan with its rigid formulas based on years of service and final salary would make little sense to them. It is a relic from an industrial past. Indeed, this is likely why so many employees are content with 401(k) and IRA plans. The employer’s only responsibility is to contribute 5% to 10% of their annual salary cost to this piggy bank, and the employee is responsible for everything else. They take the risk and get the reward.

The statistics confirm this way of thinking. Many of the companies freezing or converting their defined benefit (DB) pensions and replacing them with defined contribution (DC) plans are doing so partly as a result of the demand from employees.

And yet, as the trends in aging continue to develop themselves out over time, the topic of pension and retirement income will only grow in importance. Remember that retirees face a number of unique financial risks that are not (as) relevant earlier on in life. Retirees face longevity risk, which is the uncertainty of their life horizon and its costs. Retirees face unique inflation risk.” Finally, they have to deal with a particular type of financial market risk, which has been dubbed the term sequence of returns. So, the risks are new and different and you will need a different strategy.

As you can see from Table 1, approximately 80% of the income being received by individuals above the age of 85 is longevity-insured. The remaining 20% of their monthly income might be exhausted prior to the end of their life. For younger individuals the percent that is longevity insured is even lower.

Table 1 What Fraction of Elderly Income Contains Longevity Insurance That Can’t Be Outlived? (Average for U.S. Population)

Step 1: Get a Retirement Needs Analysis

Obviously, boiling down the entire topic of retirement income planning into a 30-second sound bite is impossible. This is likely one of the most complicated calculations that an individual must make over the course of his life, and even the great Allan Greenspan has been quoted as saying this! That said, I can provide some general rules on how to think about this problem.

So, when you are ready to seriously think about the financing of your retirement, the first step is to sit down (perhaps with a financial advisor) and carefully estimate what you will need in retirement. Some people dismiss the importance of a formal written retirement needs analysis altogether. Or some confuse it with its close cousin—the retirement wants analysis, which is much more than your needs. Either way the exercise is informative. Add up the estimated annual cost of all the things you simply can’t live without. These can be items as basic as rent, electricity, and heating, all the way up to the annual cost of a golf club membership, or lease payment on the Mercedes Benz. Do your best to come up with a rough annual retirement needs estimate. Remember, though, it is a number that will not stand still. It is a moving target over time. This is because you will likely experience a higher and unique inflation during retirement. Either way, don’t move to the next step until you have this needs estimate. Also, remember these are your needs, not your wants.

Step 2: Determine Your Income Gap

The next step is to add up the sources of all of your retirement income benefits or guaranteed pension benefits. Start by getting your Social Security estimate and move on to any DB pensions you are entitled to from work. Make sure to differentiate income sources that are adjusted annually for inflation, such as Social Security and many state pension plans, from income sources that are not adjusted for inflation.

The difference between your retirement needs and your guaranteed retirement income is your income gap. This number can be $10,000 or $100,000 or $1,000,000 but is truly the most important number in retirement income planning.

For now, if 85% of your retirement income needs will be supplied by a Defined Benefit (DB) pension that generates inflation adjusted income, then you are hedged against most of your retirement risks. Stated differently, if your income gap is a mere 15% of your projected income needs, then you do not need to get any insurance or other forms of guarantees and protection. For many people though, an 85% replacement rate from pensions and Social Security, is not very likely. Refer back to exhibit 8.1 for a graphical illustration of this calculation.

Now, let’s move to the asset side of your personal balance sheet and the investment assets that are available to close the income gap. Presumably, you have by now converted most of your human capital into financial capital, which is your financial nest egg. Add up the value of the 401(k), 403(b), IRA, stocks, bonds, mutual funds and other investment-based (that is, DC) pensions. Anything you can and are willing to sell should be included in this calculation of wealth. At this point you should not include the value of your house unless you plan to sell, move out, and use the funds to generate your retirement income. For now, this is your “financial assets number.”

We are now ready for the big question. What is the mathematical ratio between the market value of your financial assets and your income gap? The larger the mathematical ratio is, the better your situation. For example, if your financial asset value is $1,000,000 and your income gap is $50,000, then your ratio is 20. But, if you have the same $1,000,000 in financial assets and your income gap is a higher $100,000 then your ratio is 10.

You will notice that so far I have not mentioned anything about your age, your gender, your marital status, or even your health. The calculation of the mathematical ratio between your wealth and your income gap doesn’t depend on any of these demographic factors.

Now you are ready for some general recommendations. Please don’t take this as investment advice, but rather as a blueprint for discussion.

Table 2 The Two Dimensions of Retirement Income Risk Management: How Much Wealth Do You Have to Finance Your Income Gap?

Grade Legend:

A: You are in great shape. Don’t worry about insuring any retirement risks. You can finance your income gap using a systematic withdrawal plan. However, make sure to invest your nest egg in a portfolio of diversified stocks and some inflation-adjusted bonds, and then periodically withdraw your income needs.

B: You are in good shape, although you might want to consider allocating a token 5% to 10% of your nest egg to protect against longevity risk, either using an immediate annuity or a variable annuity with a guaranteed living income benefit, especially if you are not willing to consider your personal residence as an eventual retirement income vehicle.

C: You should have enough, but you might consider allocating 10% to 20% to one of the many pension-like annuity instruments to help manage retirement risks, especially longevity risk. The exact amount would depend on the strength of your bequest motives, or how much of your financial estate you would like to leave to the next generation.

D: You are at the lower edge of income sustainability. This is where product allocation is most important and has the greatest impact. You should consider allocating 20% to 40% to annuity products with an emphasis on instruments that protect against longevity risk and the risk of sequence of returns.

E: It’s going to be very tight. That said, you might want to consider allocating 10% to 20% of your wealth to some sort of annuity instrument with insurance against longevity risk and sequence of returns, especially if there is no flexibility in your spending. You might want to delay retirement for a few years.

F: Not good. At some point during your retirement, you will be forced to reduce your standard of living. You should consider delaying retirement for a few years. Don’t try to gamble or speculate your way out of this problem.

As you can see from the table, for those retirees and near-retirees who have 90% of their income guaranteed from pensions plus Social Security, they don’t have to worry about product allocation or converting their nest egg into more pension income. Indeed, the billionaire Bill Gates does not need an annuity. He will never outlive his money, even if he doesn’t have a defined benefit pension from Microsoft.

Obviously, many variations exist on Table 2. Needless to say, if you are thinking of retiring at a younger age (say 60 or 55) then your investment wealth multiple—the first column in Table 2—should be higher in order to get a high grade in the safe region. Likewise, if you are retiring in your early or late 70s, you might not need as much. Also, if you are trying to protect a spouse and are planning for two people, then you should do these calculations jointly. Compute your total income gap and the total amount of assets to support that gap. Also, and just as importantly, there are health risks that go beyond the financial realm, which is why you should consider long-term care insurance, or at the very least learn something about it, so that you can talk intelligently about why you are not insuring against this risk. This is the beginning of a planning process, not the end. A new generation of retirement income products is now available. Figure 1 is just one indication that there is more innovation to come.

Figure 1 Innovation in the insurance industry

In sum, the money in your 401(k), 403(b), or IRA plan is just a random number. Hopefully it’s a big number, but by now you should know that it’s not a pension. That part is up to you. So, don’t let your fickle moods, fears, and phobias exert undue influence on the composition of your nest egg. Rather, use the unique nature and composition of your human capital to approach the management of your financial capital. Think and manage risk comprehensively, like the chief financial officer of You, Inc. Your future depends on it!

Endnotes

Benartzi and Thaler (2007) review the many biases that impact retirement saving behavior. They have collectively and individually conducted and reported on many experiments in behavioral finance and are two of my favorite authors and pioneers in this field. Belsky and Gilovich (1999) and Bazerman (1999) are two great and readable books on the systematic mistakes we make with money. Finally, Swenson (2005) and Malkiel (2003) are references for the individuals who truly want to embark on this journey themselves, with low costs, low fees—and no one to blame if something goes wrong.

If you liked this Element, you might like the book by Moshe A. Milevsky, Ph. D., Are You a Stock or a Bond?: Create Your Own Pension Plan for a Secure Financial Future (ISBN: 978-0-13-712737-5).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2011 by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0132371553

ISBN-13: 9780132371551

For more information, please contact us at info@ftpress.com

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Getting Your Retirement Act Right

Trent Hamm

Retirement no longer means kicking back in the Barcalounger watching The Price is Right and waiting for the grandkids to come and visit. It means an exciting new stage in life, complete with new challenges.

It’s becoming the trend for retirees who find themselves at the age where they can start cashing in on their pensions and their 401(k)s but discover they have a lot of vitality left in them.

With the longer lifespans and greater vitality that we all have in store, retirement no longer equates to idleness.

In his book Free Agent Nation, Daniel Pink looks at burgeoning movement of retirees who are reinventing themselves at a traditional retirement age. “Legions of [...] sixty-plus Americans are becoming freelancers, micropreneurs, self-employed knowledge workers, temps, home-based businesspeople, and independent professionals. They’re working as part-time, some time, and anytime free agents—using the Internet as a platform for finding and executing work.”[1]

The new frontier of building professional opportunities for yourself comes from connecting with communities of your peers who are also engaged in your career. These communities often develop online, sharing resources and making themselves ever more open to opportunities of all stripes. Rather than focusing on who you are, these communities place value on what you can provide to the community, and Americans near retirement age, with an enormous wealth of knowledge and experience built up over a long career, have a lot to offer.

What’s your next act? What excites you? What do you want to do with the rest of your years? Your lifetime of work has given you the tools and resources you need to succeed, and the Internet provides the access you need to a community of supportive peers. There’s no better time than now to dive in and find out where this new path will lead you.

Recasting Retirement Savings

From this perspective, saving for retirement no longer has the same goal that it once had. Previously, retirement savings was intended to allow people whose vitality was slipping to live out their final years in financial peace. Today, however, retirement age arrives, and people still have vitality. They still have the desire and the ability to work on projects that challenge and excite them.

What does that do to the traditional role of retirement savings?

To put it simply, it turns retirement savings into a tool to support challenging professional and personal choices. Instead of fully supporting you in a reduced lifestyle, retirement savings can maintain you in the lifestyle you’re accustomed to while you take on personally fulfilling challenges that might not be financially lucrative. Doing things like becoming the secretary of your church, becoming a freelance artist, or taking a job at a nonprofit are no longer financial suicide if you have retirement savings to supplement such a position. Instead, they become deeply fulfilling personal opportunities.

For many, retirement savings has a depressing feel. People don’t want to visualize their life during the period that many of us think of as retirement. However, the nature of those retirement years is changing fast. Instead of being a slow ride into the sunset, retirement is an opportunity to claim a lifelong dream, and retirement savings makes that possible.

Instead of saving for retirement, you’re saving (in part) to support your next act in life.

Retirement Savings versus College Savings

“The last thing I want to do is become a burden to you when I reach the end of my years,” my mother told me on the phone. She had spent the last two months slowly digging through her mother’s estate, going through giant boxes of unsorted paperwork, trying to make sense out of the mess of my grandmother’s final year of life, which involved a slow slide into dementia. My thoughts drifted to my own children. How would I be able to ensure that they would not be burdened by me in their adult years? I would have no problem taking care of my own mother, and I’d like to believe that my children would be willing to take care of me. I looked at the picture of my two children that serves as my desktop wallpaper and asked myself what I really wanted out of my golden years.

Parents often have a challenging choice to make once their children are born. At a time in their lives when their money is tied up on many fronts—saving for a down payment on a home, struggling with the relatively low income level one earns early in a career—they’re hit with the double whammy of needing to save for retirement and also needing to save to support their child’s education.

It seems like a difficult choice, but it really isn’t. Save for retirement and let the cards fall where they may when it comes to college savings. There are several reasons for this.

First, a college education can be earned without college savings, while retirement cannot. Many students earn a college education with minimal financial support from their parents—myself included. Not having such support requires students to seek out more scholarships and take more responsibility for the value of their education instead of having it handed to them on a silver platter. It also provides a better case for financial aid. At the same time, the early years of retirement savings—the ones that provide the longest timeframe for aggressive investing and the most years for compound interest to work in your favor—are absolutely vital and should be maximized.

Second, eschewing retirement savings in favor of college savings puts your children at risk later in life. Many parents choose to forego retirement savings and save for their children’s education under the belief that the best assistance they can give their child in adulthood is to not saddle them with student loan burdens. However, by doing that, you put them at a much higher risk of having to support you financially in your old age due to inadequate retirement savings.

Third, college savings may not even be necessary for the path your child chooses. Your child might choose an entrepreneurial path. Your child might choose a lucrative trade school, choosing to become an electrician, a plumber, or a carpenter. Your child also could earn enough in scholarship money to make college savings redundant. In any case, following a typical savings plan for college may be redundant.

Often, caring parents—such as myself—are unconvinced of this argument. Yet, there’s a simple solution for balancing both of these conflicting desires: Save for retirement in a Roth IRA.

A Roth IRA is an individual retirement account that you set up on your own, independent of your job. You put money into this account after taxes, which means that it doesn’t go straight out of your paycheck like 401(k) savings does. However, a Roth IRA has a huge advantage: You can withdraw your Roth IRA contributions for any reason without penalty. If you are saving for retirement but then decide to make a withdrawal to help with educational expense, you can do so with minimal consequence—the only drawback is that you cannot replace the contributions once you withdraw them.

A final point: Involve your adult children in your estate planning. This goes far beyond merely involving them in the preparation of a will. Prepare a document with them that explains every significant step that needs to be taken to cash in all of your insurance policies, cancel your accounts, and settle your affairs. Keep this document updated. It’s a simple step that you can take to make the burden of your eventual passing much easier on your next of kin.

Revisiting the Crossover Point

A crossover point is the point at which the income from your savings and investments exceeds your living expenses. There is also a partial crossover point, the point at which the income from your savings and investments plus the reduced income from a job that deeply fulfills you (but perhaps doesn’t earn as well) exceeds your living expenses.

This “partial crossover point” is exactly what you want to shoot for in this brave new age of retirement. As you transition into a second act, you’ll likely find new avenues for income—but these income sources may be a significant drop from what you’re currently earning. Transitioning from middle management to a job at a charity can equate to a huge drop in income, as can switching from a career in nursing to a career as a church organist. Even switching to a potentially lucrative freelancing career can have challenges, as income is wildly uneven for people in such careers. Your retirement savings becomes the bridge between paydays.

The most amazing part? The tax advantages and matching funds for retirement savings make all of this look easy.

Five New Steps Toward “Retirement”

Here are five steps you can take as you approach this new kind of retirement:

1. Spend some time thinking about what you would do with your time if you had a small supplementary income to help you live the life you wanted to lead as long as you stayed productive. What dreams would you chase? What opportunities would you grab hold of?

2. Plan ahead for your second act. Look for opportunities in the career path you have now to build the skills you will need when you reinvent yourself. In particular, always work on your transferable skills—communication skills, leadership, information management, and so on.

3. Take advantage of all matching funds in your 401(k)/403(b). Matching funds are essentially free money given to you by your employer to accelerate your retirement savings. Take advantage of them.

4. Open a Roth IRA for additional retirement savings. Because you’re able to withdraw contributions from a Roth IRA without penalty, their flexibility for retirement savings and for other major goals make them valuable.

5. Make a master information document. A master information document simply lists every significant piece of information about your life and your financial state that someone might possibly need to know in the event of your passing. Include descriptions, contact names, business names, addresses, phone numbers, account numbers, and other such necessary information. Keep it all in one place, somewhere safe, and let the most important people in your life know where it is.

Endnotes

1 Daniel Pink, Free Agent Nation. p. 234. ISBN: 9780446678797.3

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly from the use or application of any of the contents of this item.

If you liked this Element, you might like the book by Trent Hamm, The Simple Dollar: How One Man Wiped Out His Debts and Achieved the Life of His Dreams (ISBN: 978-0-13-705425-1).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2011 by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-248984-8

ISBN-13: 978-0-13-248984-3

For more information, please contact us at info@ftpress.com

FTPress Delivers Elements

An e-burst of inspiration for business and life.

31 Simple Rules for Protecting Your IRAs and 401(k)s

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How to Find a Financial Planner

Liz Pulliam Weston

There are hundreds of thousands of people passing themselves off as financial planners in the United States today. Very few are what they seem.

Anyone can call herself a financial planner or financial advisor. There are no education, experience, or ethics requirements for using those terms.

Furthermore, most of the people who want to offer you advice are not legally obligated to put your interests before their own. They can sell you overpriced, poorly performing investment products—even when less expensive, better-performing ones are available—because they get fatter commissions or other incentives from the inferior investment.

Sometimes there’s more at stake than just the advisor’s paychecks. Some insurance companies take away their agents’ health insurance coverage if those agents don’t push enough of the companies’ products. I feel sorry for agents who have to choose between recommending a suitable product and protecting their families’ health, but I feel sorrier for their clients.

You also shouldn’t assume that someone who works for a bank, brokerage, or insurance company is necessarily well educated about personal finance. Many times, the only education they’ve received is about their companies’ products. If they haven’t taken it upon themselves to pursue a comprehensive financial planning education, they may have no idea that alternative products or strategies exist—or that the information their companies have been feeding them isn’t accurate.

I’d even be leery of using an advisor simply based on a friend or relative recommendation. After all, how savvy are your friends and relatives about finances? Would they recognize an unqualified or unethical person? Did they perform a background check themselves before hiring this advisor? There are way too many affinity frauds out there—scam artists who convince a few influential people in a community or religious organization to invest with them and then get those influential people to recommend them to others.

So how do you find someone who can actually help, rather than harm, your finances? The following sections should put you on the right path.

Insist on a CFP

The Certified Financial Planner (CFP) mark has emerged as the gold-standard credential for the financial planning profession. Someone who’s a Certified Financial Planner has gone through a comprehensive education process, passed a tough test, and gotten some experience under his belt. That doesn’t necessarily mean he is competent or ethical, but a CFP is the minimum credential you should demand from anyone who wants to give you financial planning advice. Just as good is the PFS, or Personal Financial Specialist, which is a planning credential offered to CPAs.

Choose a Fee-Only Planner

A true fee-only planner is compensated only by the fees you pay, not by commissions or fees paid by other entities. Don’t be confused by advisors who call themselves fee-based. They could be (and probably are) receiving commissions in addition to the fees that you pay. Taking commissions doesn’t make someone a bad person, but it does present a pretty substantial conflict of interest. Besides, it’s so last century. The smartest, most ethical, and most competent planners I know are all fee-only. Also they’re willing to say, in writing, that they are “fiduciaries,” which means they’re obligated to put your interests ahead of their own.

Get Referrals

Those smart, ethical, competent planners I just referred to? Most are members of The National Association of Personal Financial Advisors at www.napfa.org, which represents fee-only planners and has strict experience, education, and ethics requirements. Not all NAPFA members advise middle-class folks; many of these planners require their clients to have substantial portfolios, and they tend to charge a percentage of their clients’ portfolios, rather than flat or hourly fees. If you’re looking for by-the-hour planning, consider referrals from The Garrett Planning Network at www.garrettplanningnetwork.com.

Ask Questions

If you’ve chosen a fee-only CFP, many of the important questions have been answered. But there are a few more things you should know. How long has the planner been in the business? (To get a CFP, a planner needs at least three years of experience, but I’d be more comfortable with someone who’s been planning professionally for at least five years.) What are his areas of specialization? What is his typical client like? You probably want a planner who has experience working with others in situations similar to yours.

Check Their Background

Ask for Form I and Form II of their ADV, which is paperwork that advisors have to file with the Securities and Exchange Commission. These forms will show you how your advisor is paid (commissions, fees, or a combination) and recap any disciplinary history with regulators. Go a step further and check that history with the SEC (www.sec.gov), the National Association of Securities Dealers (www.nasd.com), and your state’s investment regulator.

Most true financial planners prefer to look at your entire financial picture, including your spending, investment, insurance, tax, and estate situations, so that they can offer comprehensive advice. This process will involve many hours of their time and, typically, a fee that can reach thousands of dollars. But some—particularly those you pay by the hour—are willing to limit themselves to specific situations, such as a review of your retirement portfolio. That would allow you to get some of your burning questions answered for a few hundred dollars.

When You Need a Tax Pro

I once heard from a stay-at-home mom who was very proud of the money she saved her family in various ways, including doing their taxes herself. Then she discovered that her family of four children was eligible for child tax credits—credits that she had failed to claim, because she didn’t know about them. She was able to amend her most recent tax returns, but you can’t claim refunds after three years, so the earlier unclaimed credits were lost for good. Her sincere desire to save her family a couple hundred bucks a year wound up costing them thousands.

I discovered how truly tricky taxes could be during the 1990s when I tested various kinds of tax software as part of my newspaper reporting job. Each year, I did my taxes as many as eight times using different programs. My situation wasn’t extremely complex, but I did own a home and run a freelance business in addition to my W-2 income.

Inevitably, my tax bill would come out differently depending on the software I used. Then my tax pro did my return, and every time she found mistakes I had made and deductions I had missed. Every year, she more than made up for her fee in an increased refund—but even if she hadn’t, I would have used her just for the assurance that my taxes were being done by someone who really and truly knew what she was doing.

Perhaps there was a time when a taxpayer with a pencil, a calculator, and a lot of patience could do a reasonably good job of completing her own return. Today, though, the U.S. tax code has gotten so complex that it could be compared to a really bad neighborhood: You shouldn’t go there alone.

At the very least, you should be using good software, such as TurboTax or TaxCut. If you do your own taxes, you must also keep up with major new tax developments; you can buy a good annual guide like J. K. Lasser’s Your Income Tax or The Ernst & Young Tax Guide and read the chapters about what’s new in the tax law.

But really, most people should consider hiring a knowledgeable tax pro. It’s not just smart delegation, although of course someone who lives and breathes tax law is going to do a better job with your return. But you’re also providing yourself with a valuable resource during the rest of the year when tax questions pop up and you need answers.

You absolutely should hire a tax pro when any of the following conditions apply:

• You own a business—As complicated as personal taxes can be, business taxes are worse. Just the decision of how to conduct your business—sole proprietorship? partnership? corporation? C or S or LLC?—could drive a regular person around the bend, but CPAs handle these questions every day. A tax pro can also give you good advice about maximizing your business-related deductions, audit-proofing your returns, and picking the right retirement account. Good business owners know how to delegate, and delegating taxes to a professional is a smart choice.

• You’ve fallen under the dreaded alternative minimum tax (AMT)—This parallel tax system was set up to keep the wealthy from using loopholes to avoid all tax liability. Because Congress hasn’t linked it to inflation, however, millions of decidedly not-wealthy folks have lost deductions and found their tax bills hiked by the AMT. You’re most at risk if you have a lot of write-offs, have lots of kids, or live in a high-tax state. The good news is that you may be able to lessen the pain with smart planning, and a tax pro can help.

• Your company has issued you stock options—Stock options can bring you wealth, but they can also trigger all kinds of nasty surprises—including big tax bills even when your investment has lost value. You’ll want a professional review of your situation before you exercise any stock options as well as follow-up afterward.

• You’ve just received a notice that you’re about to be audited—Not only should you not represent yourself in an IRS audit, but you also probably shouldn’t even be there when the auditor and your tax pro review your returns. If you do insist on coming, sit in a corner and keep your darn mouth shut.

How do you find a good tax pro? If you’re looking tax savvy at an affordable price, consider hiring an enrolled agent (EA). These folks are licensed by the federal government and can defend you in an audit. (Many EAs, in fact, are former IRS employees.) The National Association of Enrolled Agents at www.naea.org can provide referrals.

For more complicated situations, consider a certified public accountant (CPA). CPAs tend to be more expensive than EAs but may offer more expertise in specific areas like corporate or international taxation. If you want a CPA with financial planning expertise, look for one who has a PFS credential. Your state CPA society can offer referrals, or you can visit the American Institute of Certified Public Accountants at www.aicpa.org.

As with financial planners, you’ll want to find a tax pro who has other clients like you—with similar incomes and tax situations. You should ask not only how much the pro charges but also how they charge. (Some are happy to answer the occasional question for free, figuring it’s included in your annual tax preparation fee, while others charge like lawyers—by the minute.)

There’s another issue you need to assess, and for lack of a better term I call it audit compatibility.

There are plenty of gray areas in tax law—and sometimes not much enforcement. Some tax pros pride themselves on saving their clients as much money as possible, even if it means taking aggressive stances that might not survive an audit.

At the other end of the scale are those whose goal is to avoid IRS scrutiny at all costs. These folks may pass on perfectly legitimate deductions because it raises the chances of an IRS audit by a few percentage points.

Obviously, most tax pros are somewhere between these two extremes. But you’ll want to make sure that wherever your pro lands on the spectrum, you’re comfortable with that.

How do you determine their philosophies? It may become obvious during your introductory chat, while you’re asking about their background, experience, and other clients. A tax pro who brags about the big refunds he lands his clients is probably going to be more aggressive than one who highlights her low audit rate.

If you’re not clear, though, raise a thorny tax issue or two. Mention, for example, that you’re considering hiring a housekeeper but don’t want to hassle with paying employment taxes. The hot-rod tax pro might launch into an eager discussion of ways to keep your arrangement off the IRS’s radar while the most conservative might refuse to work with you at all. Someone in between might go over all your legal alternatives, such as hiring a payroll tax service to handle the paperwork or simply using a business, like Merry Maids, that takes care of such issues for you.

Working with an Estate Planning Attorney

Every once in a while, you’ll see an article about how “everybody” needs a will. It’s just not true.

If you don’t have children and don’t care what happens to your money and possessions after you die, you don’t need a will. Your state has rules for what happens to your stuff.

The thing is most of us do care.

One of my friends blithely put off creating a will, knowing that under her state’s laws, her husband would inherit everything if she died. Then a married couple she knew was killed in a plane crash, and she started wondering who would inherit if she and her spouse died together. The answer, in her state, was her father—an abusive man from whom she’d been estranged for years. Suddenly, creating a will became a top priority.

Having a will is also essential if you have minor children. You need to name a guardian and set up a trust to manage any money they inherit from you. Otherwise, a court battle could erupt over their care, and their money would be turned over to them at age 18—which is way too young to handle a big lump sum of cash.

Even if you don’t think you need a will, you do need three things:

• A durable power of attorney for finances, which allows you to name someone to make financial decisions for you if you’re incapacitated

• A durable power of attorney for health care, which allows you to name someone to make medical decisions for you

• A living will, which tells your doctors what kind of end-of-life care you want if you are terminally ill and incapacitated

These documents can make an enormous difference in the quality of your life while you’re still around to care.

You can create your own estate documents using software; the best by far is Quicken WillMaker, which uses an interview process to help you refine and set down your wishes. The Nolo Press book Plan Your Estate is another good resource to have on hand.

This do-it-yourself approach can work fine if your affairs are simple and your estate is relatively small. But you’ll want to hire an estate-planning attorney to draft your documents if any of the following is true:

• Your estate is big enough to incur federal estate taxes—Estates worth more than $2 million in 2007 and 2008 may have owed taxes; the so-called estate tax exemption rose to $3.5 million in 2009, but this has changed again for 2010, and will no doubt change again for 2011. You should strongly consider an estate planner’s help as soon as your net worth clicks over the $1 million mark, particularly if your wealth is likely to grow in the future. Getting expert advice on minimizing taxes and probate costs can be a worthwhile investment.

• You have a contentious family—If anyone is likely to contest your will or start a court fight over guardianship of your child, you’ll want an experienced professional to help you ward off or nullify their attempts to upend your wishes.

• You have a special-needs child—If your child is disabled, you’ll probably want to set up a special trust and protect your assets to ensure lifetime care. This can be an incredibly complicated area of the law, and your chosen professional needs to be up-to-date with all the latest state and federal developments.

If your estate is complex enough to require an attorney, it’s probably worthwhile to seek out one who specializes in estate planning, rather than a general practitioner. One place to check is with your state’s bar association to see if it certifies estate-planning specialists. (Some states do; others don’t.)

Another good source for referrals is other attorneys. If you know a lawyer who you like and trust, ask whom she would recommend. Doctors and other professionals may be able to offer recommendations. So might your tax pro or financial planner.

An estate-planning attorney’s background, education, and experience are all important. But, so too, is your rapport with your attorney. Before you sign up, take some time to chat about your various estate-planning concerns. Does the attorney answer your questions in a way you can understand? If you need clarification, does she provide it? Estate law can be dauntingly complex, but a good attorney will be your guide. She won’t make you feel like an idiot for your ignorance or try to waive off your concerns with a “don’t worry your pretty little head” attitude.

The advice you’re getting won’t come cheap. Although an attorney can draft a simple will for a few hundred bucks, more complicated estate plans will cost a couple thousand dollars—and up. Take the time to find someone who gives you your money’s worth.

Do You Really Need a Living Trust?

A living trust is an estate-planning document that does everything a will can do, plus it allows an estate to bypass probate, the court process that otherwise follows death.

In some states, like California, probate is a real nightmare. It can take more than a year for the typical estate to complete probate, and the fees involved can eat up 3 percent or more of the assets involved. Your heirs typically must wait until the long process is over to receive their inheritances; guardians for minor children and those running your business must submit to court oversight and approval of their actions.

In other states, probate takes just a few months, and costs are relatively small, making the $2,000 to $3,000 cost of setting up a living trust harder to justify for modest estates.

To determine whether a living trust is right for you, I’d encourage you to read the Nolo Press book Plan Your Estate, as well as 8 Ways to Avoid Probate by Mary Randolph.

In general, though, the younger you are and the less you own, the less a living trust makes sense. You may be able to avoid probate through other means, such as owning property in joint tenancy and using “pay on death” designations for financial accounts. If you’re in your 50s or older and have substantial means, though, you should at least consider the benefits of a living trust.

To reduce costs, you could make this a do-it-yourself project. Nolo Press has a guide, “Make Your Own Living Trust,” that includes a CD-ROM of forms to fill out. But given the potential complexities involved, I’d invest in a lawyer’s help, particularly if you may someday have enough assets to incur estate taxes.

What you don’t want to do is buy a cut-rate trust or boilerplate forms from a so-called “living trust mill.” These outfits often try to scare older people with exaggerated horror stories about probate. Their usual purpose is to get their clients to reveal details of their finances so that they can be sold overpriced annuities and other unsuitable products.

If you’re going to pay someone for a trust, make sure she is a qualified estate-planning attorney and that the trust is customized for your needs.

Your Checklist

Here’s your list of things to do.

If you’re looking for financial planning help:

• Insist on a CFP or PFS.

• Get referrals to fee-only planners.

• Ask about experience, cost, and typical clients.

• Do background checks.

If you’re looking for tax help:

• Use software like TurboTax or TaxCut if your situation is relatively simple.

• Seek a pro’s help if you own a business, are subject to AMT, are issued stock options, or are notified that you’ll be audited.

• Consider enrolled agents, who can provide tax help and representation at a reasonable cost.

• Choose a CPA for more complex or specialized situations.

When you need an estate plan:

• Determine whether you need a will. Use do-it-yourself resources only if your estate is small and your situation is straightforward.

• Make sure you have powers of attorney for finances and health care decisions and a living will.

• Seek an attorney’s help if you have a large or complicated estate or a contentious family.

If you liked this Element, you might like the book by Liz Pulliam Weston, Easy Money: How to Simplify Your Finances and Get What You Want out of Life (ISBN: 978-0-13-238383-7).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2011 by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-241754-5

ISBN-13: 978-0-13-241754-9

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Who Can You Trust with the Financial Planning of Your Money?

Bonnie Kirchner

Financial planning is a larger field than you might think. It is actually made up of a number of components, and it is difficult for any one advisor to be an expert in every aspect of it. Relating financial planning to the medical field, you will have advisors who have a broad base of knowledge and might act as a generalist. These advisors very often can work with clients in a holistic manner but might have to find “specialists” in more complex situations. Whether you work with a generalist or a specialist, it is important to have an integrated financial plan. As one of my former colleagues put it, “If you don’t know where you’re going, any road will take you there.” The major areas of financial planning that need to be considered are the following:

• Cash Flow: This is where it all starts. Without positive cash flow, there are no funding mechanisms for other goals. Unfortunately, our culture has fostered poor cash flow habits. Americans have become far too reliant on the use of credit to feed their immediate desires to the detriment of their long-term goals. The first step to financial planning is understanding what is coming in by way of resources and what is going out via expenses and whether or not there is anything left over in the end. If the cash flow is zero or negative before other goals are funded, budgeting must be addressed.

• Taxation: It’s not what you make; it’s what you keep. Proper tax planning can actually create resources to help fund other goals. Tax laws change nearly every year, which is why it is important to review your tax return with your advisor to see if there are adjustments that can be made to help save money or fund financial planning objectives.

• Retirement: Financial educator Dee Lee says it in a nutshell, “There are no scholarships for retirement.” For most people, retirement seems too far away when they should start saving for it that it gets put off. Throughout my 20-year career, I’ve seen the retirement picture change drastically. When I first started working with retirees in 1990, it was pretty typical to meet with people whose major retirement resources were Social Security and a corporate pension. Since then, I’ve seen more and more companies moving from Defined Benefit retirement programs to those of the Defined Contribution type. The difference? The latter puts more responsibility on the employees for decision making in regard to the vehicles for growing their retirement savings and, in many cases, funding. Though corporations do make attempts to educate their employees, efforts are not effective enough at this point and rarely impact the younger workforce. As corporate benefits change and Social Security remains in question, proper retirement planning must become a priority for the vast majority of individuals.

• Risk Management: This is a fancy way of saying “insurance planning.” Insurance is needed for protection against those risks you can’t afford to cover with your existing assets and income level. A proper financial plan will analyze what insurances are appropriate and at what levels. Coverage in the areas of life, disability, homeowners, liability, auto, and long-term care should be reviewed as part of the planning process and reviewed periodically. Coverage needs to be changed over time and is dependent on situational circumstances and financial resources.

• Education Funding: The cost of higher education rises each year at a rate higher than inflation; thus, it is never too early to start building a fund to cover these expenses. The problem with college funding is that it comes in direct conflict with other planning goals. For a lot of people, decisions must be made on how to allocate funds between retirement and education objectives, all the while maintaining the proper insurance coverage to protect the overall financial plan.

• Estate Planning: Believe it or not, everyone already has an estate plan. If you have assets, it makes sense to put some plans in for “when your case matures.” (My estate planning professor, Dr. Robert C. Suter, used this phrase when referring to death.) If you have a spouse and children or elderly parents to care for, it is imperative. If your assets are above a certain level, which will vary from state to state, and you prefer to leave Uncle Sam and your state’s coffers out of your will as much as possible, it is important to bring an attorney who specializes in this field onto your financial planning team.

Though not all of these areas will apply to everyone, a well-shaped plan will incorporate all applicable pieces in a way that the whole will be greater than the sum of its parts. The challenge of financial planning is one of conflicting goals. It is not atypical to have limited dollars chasing a number of different financial objectives. In this situation, planning is imperative. Plan preparation should be followed by reviews and adjustments on a regular basis. Just as most people have their health evaluated on an annual basis, financial planning should have the same prerogative. Unfortunately, most people spend more time planning their annual vacations than working on their financial futures. Hopefully, some of the positive outcomes of our most recent financial crisis are that Americans will become more responsible about spending wisely and not over using credit and learn to dedicate more time to planning their finances.

Does each area of financial planning require its own specialist? It depends on how complicated the situation is. Many financial advisers can proficiently assist clients with putting together a plan and helping them find the proper products to use or appropriate specialists. Unless the advisor is also an attorney, most people will need a lawyer to prepare legal documents for estate planning purposes in the client’s state of residency. Some financial advisors also do tax preparation in addition to planning, though many clients choose to do their own taxes. Regardless of how many advisors are involved and what roles they play, it is important that all parties work together as a team. Frequently, the financial advisor is responsible for coordinating the various components and the individuals involved to keep the financial planning ball rolling effectively and efficiently.

In working with individuals for nearly 20 years, I’ve come to realize the role of various advisors can be confusing, probably because the lines are not clear cut. Typical advisors include the following:

• Financial Planner: A financial planner is an advisor who is focused on the big picture and can provide direction in the various areas of financial planning. He might get paid by the hour, a set amount for a particular plan provided, based on a percentage of assets managed, or via product sales. In the event a planner is compensated via product sales, be sure she has the appropriate licenses and registrations for the products being provided. A financial planner can be independent or work for a brokerage firm or an insurance agency. How he has chosen to set up his practice might give you clues as to his areas of expertise and even how he gets paid. In other words, if the advisor is associated with an insurance company, she might have more of an insurance affiliation and a background in risk management and estate planning. An advisor who chooses to represent a brokerage house may be oriented toward investments. A financial planner will typically have training in six areas of financial planning and is likely to have or be working toward credentials such as CERTIFIED FINANCIAL PLANNER® professional or Chartered Financial Consultant.

• Insurance Representative: An insurance representative might be independent and represent a number of companies or affiliated with a particular insurance company. He is likely to be compensated via the sale of products, typically insurance and annuities, though he might also be able to provide mutual funds and other investment products as well. It is important to understand whether the advisor is influenced in any way to recommend particular companies or products when providing advice or if she is able to offer a wide variety of companies and products, helping you to get the best fit for your situation. Be sure the insurance representative is licensed to do business in your state of residency as each state has its own requirements for insurance licensing. If she is also offering investments, make sure she has the proper securities licenses for the products being discussed.

• Investment Representative: Like the insurance representative, an investment professional might be independent or part of one particular company. He is likely to be compensated via product sales or assets under management. The representative is most likely to be registered with a brokerage firm or an independent broker/dealer.

• Certified Public Accountant: More and more CPAs and tax preparers are getting into the financial planning and investment fields. It is a natural fit given that the IRS Form 1040 and its various schedules are some of the most information-packed resources for a financial advisor. However, don’t forget that it does take specialized training to provide specific recommendations on investments and insurance, not to mention proper licensing and registrations.

• Registered Investment Advisor (RIA): An RIA is an entity which manages money for a fee and could be regulated by the Securities and Exchange Commission or the State, regardless of whether or not it has a broker-dealer affiliation. An RIA will typically be fee-only, however some choose to affiliate with a broker/dealer so that they can also perform transactional work and get paid.

• Investment Advisor Representative (IAR): Performs for fee investment management services as a representative of a Registered Investment Advisor firm.

If you liked this Element, you might like the book by Bonnie Kirchner, Who Can You Trust With Your Money?: Get the Help You Need Now and Avoid Dishonest Advisors (ISBN: 978-0-13-703365-2).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2010 by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-217301-8

ISBN-13: 978-0-13-217301-8

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Spotting Red Flags

Financial Advisors to Avoid

Bonnie Kirchner, CFP®, MST

Unfortunately, taking a leap of faith is part of hiring a financial advisor. If you do your homework, most likely it will work out for the best. At the very least, you will keep your assets and peace of mind out of harm’s way by avoiding the Bradford Bleidts and Bernard Madoffs of the financial advice world. Fortunately, there really are more decent financial advisors out there who are dedicated to the craft and their clients than there are evil ones who are only out for themselves.

Red flags can pop up at various stages during your journey in search of the perfect advisor. Pay attention to them as they will not only help you narrow down your list of potential candidates, but they might actually save you some or a lot of grief down the road.

The Name and Information Gathering Phase

As you collect names of potential advisors to interview, do a FINRA (Financial Industry Regulatory Authority, Inc.) broker check on those who are “Registered Representatives” at www.finra.org/Investors/ToolsCalculators/BrokerCheck/index.htm. You can look up the advisor and his or her broker/dealer to see if there have been any customer disputes or regulatory and disciplinary events. The report also tells you in what states the advisor is licensed, what licensing exams he or she has passed, and about the advisor’s employment history. Firm reports also provide information on regulatory and disciplinary events, as well as a profile, history, and information on operations. Keep in mind that most firms have hundreds, if not thousands of advisors associated with them. Thus, any arbitration, regulatory, or disciplinary problems might not necessarily reflect the particular advisor with whom you are considering doing business. Most reputable firms who have had issues typically take steps via their compliance department to see that future problems are avoided as it is in their best interest to avoid arbitration, regulatory, and disciplinary problems. Not that you should ignore negative event history. It is worthwhile asking questions about pertinent matters and what the firm has done to prevent future problems.

If the advisor with whom you are doing business is a Registered Investment Advisor (RIA) or Investment Advisor Representative (IAR) associated with an RIA, you can search for the advisor’s or firm’s Form ADV via the SEC’s (Securities and Exchange Commission) website at www.adviserinfo.sec.gov/IAPD/Content/Search/iapd_OrgSearch.aspx. This application for registration contains a wealth of information covering business activities, affiliations, custodial arrangements, state registrations, employees, clients, compensation, as well as any disciplinary history.

Should you discover any grave discrepancies through this discovery phase or feel uneasy about any reported arbitration, regulatory, or disciplinary events, you should take this as an opportunity to ask questions, which you may want to save for a face-to-face meeting to see how the advisor reacts, or take it as a “red flag” and move on to the next name on your list. Should you chose to ask more questions, be sure that the explanation you receive is satisfactory before dismissing the discovery as a minimal factor in your decision-making process.

If the advisor’s firm acts as its own custodian, as Bernard Madoff’s firm supposedly did, it is time to check out the firm’s auditor. You might want to request a copy of the firm’s most recent audit and its findings. If you find a lack of cooperation with this verification process or you find information about the auditor difficult to obtain, this could be a red flag. You might want to check out the American Institute of Certified Public Accountants website at www.aicpa.org for more information on the firm.

If the advisor is a CERTIFIED FINANCIAL PLANNER™ professional, you can see if there has been any applicable disciplinary history through the CERTIFIED FINANCIAL PLANNER™ Board of Standards, Inc. along with checking out their certification status via www.cfp.net/search/. Again, any grave discrepancies or troubling history should send that red flag waving. For example, if you look up my ex-husband, Bradford Bleidt, you will see that his certification has been revoked along with a description of his violations of the CFP® Board’s Code of Ethics and Professional Conduct.

For Certified Public Accountants, disciplinary history can be searched on the American Institute for Certified Public Accountants website at www.aicpa.org/pubs/cpaltr/disciplinary_actions/sortlist. aspx.

If the potential advisor has already sent you a list of references, it might not hurt to call them before you have a meeting with the candidate as you might get a better feel for who he or she is. You might also obtain names from the references of others who are or have been clients of the advisor previously who might be able to give you some valuable information. In speaking with people who have employed the advisor, you should be looking for information in regard to whether the advisor

• Works with people who have similar circumstances to yours

• Has a communication style consistent with your expectations

• Disappointed any clients in any way and if so, how

• Performed relatively well in good and poor market periods

• Provided you with any information that is in conflict with what existing or former clients say about him or her.

During the Meeting

Your challenge while interviewing a financial advisor candidate is to employ your powers of observation as well as you can to

• Detect important inconsistencies with any information conveyed to you verbally by the advisor, advisor’s staff, clients, or former clients or provided in any literature. Major inconsistencies could be clues about whether or not the advisor is too busy to keep his or her facts straight or an indication that the advisor may say anything to get your business.

• Determine how well you communicate with the advisor about important matters. If you have any difficulty following anything the advisor discusses with you, be sure to ask for clarification. After all, this is all about you and your money, and you should be able to effectively and efficiently exchange information with your advisor.

• Perceive whether your business is not particularly important to the advisor or potentially vital. Either could be a red flag for service quality or worse, considering Bernard Madoff had a way of making those who did business with him feel fortunate for having the privilege of doing so. Bradford Bleidt was desperate to get new money in the door any way he could and may have appeared overly eager to please, especially in the end.

• Evaluate the advisor’s organization and preparedness for the meeting, especially if you sent information about you and your situation ahead of time.

• Identify whether or not the advisor acknowledges how important this initial introductory meeting is for you. If the candidate is constantly taking telephone calls or being interrupted with other matters during time that should be set aside for you, it could be an indication that the advisor is incapable of making time for you once you are a paying customer.

• Clarify custodial arrangements for any assets that will be invested. Any ambiguity surrounding this issue should be considered a red flag. No transfers should be made or checks written until you are absolutely confident about what institution will be holding your funds. No checks representing investable assets should be written to the advisor personally. In most cases, checks will be written to a custodian or wirehouse (such as Merrill Lynch or Morgan Stanley Smith Barney) providing SIPC Inc. (Securities Investor Protection Corporation) coverage and possibly additional insurance protection. If the investment advisor’s firm performs custodial functions via the use of an omnibus account, be sure to find out who the firm’s auditor is and what practices are employed to protect client funds.

• Understand potential compensation arrangements and how much engaging the advisor may end up costing you. The advisor should be able to give you an idea of how they will charge you: assets under management, commissions, fees, or a combination of structures, and provide you with an idea of what costs might be involved. Ambiguity about the advisor is compensated can also be a red flag, as in the extreme case with Bernard Madoff who didn’t seem to charge fees. Keep in mind that a good advisor should be compensated reasonably, and you, as the client, should have a good understanding how that compensation is derived.

• Solicit recommendations. Though the advisor is unlikely to develop a specific strategy for you on the spot especially without an executed agreement, you should be able to get an idea of what the candidate is thinking will work best for you along with a description of what steps it will take to start moving in the right direction.

• Ask for referrals. If the advisor is unwilling or unable to provide you with contact information of existing clients, consider it a concern. Though there are confidentiality issues when it comes to the world of personal finance, most good advisors have clients who are willing to speak to potential new clients on their behalf in these situations.

After the Meeting

After you have met with the advisor it is a good idea to take some notes about your perceptions during the meeting especially if you are meeting with a number of candidates. Be sure to detail anything that might have occurred during the meeting that caused you to be uncomfortable in any way especially anything that could impede a functional relationship with the advisor.

It is important to follow up with any referral contacts given to you in the meeting. Though it might seem to be a useless exercise given that you are most likely to receive a list of clients acting as cheerleaders for the advisor candidate, you never know what you could learn. Should you hear anything negative through your conversations, this could be very telling given that a client serving as a referral is not expected to provide anything but positive feedback. At the very least you will get a feel for the types of people with whom the advisor works and whether or not they have similar financial circumstances to your own.

It is not uncommon for an advisor to follow up with you with some form of recap of the meeting. This can give you the opportunity to determine how well the advisor was listening to you and interpreting your financial situation and goals. There might also be matters that were left unsettled either because of additional data about you requested by the advisor or materials and information promised to you. In the event the advisor candidate is not responsive in providing agreed upon follow-up items, consider this as a potential organizational or interest level problem on the part of the professional. In other words, the professional was not organized enough to get what was promised to you, or it was not a priority to do so. Either is a concern.

Advisors to Avoid

Up to this point, if you’ve done the leg work and all of your homework, it is time to narrow the choices by removing candidates who could be problematic. This could include those who

• Have a disturbing disciplinary history with FINRA, the SEC, or any other professional organization to which they belong or once belonged.

• Cannot adequately show you where your assets will be held and in what ways they will or will not be protected. Keep in mind that SIPC and similar insurances do not protect your assets against market fluctuation. These coverages are available to protect customers from the failure of a covered brokerage firm. Thus, any advisor who “over promises” in regard to what these types of insurances offer investors is someone to steer clear of. They are either untrained or manipulative. Neither are qualities you want in a financial advisor.

• Are unable to communicate with you effectively. This is not necessarily an indication that a candidate is incompetent or dishonest. However, the relationship you have with your financial advisor is incredibly important. People have different communication styles, and sometimes they just don’t mesh. You do not want to find yourself in this situation with your financial advisor. They can’t help you if you don’t feel comfortable opening up to them. They also can’t help you if they are unable to communicate their ideas, advice, and recommendations to you in a way that you can absorb and implement them.

• Provide ambiguous explanations about potential investment strategies. The advisor should be able to give you reasonable guidance about the strategies he or she is intending to employ and be willing to educate you about them.

• Avoid providing you with a reasonable explanation about how they get paid and applicable costs affecting your situation. Again, you should understand the advisor’s compensation structure and how it affects you and potentially your investments for the long term.

• Don’t measure up in the eyes of their referrals especially if a lack of satisfaction is consistent over a number of contacts. If the advisor is unaware of problems existing with those clients he or she has chosen to endorse them, there probably is trouble in paradise.

• Furnish information verbally or through brochures or other sales materials that is inconsistent or in conflict with other available information, such as what is published on the websites of the SEC and FINRA. For example, is the advisor claiming that he is a CFP® Practitioner when he has not yet, in fact, finished all of his requirements? If so, this is the type of grave inconsistency that should not be overlooked.

• Disclose any confidential information about existing or former clients without permission from them. Confidentiality is imperative to the advisor-client relationship, not to mention required by regulatory and professional organizations.

Identifying whether or not any of the red flag conditions exist can help you narrow down your list of potential candidates and hopefully keep you out of harm’s way at the same time. Utilize the rest of the information you gathered throughout your fact finding mission to help you pinpoint the candidate who is going to be best for you. In the event that relationship does not work out for some reason, you’ve probably created a decent back-up list through the process, so hold on to those names in case you need them.

Quick Tips

• Be sure to ask an advisor about any negative regulatory or disciplinary events you uncover during your investigation as well as what steps the advisor and his or her firm have taken to prevent future problems.

• Be wary of any discrepancies you discover or a lack of a desire on the potential advisor’s part to provide you with requested information.

• Evaluate whether or not you and the advisor can effectively communicate about important matters.

• Clearly understand the strategies that could be employed in your situation.

• Verify custodial arrangements for assets.

• Uncover potential compensation arrangements and determine whether or not they are in line with your expectations.

• Check references.

If you liked this Element, you might like the book by Bonnie Kirchner, Who Can You Trust With Your Money?: Get the Help You Need Now and Avoid Dishonest Advisors (ISBN: 978-0-13-703365-2).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2010 by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-217305-0

ISBN-13: 978-0-13-217305-6

For more information, please contact us at info@ftpress.com

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31 Simple Rules for Protecting Your IRAs and 401(k)s

A quick, indispensable checklist for better retirement decision-making and financial planning—and a more secure, comfortable retirement!

Steve Weisman

ISBN: 978-0-13-703975-3

$1.99

Homebuying Tips on How to Get the World's Cheapest Loan

Don’t put up with the financial services industry’s rip-offs: Learn how to get an amazingly great deal on your next mortgage!

Carolyn Warren

ISBN: 978-0-13-706272-0

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Make Your Credit Cards Work for You Instead of You for Them

Even the odds! How to play the credit game right and save a fortune!

Gregory Karp

ISBN: 978-0-13-705336-0

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How to Save Wisely

Aiming for the Retirement You Deserve

Jane White

My approach to saving for retirement is Keep It Simple. For the most part, you have to obey some basic rules. Invest mostly in stocks, gradually shifting your allocation to money market funds as you approach retirement age. Avoid brokerage accounts (in which you trade shares of stocks) because you can’t time the market. Don’t sell in a stock market downturn. Don’t cash out; that is, don’t tap into your 401(k) savings when changing jobs. And that’s it.

Rule 1: Work Longer, and Both Spouses May Have to Work

If you’re part of a married couple, you should expect that both of you will have to work and one spouse will have to save most of his or her paycheck; but at least you’ll have the power of two paychecks to feather your nest egg—that is, unless both incomes are needed to meet all living expenses. Needless to say, both of you should contribute the maximum to your 401(k) accounts.

Although the length of time you need to work will vary by individual, assume that if you are a Baby Boomer you will probably need to work another eight to ten years, even if 401(k) reform takes place, because you will have fewer years to benefit from the increased employer contributions and investment returns on them.

Rule 2: Don’t Sell in a Downturn

Along with being clueless about whether their clients can retire, most mutual fund companies—with the Vanguard Group being the exception—neglect to tell investors not to “rush to the exits” when the stock market is in turmoil. As former Securities and Exchange Commissioner Arthur Levitt says, “(Brokers) want you to buy stocks you don’t own and sell the ones you do....They earn commissions even when you lose money.”

The inconvenient truth about investing is that often when the stock market slumps it’s not a setback, it’s simply a “bad stock day.” Take the stock market swoon of October 19, 1987, the largest one-day slump in history, causing millions of investors to stampede out of the market and stay out. However, a mere two years later the S&P 500 turned in a whopping return of more than 30%—one of only 18 calendar years since 1926 that the market performed that well.

Have investors learned anything in a couple of decades?

Nearly 20 years after the 1987 slump, on hearing bad stock market news in March of 2007, thousands of 401(k) investors moved half a billion dollars out of stock mutual funds into fixed income funds. Unfortunately, two scant months later the S&P 500 closed above 1500 for the first time in more than six years, the longest run of bullishness since 1944.

Why is it self-destructive to head for the exits during a market slump? Because the market isn’t falling apart, its shares are temporarily dropping in value. If you react by selling your shares in a downturn and then wait for an upturn to invest again, you’ll end up paying top dollar for your shares and buying fewer shares. If, on the other hand, you stay invested, you’ll wind up buying more bargain-basement-priced shares that will eventually rise in value, boosting your nest egg.

In fact, some of the biggest stock market booms during the past eight decades have occurred right after the so-called busts. In the 17 calendar years since 1926 that the Standard & Poor’s 500 has produced better than 30% returns, eight of these bullish years followed a year of negative returns—most likely because the savvy bargain hunters bought cheap stocks dumped by not-so-savvy investors, causing the share prices to swoon.

What’s more, what’s rarely mentioned about the Depression is that although there were negative investment returns between 1929 and 1931, the S&P 500 turned in some of the best returns on record during that decade: 53.99% in 1933, 47.67% in 1935, 33.92% in 1936, and 31.12% in 1938. Not only are the 1933 returns the highest on record, there have been only four calendar years in the 83-year stock market history when the S&P 500 has generated better than a 40% return and only 18 calendar years when it has generated better than a 30% return.

The funny thing about the stock market is not only that it’s impossible to predict when it’s going to be up, but that many of the eye-popping double-digit returns happen during a tiny percentage of the time, which is why you can’t time the market. For example, investors who missed the 40 best days in the decade 1994–2004 would have lost 3.23% instead of gaining 12.09% if they had stayed fully invested. Go out even further and the stats are even more mind-boggling: Investors who missed the best 90 days between 1962 and 1993 would have lost 95% of market gains. To put it another way, a dollar would have been worth $24 for the buy-and-hold investor but only $2.10 for the investor who “timed it wrong.”

Rule 3: Change Your Investment Strategy as Your “Time Horizon” Changes—That Is, When You Get Closer to Retirement, Not When the Stock Market Changes

Does ignoring market slumps mean that you should never change your 401(k) investment strategy? No—but your decision to change your strategy should be driven by how close you are to retirement and not yesterday’s or today’s news. Specifically, while younger 401(k) investors in their 20s and 30s should have a higher concentration in stock mutual funds—80% to 100%—that concentration should shrink as investors hit their 40s and 50s, shifting to bond mutual funds or money market funds. (My preference is for the latter.) One of the no-brainer ways to accomplish this shift is to move your 401(k) investments into a target date fund if your employer’s plan offers one, which does the shifting automatically.

Rule 4: Choose a Roth 401(k) If Your Employer Offers One

As of 2006, employers could offer a Roth 401(k) option, in which participants pay taxes on the income contributed today in exchange for tax-free withdrawals at retirement instead of making tax-deductible contributions, which is the case with regular 401(k) accounts. Although some employers have been reluctant to embrace the Roth option—one recent survey found that only around 22% of employers were planning to offer it—my question is: Why do we have anything else but Roths from the get-go?

Let’s face it, there’s a reason for senior citizens discounts—it ain’t easy living on a fixed income. With the Roth option, you “get taxes over with” when you can afford to pay them because you are working. Then at retirement you owe Uncle Sam nothing on either your contributed income or your years of investment returns. In contrast, if you have a traditional 401(k) account you’ve got a huge tax bill when you start withdrawing from your nest egg—not just on contributions but also on investment earnings.

Rule 5: Contribute the Maximum, Avoid Auto-Enrollment, and Save Outside of Your Plan

401(k) accounts alone aren’t going to get you on track for retirement. But that still shouldn’t stop you from saving as much as you can. If it turns out your employer automatically enrolled you at a 3% contribution rate, contact your service provider and arrange to increase the rate to as much as you can afford, up to the current limits.

If you’re part of a two-income household, not only should both of you contribute the maximum allowed to your accounts, but if you can afford to, consider setting aside savings outside of your plan in a Roth IRA and in non-tax-favored investment accounts. Unfortunately, the income and contribution limits on Roth IRAs make it necessary for many people to save in non-tax-favored plans.

Rule 6: Develop a Low-Cost, Buy-and-Hold, Commonsense Investment Strategy

You basically need to stay invested mostly in stocks until middle age, stick with large-company stocks, and reduce costs and improve investment returns by choosing index funds over managed funds. Here are six simple steps to achieve your goals:

Step 1: For the Most Part, Stick with Stocks

For some strange reason, people who are not “risk tolerant” are advised to stay out of stocks. This is nonsense. For most of your life, most of your money should be invested in stocks. As a part owner of several companies, you’re placing a bet that your shares will be worth much more when you’re ready to sell them 20, 30, or 40 years from now. On average, you will double your money every seven or eight years if you leave it in stocks. On the other hand, bonds and cash-equivalent investments such as money market funds don’t perform as well as stocks because the issuer of the bonds/money market funds “controls the coupon” on their investment returns, and inflation can devour these returns. For example, if you’re investing in a certificate of deposit or money market fund that pays 2% and the inflation rate is 3%, you’re losing money.

Step 2: Diversify by Investing in Many Stocks—That Time-Honored Notion of Putting Your Eggs in Different Baskets

The best way to decrease your risk of losing money over the long term is by diversifying, or dividing your money among many stocks; the best way to do this is to invest in mutual funds. The more stocks you own, the more likely that most of the stocks in your portfolio will be winners.

Step 3: Reduce Risks by Investing in Mutual Funds That “Bet on Companies with Winning Track Records”: Large-Company Stocks

If you’re lucky enough to own a crystal ball, you can make more money investing in the new-kid-on-the-block companies that are plowing their profits back into their businesses than in the old reliable ones. The successful small companies of today will become the Wal-Marts, Amazons, and Apples of tomorrow. However, there’s a downside of investing in a small company: Few of us can predict which companies are going to be the next Google and which are going to be the next failed dot-com. Half of all new companies go out of business within five years of start-up. So instead of betting on a long shot, a safer strategy is to bet on the winners: mutual funds that invest in large-company stock funds, commonly known as large-cap funds.

Step 4: Reduce Costs and Improve Returns by Buying “Generic”—Index Funds Versus Managed Funds

As far as which funds you should invest in, my preference is for index funds, or passive investing, which involves buying and holding a broad array of stocks in their proportion to the overall market rather than buying only those stocks that a fund manager believes are likely to outperform the market.

Index funds are like generic drugs when it comes to large-cap funds. You know how when a prescription drug first hits the market, it can cost an arm and a leg? However, after the patent runs out, other drug companies can copy the formula for it and sell it cheaply—or at least more cheaply than the original version. I would describe the S&P 500, which encompasses the 500 American companies with the greatest market value of stock outstanding, as the “generic equivalent” of a mutual fund made up of large company shares. Why? You’re pretty much going to invest in the same companies whose shares are in the managed fund without paying extra for the salaries of the fund managers.

Step 5: If You Do Choose a Target Maturity Mutual Fund, Also Known as a Life-Cycle Fund, Put All of Your Money in This Fund

Target date or target maturity funds are set up to shift your allocation away from stocks and toward fixed-income investments as you get closer to retirement. This is a good idea, but many participants are using them the wrong way: A Vanguard study showed that 60% of 401(k) participants who used target date funds invested in more than one target date fund. If you choose a target date fund, all of your money should be in this fund. Needless to say, if your employer offers an S&P 500 target date index fund, that’s your best choice.

Step 6: If You Can Find a Target Fund That Includes International Stocks, Go for It

Although the average American is very likely wearing jeans sewn in China, grinding coffee beans grown in Columbia, talking on a cell phone made in Finland, and driving a Japanese car, it’s very unlikely that her 401(k) investing money is going where her spending money is. Only one-third of 401(k) participants invest in international funds.

One of the untold stories of globalization in the 21st century is that two-thirds of the world’s largest publicly held companies are based overseas—and have been since Fortune magazine launched the Global 500 ranking in 1989. It was a different story—at least for the top 50 companies only a few years earlier in 1982—with 23 American firms making the list compared to 17 today.

Although consumers hate paying through the nose to fill their gas tanks, investors might as well reap some payback. 401(k) savers who invest only in the S&P 500 will “own” only six oil companies, missing out on the investment gains of 22 others—a French petroleum refiner is one of the world’s biggest companies, rocketing up 43 notches in just a year. And although there’s always the risk of business failure wherever you put your money, a lot of the European-based biggies have been around for decades, if not centuries.

Rule 7: Avoid Borrowing from Your 401(k) Account

Although it may be tempting to borrow from your 401(k) account because there’s no credit check and there may be a lower interest rate compared to other loans, consider the “cost” of the loan to your retirement future. First, your retirement money should be “working for you,” that is, earning investment returns. Second, if you leave your job, your entire loan balance may be due when you can’t afford to pay it back—and the tax penalties could cost you a bundle.

Here’s an example of the potential hit on a $5,000 loan, assuming investment returns of 8%, a loan interest rate of 7%, a 5-year term, and that you’re 35 years from retirement. Even if the loan is repaid on time, you’ve lost $20,716.94 in investment returns.

Rule 8: Don’t Tap into Your 401(k) Account Balance When Changing Jobs

Very often when people leave a job, they “cash out” of their vested 401(k) account balances—or spend part or all of it rather than rolling it over to an account at the new employer or to a rollover IRA. But similar consequences face those who cash out of their accounts as those who borrow from it. And the better choice is to keep your money working hard for you.

Here’s why: Cashing out doesn’t just mean potentially spending your retirement money. If you’re under age 591/2 when you cash out, Uncle Sam takes 20% of your hard-earned money off the top and collects more when you file your return.

Rule 9: Move Your Old 401(k) Balance to a Rollover IRA, Not Your New Employer’s Plan

The best way to keep your retirement money working for you is to roll it over into an IRA at a mutual fund company rather than moving it to the 401(k) plan at your new job or leaving it at your former employer. That’s because you keep your retirement money working for you and you don’t lose track of it.

With Americans changing jobs every four years on average, why deal with the hassle of keeping track of 401(k) accounts at various employers when you can have “one-stop savings” in one IRA? Keeping track of old balances is challenging if one or more of your former employers goes out of business or gets acquired by another company. Even better, unlike a regular IRA, there’s no limit to how much money you can save in a rollover IRA as long as the money started out in a qualified retirement plan such as a 401(k). The other reason a rollover IRA is a good idea is that you have more investment choices; for example, your new employer may not offer an index fund as one of its 401(k) investment choices, whereas most mutual fund companies offer them as an IRA investment option.

If you liked this Element, you might like the book by Jane White, America, Welcome to the Poorhouse: What You Must Do to Protect Your Financial Future and the Reform We Need (ISBN: 978-0-13-702017-1).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2010 by Jane White

Published by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-706729-1

ISBN-13: 978-0-13-706729-9

For more information, please contact us at info@ftpress.com

FTPress Delivers Elements

An e-burst of inspiration for business and life.

31 Simple Rules for Protecting Your IRAs and 401(k)s

A quick, indispensable checklist for better retirement decision-making and financial planning—and a more secure, comfortable retirement!

Steve Weisman

ISBN: 978-0-13-703975-3

$1.99

Are You Asking the Right Questions?

Learn how to ask the questions that really matter—and get the answers your business really needs!

Terry J. Fadem

ISBN: 978-0-13-704896-0

$1.99

Mastering the Roll

Pilot a kayak, not an ocean liner! In turbulent times, you will capsize—learn how to prepare for it, recover gracefully, and “paddle” from failure to success.

Gregory Shea, PhD, and Robert Gunther

ISBN: 978-0-13-703907-4

$1.99

31 Simple Rules for Protecting Your IRAs and 401(k)s

Steve Weisman

If you liked this Element, you might like the book,

The Truth About Protecting Your IRAs and 401(k)s

(ISBN: 978-0-13-233384-9).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2010 by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-703975-1

ISBN-13: 978-0-13-703975-3

For more information, please contact us at info@ftpress.com

When it comes to retirement, the decisions you make earlier in life can go a long way in determining your financial success or failure in retirement and the quality of your retirement experience. Knowing and following a few simple rules can help you make good decisions when it comes to using IRAs and 401(k)s toward a rewarding retirement.

Rule 1: Take your minimum required distributions on time. Many people lose track of when they are required to take their minimum required distributions from their traditional IRAs and traditional 401(k)s. If you’re late in taking your initial withdrawals, you’ll be charged serious penalties. As you approach your seventieth birthday (and hopefully well before then), you should have a plan for how you’ll most effectively take your minimum required distributions, with an eye toward the income tax ramifications of delaying your first payment to the latest possible time and having to take two distributions in one year.

In addition, in any year that you fail to take your minimum required distribution, you can be subject to a heavy tax penalty, so make sure you keep track of your required distributions.

Rule 2: If you haven’t paid attention to Rule 1, make sure that you file an IRS Form 5329. Even if you did not take your minimum required distribution in a timely fashion, you can always argue to the IRS that your failure was a “reasonable error,” correct the problem, and take the required distribution. File a Form 5329 and request a refund of your 50% excess accumulation tax. Include a letter of explanation, and do your best to be persuasive. You’ve got nothing to lose.

Rule 3: If you leave a job, don’t cash out your 401(k). When you leave your job, you can leave your 401(k) at your company, roll it over into an IRA, roll it over into your new employer’s 401(k), or take the money and run. The first three options will continue your retirement planning. The last will require you to pay income taxes, stop your tax-deferred growth, and even subject you to a large tax penalty if you are younger than 59-1/2.

Rule 4: Don’t borrow from your 401(k) unless you absolutely have to do so. Borrowing from your 401(k) defeats the purpose of the account, limits the amount of growth in the account for retirement, and carries risks of penalties. No one should borrow from their 401(k) unless they have fully explored other options, such as a home equity loan where the interest can be tax deductible.

Rule 5: Make sure that the beneficiary designations of your 401(k)s and IRAs are in good order. Make sure your beneficiary designation is current and reflects any changes you might want to make as to who will be your beneficiaries due to marriages, births, deaths, or divorces.

Rule 6: Make sure that the beneficiary designations of your 401(k)s and IRAs have contingent beneficiaries. To provide the maximum flexibility and enable you to take the fullest advantage of the rules permitting Stretch IRAs, your beneficiary designations must contain the names of contingent beneficiaries.

Rule 7: Reduce the fees that you pay in your 401(k) and IRA as much as possible. The amounts that you pay in various fees for the management of your 401(k) and IRA as well as other services you are billed for in your retirement accounts have a significant effect on what your money will earn for you. Make sure that you understand all the fees you are paying, and take the steps necessary, where possible, to reduce them.

Rule 8: Don’t rely on automatic enrollment in your company’s 401(k) plan. If you are automatically enrolled in your company’s 401(k) plan, the amounts that you contribute and the investments that form the basis of your 401(k) are determined by default. These decisions may not be the ones you would make. Enrollment in a 401(k) plan, whether done automatically or intentionally, is good. But it is a better when you make informed decisions as to how much money you’ll be investing and where you’ll be investing it.

Rule 9: For most people, the benefits of a Roth IRA are greater than a traditional IRA.

Rule 10: A traditional 401(k) is better than a Roth IRA if your employer provides matching contributions. There are many fees involved with a traditional IRA, over which you have little or no control, that can limit the growth of your 401(k). With a Roth IRA, you are in a much better position to pick your investments and control your fees. However, if your employer provides matching contributions to your traditional 401(k), that is free money that tips the scales in favor of a traditional 401(k) over a Roth IRA.

Rule 11: Pay off your credit cards before you invest in any retirement plan other than a traditional 401(k) that has employer matching contributions. You will get more bang for your bucks if you pay off your high-interest credit cards before saving for retirement with the one exception of investing in a traditional 401(k) that provides you with the free money of employer matching contributions.

Rule 12: Never invest more than 10% of the value of your 401(k) in your own company’s stock. It doesn’t make sense to put all your investment eggs in one stock basket regardless of the company. The fact that you work for a particular company already means that you’re invested in it. Think Enron. To additionally put a large portion of your 401(k) dollars into the same company’s stock is just too risky.

Rule 13: Customize your IRA or 401(k) beneficiary designation as necessary to have it most accurately reflect your estate and financial plan. To have your beneficiary designation be a part of your estate and financial plan, you may have to customize the form to make sure that your wishes are clearly indicated and your options preserved.

Rule 14: Make sure that your heirs are aware of their ability to use qualified disclaimers. A qualified disclaimer when coupled with a properly completed beneficiary designation opens the possibilities of many years of tax savings through the use of Stretch IRAs.

Rule 15: Have a Durable Power of Attorney. A Durable Power of Attorney is a document by which you appoint someone to act on your behalf in financial matters. It is particularly helpful if you are incapacitated and need to change your beneficiary designation or make a disclaimer.

Rule 16: The investment choices that you make within your IRA and 401(k) should be part of an overall asset allocation strategy. A proper asset allocation strategy is the best way to control risk and seek a good return on your retirement investment dollars. The investment choices that you make in your IRA and 401(k) should be part of an overall asset allocation strategy.

Rule 17: Never transfer IRA or 401(k) funds to a divorcing spouse before the court issues an order of divorce. If you transfer IRA funds to a spouse you are in the process of divorcing prior to the court issuing an order of divorce or without a provision for the transfer of those assets specifically being contained with the divorce judgment, you will be subject to severe tax penalties.

Rule 18: If you are 50 or over, take advantage of catch-up provisions that permit you to contribute more to your 401(k) or IRA. The law permits people who are at least 50 years old to make additional contributions to their IRAs and 401(k)s that younger people are not allowed to do. Whenever possible, take advantage of this favor that Congress is doing for you.

Rule 19: Correct any excess contributions you may have made to a Roth IRA as quickly as possible. If you made too large a contribution to a Roth IRA or did not qualify for a Roth IRA but made a contribution, the law permits you to correct this with minimal problems. However, if you fail to correct this mistake in a timely manner, you will be subject to a large excise tax penalty.

Rule 20: If you are young and healthy, you should consider a Health Savings Account. Young, healthy people may find a Health Savings Account (HSA) an effective way to save both for health care and their retirement.

Rule 21: Consider the effects of delaying to the last moment withdrawals from your traditional 401(k) or traditional IRA. If you wait until the last possible moment to start taking your withdrawals from your traditional 401(k) or traditional IRA, you may unnecessarily increase your income tax burden. Do your homework, and consider taking regular withdrawals earlier and investing the money in tax-advantaged investments such as municipal bonds or converting to a Roth IRA.

Rule 22: Consider a SEP IRA, SIMPLE IRA, SIMPLE 401(k), or an Individual 401(k) if you are self-employed. All these options are available to you to help you plan for retirement if you are self-employed. All of them have advantages and disadvantages, so you should compare them carefully and determine what is best for you.

Rule 23: Consider converting your traditional IRA to a Roth IRA. Converting your traditional IRA to a Roth IRA in a properly timed manner can provide you with all the benefits of a Roth IRA, including greater flexibility and control over your retirement funds.

Rule 24: As you approach retirement, consider the effects of IRA distributions on the taxability of your Social Security benefits. The money that you receive from your minimum required distributions from a traditional IRA may affect the taxability of your Social Security benefits. Roth IRA distributions do not affect the taxability of your Social Security benefits. Plan early to deal with this possibility. A Roth IRA conversion may be in order.

Rule 25: If you meet the income guidelines, take the Retirement Savings Contributions Credit. Income tax credits provide a dollar-for-dollar reduction of the amount you are required to pay in income taxes. Always make sure you’re getting every credit you’re entitled to. The Retirement Savings Contribution Credit can be worth as much as $2,000 to you.

Rule 26: Consider setting up a Roth IRA for children or grandchildren as young as seven years old. A Roth IRA established for a child who is paid for legitimately performing services can be an astonishingly tremendous savings vehicle.

Rule 27: If you’re interested in investing your IRA money in types of investments not usually contained in conventional IRAs, consider setting up a Self-Directed IRA. A Self-Directed IRA permits you to put your IRA money into investments such as real estate, stocks and bonds of privately owned companies, and even race horses. If that is your cup of tea (or oats), you should consider a Self-Directed IRA.

Rule 28: If you are married and qualify, set up a Spousal IRA. Even if your spouse is not working outside of the home, you may be eligible for the considerable benefits of a Spousal IRA.

Rule 29: If you have a Roth 401(k), roll it into a Roth IRA at retirement. A quirk in the law requires people who have Roth 401(k) accounts to take mandatory distributions at age 70 1/2. However, you can avoid these mandatory withdrawals by rolling over your Roth 401(k) account to a Roth IRA.

Rule 30: A trust is a good beneficiary for an IRA where young children would otherwise directly inherit the money. A trust is a good way to provide the benefits of an IRA to a person who might inherit your IRA but may be too young to handle the money or otherwise needs the protection of a trust.

Rule 31: Don’t leave a job until you’re sure what the vesting requirements are for your 401(k). Although this should not be the sole determining factor as to whether you leave a job, leaving a job just short of being vested in your employer’s contributions to your 401(k) can cost you a lot of money.

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Where Does Social Security Fit Into Your Retirement?

Frank Armstrong, III and Paul B. Brown

Let’s start with the most important question: Do we think that Social Security is going to be around to augment your retirement? Yes, but with qualifications.

Many people are concerned that they won’t get any Social Security at all because the system is going bust, and it is certainly in real trouble. (We will explain exactly how bad off it is later.) However, it’s not going away. It’s too important to the American people—hard though it is to believe, for some 20% of retirees, Social Security is their only source of income, and millions of others depend on it to a large degree—and politics being what drives our system, it’s here to stay.

The follow-up question is, “Here to stay, but in what form?” Our best guess is that if you are 10 years away or closer to the time when you are going to stop working, your benefits will probably be unaffected. As you know, Social Security benefits depend on your age at retirement, the number of years you have worked, how much you have made, the number of dependents, and even whether you are disabled. Fortunately, the Social Security Web site provides an excellent calculator that will estimate your specific projected benefits with just a little input from you. To determine what your benefits will be, visit www.ssa.gov/planners/calculators.htm.

If you are more than 10 years away from retirement, we wouldn’t bank on receiving all of the money that the Social Security Administration (SSA) projects you will receive. We hope it does, and it might (courtesy, as we will see in a minute, of higher payroll taxes, and/or pushing back the age when someone can receive full Social Security benefits). However, the financial troubles facing Social Security are real, and something will have to be done. That something could be a reduction in benefits, which could happen during President Obama’s administration.

But before we talk about potential cuts, let’s spend some time on why you probably want to pay more attention to the debate over the future of Social Security than you have been. Those potential benefits—your potential benefits—are much more valuable than you might think.

Nothing to Sneeze At

Social Security is a big asset for you and your family. To see just how important it is, multiply the projected annual Social Security benefit you are going to receive from the Social Security Administration (again, the place to figure that out is www.ssa.gov/planners/calculators.htm by 25.)1

This figure will show just how much in savings you must have to generate the same income. For example, if you are scheduled to receive a monthly Social Security check of $2,500, or $30,000 a year, you would need to have saved $750,000 to provide the same sort of income.

Here’s another way to think about it. Ask yourself: “How big an annuity would I have to buy to generate the kind of annual income I am projected to receive from Social Security?”

If you do the math, you will see you would have to buy a fairly substantial one because not only does Social Security provide a monthly check, but your benefit is adjusted upward each year to account for inflation. Therefore, the comparable annuity would have to be adjusted for inflation as well.

Consider a couple scheduled to receive $30,000 in Social Security benefits. If Social Security disappeared tomorrow, they would have to purchase a $408,750 inflation-adjusted annuity^2 to replace that $30,000 in income.

1. Withdrawing no more than 4% of your retirement savings each year virtually guarantees that your retirement savings will last as long as you do. Multiplying by 25 is a quick way of figuring out how much principle you will need to have to generate the annual income you want, assuming you are withdrawing exactly 4% of your retirement savings each year.

2. We are not in favor of annuities, but the Social Security check you receive is like an annuity, in that it’s going to provide you with a fixed amount of income each month. Even better, it is an annuity that comes “free” because you have already paid into the Social Security system through your payroll taxes, by way of the Federal Insurance Contributions Act (FICA) deduction on your paycheck. The FICA tax consists of both Social Security and Medicare taxes. You pay half and your employer pays half for you. Alas, if you are self-employed, you pay the whole thing. The analogy to annuities is useful in explaining just how valuable your Social Security benefit is—even though we are not in favor of annuities.

Whether you are talking about having to save $750,000 to generate $30,000 per year in income or having to buy a $408,750 inflation-adjusted annuity to throw off the same $30,000, you can see that Social Security is a pretty valuable benefit.

Another great thing about Social Security is that unlike your IRAs and most pension plans, your benefits don’t depend on the stock market. It’s a defined benefit pension plan, meaning you know exactly what you are going to receive and when. From an asset-allocation point of view, it would be put in the bond or cash category. This is another reason you can have a bit more money in stocks than you might think, even when you are retired. Knowing that your Social Security benefits are fixed helps offset the risk that comes from being in stocks.

So Why Worry?

Given how substantial a retirement benefit Social Security is, you can understand why we are concerned that you might not get everything that you are currently projected to receive. A bit of history will explain our anxiety.

As they used to say in radio, “return with us now to yesteryear.” Specifically, let’s go back to 1935 when President Franklin D. Roosevelt created the SSA as part of the New Deal. Back then, we had lots of young people working and only a few old folks to support. In fact, there were 42 workers for each retiree. Even so, the age to receive full Social Security benefits was set high enough so that not many people would live long enough to qualify. The information in Table 1, which comes from the SSA itself, makes it clear that this was, in fact, the strategy.

Table 1 Life Expectancy for Social Security

Percentage of Population Surviving from Age 21 to Age 65 Average Remaining Life Expectancy for Those Surviving to Age 65 (Source: SSA)

As you can see, in 1940, barely half (53.9%) of men in this country even made it to age 65, the age at which they could receive full Social Security benefits, and those who did, didn’t live much longer than that. A man reaching age 65 in 1940 had a life expectancy of less than 13 years, meaning the odds said he would die before his 78th birthday. A woman would probably make it to somewhere around 80.

Given that the numbers were relatively small, we could easily afford to give everyone who reached age 65 full Social Security benefits. The fact that the first people to receive Social Security had never paid into the system didn’t matter because we could tax the people who were still working. In fact, because the number of people who would be receiving benefits was so tiny, we were also easily able to pay their survivors a benefit as well.

Flash forward to today. A man turning 65 can expect to live another 17 years, meaning his life expectancy has increased by a third. If you don’t think that sounds like a lot, look at how the number of Americans 65 or older has grown over the years in Table 2.

Table 2 Americans Age 65 or Older 1880–2000 (Source: SSA)

Just to add to the table and put those numbers in perspective: Americans 65 and older will make up 20% of the population by 2030.

Now these rising numbers wouldn’t necessarily be a huge problem, had the Social Security program been set up differently from the beginning. Let’s take a step back to explain briefly how Social Security has been funded. This is important because it will show you why your benefits could be in jeopardy.

We’ll begin by noting that we don’t fund Social Security out of general revenues; we pay for it with a dedicated payroll tax. If Social Security were a private pension plan, we would pay current retirees from that payroll tax and invest what was left over. As you saw in Table 1, when the program was first created, we didn’t have a lot of workers receiving benefits, so there would have been a lot of money to invest. Over time that investment would have grown into a huge capital account, which could have been used to keep Social Security solvent in perpetuity. Unfortunately, the program was not set up this way.

The government has been spending the surplus instead of investing it. There is not one red cent in the famed Social Security “lock box,” the money supposedly set aside to pay benefits to future retirees. What the government has done—and it was permissible under the law—was in essence to borrow from itself. It replaced the money in the lock box with an IOU. When the day comes that current receipts from Social Security taxes (FICA) don’t cover payments, the government will have to fork over funds from the general revenue into Social Security to redeem the IOUs.

That date is far closer than you might think. While he was in office, Treasury Secretary Henry Paulson (who served under President Bush in 2007 and 2008) said the government will have to start paying back what it owes beginning in 2017 so that that the program can continue to pay 100% of the benefits promised. He added that by 2041, if the system is left unchanged, Social Security will only be able to pay out 78% of what is owed to future retirees.

There are only five options to fixing the system.

1. Simply live with the fact that there will be reduced benefits. You can imagine the screaming and yelling that will ensue should our elected leaders stand up and say that they are cutting benefits to both current retirees and older workers (those now in their 50s or 60s), who have been counting on the funds when they retire in the immediate future.

2. Raise payroll taxes to cover the shortfall. Raising taxes is never popular.

3. Delay the age when people can receive full benefits. There is a precedent for this. In 2000, the government began gradually increasing the age at which people could get full Social Security benefits. For example, if you were born in 1940, you now have to wait an extra six months until you are 65 1/2 years old. If you were born after 1960, you need to be 67 to receive full benefits. (You can still start collecting at age 62, but you will receive less than if you waited. For example, someone born after 1960 will receive just 70% of their full retirement benefits if they start taking the money five years early at age 62. Again, the Social Security Web site can tell you exactly how much you will receive should you decide to apply to take your benefits early.)

4. Tax Social Security benefits to a greater degree. Currently, about one-third of people who get Social Security have to pay income taxes on their benefits. The effect of the increased tax, of course, would be to make more money available to the Treasury, money it could use to pay Social Security benefits.

5. Impose a means test. People would only receive Social Security if they had less than a certain amount of other annual income.

What is going to happen? Well, if we had to guess, sometime within the next decade we would expect to see a combination of slightly increased payroll taxes coupled with moving the full retirement age higher. People born after 1965 might have to wait until age 68 to receive full Social Security benefits. In reality, future benefit levels are entirely a political question.

We are faced with an enormous actuarial funding shortfall that is not going to go away by pretending that it doesn’t exist. Having failed to fund the program properly initially and continuing to refuse to do so, we dig ourselves a little deeper into the hole with every day that goes by. The system can be fixed, but the longer we wait, the more difficult it gets. We have to start by admitting that we have been “stealing” from the trust account for generations, and we need to figure out a way to address that.

There really is a problem with Social Security. The system is not “just fine.” Pretending so is morally, economically, and politically indefensible.

Final Thoughts About Social Security

Social Security is a valuable benefit, but don’t count on it for the majority of your retirement income, and don’t count on it to provide all the benefits to which the projections show you will be entitled. Benefit adjustments must come further down the road, so plan to save some extra to cover the difference. (For further thoughts on this, see “How Important Is Social Security” at www.Save-Retirement.com.)

The net takeaway from all this is that, as with most things in life, it is a good idea to hope for the best and plan for the worst.

Here’s a quick primer:

If you file a federal tax return as an individual and your combined income is between $25,000 and $34,000, you might have to pay taxes on 50% of your Social Security benefits. If your combined income is more than $34,000, up to 85% of your Social Security benefits is subject to income tax.

If you file a joint return, you might have to pay taxes on 50% of your benefits if you and your spouse have a combined income between $32,000 and $44,000. If your combined income is more than $44,000, up to 85% of your Social Security benefits is subject to income tax.

If you liked this Element, you might like the book by Frank Armstrong, III and Paul B. Brown, Save Your Retirement: What to Do If You Haven’t Saved Enough or If Your Investments Were Devastated by the Market Meltdown (ISBN: 978-0-13-702900-6).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2011 by Frank Armstrong, III and Paul B. Brown

Published by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-248979-1

ISBN-13: 978-0-13-248979-9

For more information, please contact us at info@ftpress.com

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In Turbulent Times, You Can’t Expect Others to Save You

Develop the mindset and skills to recover when your career “boat” capsizes—because, in today’s whitewater economy, chances are it will!

Gregory Shea Ph.D. and Robert E. Gunther

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Retirement Isn't the Only Option

You don’t have to retire! Learn how to choose from the unprecedented number of alternatives now available to you.

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Maybe You Don’t Want to Retire

Frank Armstrong, III and Paul B. Brown

Could it be that the financial shortfall you are experiencing—due to the financial meltdown of 2008, your inability to save enough money, or some other factor—is actually a good thing? It could be if it forces you to think about the following sentence: “Maybe I don’t want to retire.”

It is not as strange a thought as it first may sound.

For some people, the concept of being able to retire is the thing that keeps them going while they are employed. They work hard at a job that they don’t particularly like and put up with bosses and/or colleagues that they would not have chosen, all in exchange for a much-needed paycheck.

Why? That’s simple. There is a family to feed, clothe, house, and put through school, and there simply aren’t any other good alternatives available.

Or maybe you work because the income allows you to do what you are really passionate about—rescuing animals, volunteering at the church, organizing people to vote, playing golf, gardening....

If you fall into either of these categories, we understand completely why you are looking forward to be able to stop working—and in the pages ahead, we are going to do everything we can to help you eliminate whatever retirement shortfall you might have.

But not everyone is unhappy to be working.

What if you truly like the way you currently earn your living? Sure, there may be parts of the job you could do without—maybe the travel; maybe the interminable meetings. But all in all, when people ask you how you like your job, the first thing you say is “I love it.” It is only then that you begin to talk about the things you wish you could change or improve.

Now is your chance.

Even a quick glance at the business section of your local paper shows that corporations are petrified at the prospect of losing all the older workers who are reaching traditional retirement age. Not only do these firms NOT have a sufficient number of Generation X and Generation Y’ers to replace all those people born in the 1940s and early 1950s who are poised to walk out the door, but they are worried about retaining all the knowledge that their current older employees in their 50s and 60s have.

It’s the perfect time for you to strike a deal. If you tell the boss exactly what you want (and don’t want) to do going forward, you might be surprised how receptive he or she is. After all, if the alternative to letting you work four days a week and only traveling when absolutely necessary is losing a valuable employee who has institutional knowledge the organization would like to keep, accepting the deal is going to sound pretty good.

Because retiring is a serious option on your part, you have all the leverage (providing you are a valuable employee now.)

Highly Paid Second Acts

Of course, staying employed at your current job is not your only work option. You can always start a second career.

Traditionally, the way this advice is phrased is that you take a hobby that you have—those wonderful birdhouses you build—and turn it into a small business. That’s certainly an option, of course, and the Internet makes it possible for you to sell those birdhouses, restored muscle cars, or blueberry pies worldwide.

However, we think it is waaaaaay too limiting to think in only those terms. Your options for future work begin with performing exactly the same sort of job you are doing now for someone else, only on your terms. If your current employer won’t let you work four days a week, someone else very well might. From there, your choices range all the way to finally opening that company you have always dreamed of owning. People aged 55–64 start businesses at a higher rate than any other age group—28% higher than the adult average, according to research done by the Kauffman Foundation.

You could also take your working life in an entirely different direction. We know of

• A three-star general who retired from the military and is now teaching yoga in the Caribbean.

• A former car dealership owner who is now running a lecture series at the local state college.

• A former New York City police sergeant who retired to Florida, where he became known for building quality homes on the west coast of the state.

You can find countless examples of this everywhere you look. But this should not be surprising. Americans over the age of 50 make up a disproportionate share of the self-employed workforce at about 40%, compared to 25% of the overall workforce, according to the AARP. And research by Merrill Lynch and Harris Interactive shows that only 37% of people born between 1946 and 1964 indicated that earning money was an important reason to keep working. Some 67% thought the challenge and mental stimulation would motivate them to continue to be employed. But here’s the key point: The same study found that of those people who plan to continue to be employed, nearly two-thirds want to pursue a different line of work.

We put that point in bold for a reason. We wanted to underscore the fact that you don’t necessarily have to keep working at what you are doing now, if you still want to work.

For some people, that is a big if. They are tired of earning a paycheck. Forty or more years of working can indeed take a lot out of you. If you think it is time to stop and smell the roses (or whatever it is you plan on doing after you quit “the daily grind”), more power to you. As we said, we are here to help.

But if the idea of playing golf everyday or having nothing to look forward to but another day of gardening doesn’t make you light up from the inside, your current financial shortfall turns out to be a good thing. It gives you the chance to think about the idea of working for a few more years. You don’t have to give yourself a hard deadline, such as “I am going to work until I am 73.” But you can explore the option of working a bit longer, and if you do, a lot of good things can happen.

Let’s just quickly run through four substantial benefits you’ll receive if you keep working. (For the sake of the discussion, we’ll arbitrarily assume you decide to push back your retirement date by five years.) If you do, here’s what happens:

• First, you will have five more years of saving for retirement.

• Second, if you delay retirement for 60 months, you’ll have an additional five years to let your savings and investments grow on a compounded basis.

• Third, you aren’t drawing down your retirement savings during those five years. You are adding to them, not spending the money you have saved.

• Finally, if you delay taking Social Security, the size of your monthly check increases, as much as 30% depending on your age.

These are all good things, and they stem from the fact that you are continuing to do something that you enjoy: work.

The Key Takeaway Point

No one wants to experience financial problems. But if your current situation has you rethinking whether you really want to retire, it could turn out to be the proverbial blessing in disguise.

For one thing, it will give you a chance to stop and think about whether retirement is the goal for your life. Sure, there is the trip you always wanted to take and the volunteering/charity work you always wanted to do. But do these things require you to stop working altogether?

For another, in an odd sort of way, the fact that your financial plan may be destroyed by the recent market meltdown or the fact that you never really got around to saving for retirement can be liberating. It gives you a chance to rethink not only all the assumptions you have made about retirement, but also a chance to consider seriously what it is you want to do with the rest of your life.

If you liked this Element, you might like the book by Frank Armstrong, III and Paul B. Brown, Save Your Retirement: What to Do If You Haven’t Saved Enough or If Your Investments Were Devastated by the Market Meltdown (ISBN: 978-0-13-702900-6).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2011 by Frank Armstrong, III and Paul B. Brown

Published by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-248613-X

ISBN-13: 978-0-13-248613-2

For more information, please contact us at info@ftpress.com

FTPress Delivers Elements

An e-burst of inspiration for business and life.

Retirement Isn’t the Only Option

You don’t have to retire! Learn how to choose from the unprecedented number of alternatives now available to you.

James W. Walker and Linda H. Lewis

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Determining Living Expenses for Retirement

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Maybe You Want to Retire Later

Frank Armstrong, III and Paul B. Brown

When people, especially those now in their 40s to mid-50s, start to get serious about retirement planning, they are always shocked and dismayed. This occurs for two reasons.

First, they simply haven’t saved enough money. They realize that the $50,000 they have saved by age 50—and that is unfortunately a representative number—won’t go very far after they stop working. Even if they have managed to save substantially more, the bear market we experienced in 2008 reduced whatever money they had in their 401(k)s, 403(b)s, SEPs, Keoghs, and IRAs by a dramatic amount.

The second reason they get depressed is they realize they don’t have a lot of years left to make up for lost time. They invariably base their retirement projections on retiring at age 65.

But why? Simply by looking around, we can see that 65 is no longer old. Our steadily increasing life expectancy means that people are more than capable of working to age 70, and look what happens if they do.[1]

First, they have five more years of saving for retirement, which is no small thing. By the time they reach their late 50s or early 60s, people who are finally serious are saving for retirement typically put away 20% of their annual income. If they put off retirement for five years, they are able to save a full year’s salary.

Second, if they delay retirement to age 70, it gives them an additional five years to let their savings and investments grow on a compounded basis. A very simple example shows how powerful this idea can be.

Let’s go back to a typical 50-year-old who has just $50,000 in his retirement accounts after the market meltdown of 2008. Let’s make him as typical as can be. We will assume he is married and he and his wife earn a combined $110,000 a year.

Seriously concerned about their retirement, they start saving a combined $11,000 a year, which we’ll assume earns 8% (the historical norm) compounded tax-free in a retirement account. By age 65, they will have $322,567.11.

That’s not too shabby. However, if they withdraw 4% a year to live on, the maximum most experts think you can take out without outliving your money, they will only have $12,902.84 a year to spend in retirement. That’s not great.

However, if they continued to work to age 70 instead of 65 and still save $11,000 a year, they’d end up with $543,652.14 or 68.5% more, and withdrawing 4% annually would give them $21,746 a year.

There are, of course, other benefits that come with pushing back retirement. For example, if you delay taking Social Security, the size of your monthly check increases.

Let’s go back to our hypothetical couple and assume that their combined $110,000 salary comes about because they both make $55,000 a year. If they take benefits at age 65, they each will receive $1,501 a month, but that number climbs to $2,198 each if they wait until age 70.

To quickly review, if our hypothetical couple retires at age 65, they will have a total of $4,077 a month coming in: $3,002 from Social Security, and the rest from withdrawing 4% of their savings. It’s tough for a couple who is used to making $110,000 a year to live on less than $49,000 a year.

However, if they waited just another 60 months to retire, they would have a combined $6,208 a month (that’s $74,496 a year), or 52% more. Our hypothetical couple is likely to say, “Living on $75,000 a year is much more like it.”

Then there are advantages that you would not necessary think of at first. For example, at 65 you might decide to leave your current employer (possibly taking “a package”) and then spend the next five years or longer working as a consultant or starting your own business.

True, you might not make as much as you did in your current job, but you still have some income coming in, and your retirement savings will continue to grow. In essence, this strategy allows you to attempt a second/different career risk-free. If you don’t like your new job or it doesn’t work out, you can simply retire.

Pushing back your retirement date is not something that instantly comes to mind, if you think you aren’t going to have sufficient funds to quit working when you want. However, it could prove to be a very simple (and lucrative) solution to your problems.

Endnote

1. Let’s just underscore the obvious here: Just about all the benefits we are about to describe will accrue to anyone who pushes back their retirement by five years, regardless of when they originally planned to retire. (The only thing that might change is the size of the Social Security benefit you’ll receive.) We just used the age 65 and age 70 figures by way of illustration. The underlying idea is true no matter what five-year period you pick.

If you liked this Element, you might like the book byFrank Armstrong, III and Paul B. Brown, Save Your Retirement: What to Do If You Haven’t Saved Enough or If Your Investments Were Devastated by the Market Meltdown (ISBN: 978-0-13-702900-6).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2011 by Frank Armstrong, III and Paul B. Brown

Published by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-248612-1

ISBN-13: 978-0-13-248612-5

For more information, please contact us at info@ftpress.com

FTPress Delivers Elements

An e-burst of inspiration for business and life.

Retirement Isn’t the Only Option

You don’t have to retire! Learn how to choose from the unprecedented number of alternatives now available to you.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705332-2

$1.99

Determining Living Expenses for Retirement

Be prepared: a realistic, indispensable new look at what you’ll really be spending when you retire.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705334-6

$1.99

Dealing with X, Y, Zs

Surprising and important new insights into managing Gen X, Gen Y, and Gen Z.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705335-3

$1.99

Dealing with Retirement Risks

Frank Armstrong, III and Paul B. Brown

In light of the 2008 market meltdown, your first reaction (as well as your second or third) might be to swear off stocks and maybe even bonds forever, deciding to keep your money in federally guaranteed certificates of deposits and money market funds instead. This is understandable. When the Dow Jones Industrial Average falls nearly 34%, which is still substantially better than the performance turned in by the S&P 500 and NASDAQ, it is only natural to start rethinking things.

However, it’s important that you take the right amount of risk at every stage of your investing career. If you take too little risk in your portfolio, you will never accrue enough to meet your goals. On the other hand, if you take too much risk, a market downturn could deplete your accounts to the point where you might never recover.

Why Take Any Risk at All?

Given how difficult it might seem to balance risk, you can be forgiven for thinking that what we just said justifies playing it ultra-safe and keeping your money in something like CDs.

“Why shouldn’t I,” is a reasonable question.

The answer is simple: You can’t if you want to stay ahead of inflation and have any real (after inflation is taken into account) return. The dramatic drop in stock prices in 2008 certainly shows the downside of risk—you lose money. However, even factoring in the horrific year stocks had in 2008, in the long run (going back to 1925, a period that also includes the crashes of 1925 and 1987, as well as 2008’s dreadful performance), stocks have still have outperformed every other investment, and would have kept you comfortably ahead of inflation.

The same cannot be said of fixed income (bonds) or guaranteed investments such as CDs. Their long-term returns shows that guaranteed investments track inflation closely, and are actually net losers on an after-tax basis.

Let’s take that quick look. As we write this, the easiest and safest investment you can make is buying a Certificate of Deposit. Your local bank will pay you about 4% interest and there is absolutely no risk. (Not only is that 4% guaranteed, but so is your principal.) You give the bank $1,000, and a year later they will give you back $1,040.

Now, a 4% return isn’t bad these days, but you have to pay taxes on the $40 you earn. Depending on where you live, the odds are Uncle Sam and your state government (and maybe even your local government) combined are going to take at least one-third of everything you make. That reduces the $40 you received to $26.66, meaning you actually made just 2.66% on your money, not 4%.

But to really understand how much you’ve earned, you must factor in inflation. After all, a year from now $1,000 will buy less than it does today—thanks to rising prices—and you need to take that into account.

Well, inflation has been running around 3%, so we need to subtract that from our 2.66% after-tax return. When we do, it looks like this:

2.66% (after-tax) return – 3.0% inflation = –0.33% NEGATIVE actual return.

In other words, you actually lost ground by letting the bank hold your money for a year. Because it was an extremely safe investment, you ended up being further behind than when you started.

As you have just seen, the “safe” investment alternatives provide no return—and could actually cost you money—after inflation is taken into account. Meanwhile, stocks traditionally outpace inflation by somewhere in the neighborhood of 6% to 7%.

The net takeaway from this is that despite the disappointing market performance in 2008, the argument for “appropriate equity exposure,” as an investment theorist would put it (the rest of us would call it “owning stocks”), is as strong as ever.

However, owning stocks means accepting market risk, and that in turn means that in some years, the value of your stocks are going to decline, perhaps significantly, as they did in 2008.

However, over the long term, the rewards outweigh the risk. That’s why you need to be in stocks and put up with the occasional truly awful year like 2008. You know without being told that the overall trend of consumer prices is up. Inflation is a fact of life and it’s not going to go away. Most people assume that the official inflation rate, which has been running about 3% recently, grossly underestimates their real-life experience. (If medical costs and college tuition bills only climbed 3% a year, most of us would be thrilled.) Over time, if left unchecked, the loss of buying power caused by inflation is enormous.

For instance, most of the people reading this book can remember when a nickel bought a good sized candy bar, a soft drink, or a newspaper. That nickel won’t buy much today. Failing to keep up with inflation is no small thing. If you plan to live in retirement for a while, and/or if you want to pass on your hard-earned wealth to the next generation, you simply can’t afford a negative real return. You can’t even afford a zero real return. Assuming a modest 3% inflation rate, your real income will be cut by 26% in 10 years, 46% in 20 years, and 60% in 30 years. In other words, it will take $1.34 in 10 years, $1.81 in 20 years, and $2.43 in 30 years just to buy what your dollar will purchase today.

It follows that for you to meet any realistic investment goal, you must invest for a positive real rate of return. Like it or not, you must assume some risk in your investments. The trick is to manage risk to produce an optimal result. The prescription: Prepare financially, take no more risk than you can afford or than you can stand emotionally, and then stay the course.

Preparing financially means that money you are going to need over the next several years is set aside in rock-solid fixed income instruments such as money market funds, CDs, and short-term high-quality bond funds. These will provide the liquidity to ride out the inevitable financial storms.

Preparing emotionally means determining your risk tolerance before the inevitable market downturns. One of the surest ways to destroy wealth is to sell after the market is down. Therefore, determine your asset allocation based on as reasonable a worst-case scenario that you can tolerate, and then consider yourself committed to endure the ups and downs of the markets.

It’s not a sexy approach, and sometimes, like during the meltdown we experienced in 2008, it calls for discipline, but it’s the only time-tested way to harvest what the market offers.

What All This Really Means

We must accept certain amounts of market risk, not because we like it, but because it’s the only way to achieve our financial objectives. Accepting market risk is painless when stock markets are climbing ever higher, but it requires intestinal fortitude (our editor didn’t like the word guts) during the inevitable market declines. Managing the risks, taking the right amount of risk, providing for liquidity needs, and maintaining a long-term outlook are the essential components of a successful investment experience.

You need to think of your investment portfolio as having two parts:

• A risk-free part. These are your investments in things such as CDs, money market funds, treasury bills, bank deposits, and short-term, high-quality bond funds.

• A risky part. This consists of stocks and other equity investments.

Your first step toward managing risk is to properly divide your portfolio into the two parts, but how much in each?

If you have read this far, you already know our answer. The further you are away from retirement, the more risk you can take. That’s why we have suggested having more of your money in stocks, when retirement is relatively far off, and less as your retirement date draws near.

You must always maintain enough highly liquid, risk-free assets to cover all the expected withdrawals from the portfolio for the near- to mid-term. Depending on how aggressive you are, this could be a period of the next 7 to 10 years.

Said another way, money that you will need in the next few years should not be in the world’s stock markets; it should be in fixed income investments such as bonds and CDs.

All the rest could be in equities if you are comfortable with the risk. Remember, stock markets go up and down in unpredictable ways, and although they have always recovered and gone on to new highs, the downturns might cause you acute stress. So, if you can’t live with the market fluctuations, add more risk-free assets to the mix until you can ride out any short-term declines and sleep soundly at night.

The perfect mix is the one that makes you feel the most comfortable. We might believe that someone who is at R–5 (five years away from retirement) should have a portfolio made up of 60% stocks and 40% in bonds and cash equivalents such as CDs and money market funds. You might believe that is too aggressive, and might want to flip those percentages and only have 40% in stocks. That’s fine with us, as long as you understand the potential gains you are giving up, because over time stocks outperform any other investment.

What would the typical retirement portfolio look like over time? Early in your career, you won’t be anticipating any withdrawals for a long time, and you can comfortably load up on risky assets, such as stocks. This gives you the best chance to accumulate a tidy sum to provide a safe and secure retirement. As you get closer to retirement, you will need to shift to risk-free assets to cover the withdrawals you know you are going to make after you stop working.

Let’s use some real numbers to show how this could play out. Suppose you plan to take out 4% of your account each year to provide your retirement income. Somewhere around R–5, you will want to have a minimum of 28% to 40% of your retirement portfolio in risk-free assets to cover the needs for the next 7 to 10 years. If you are a more conservative type, you could add another 10% to those figures—boosting the percentages to 38% to 50%, respectively—just so you sleep well.

Notice that we said you want to have your retirement portfolio in place about five years before you retire. You don’t want to have your retirement decisions for tomorrow determined by what the market does today.

The more widely you diversify your risky portfolio, the better the probable outcome. We would suggest a mix of domestic, foreign, and emerging markets along with foreign and domestic real estate purchased through Real Estate Investment Trust (REIT) mutual funds and a commodities futures position (which again is possible to achieve through mutual funds).

The further you move from a fully globally diversified portfolio, the higher the risk, and the greater chance your retirement accounts will “blow up” on you. Don’t let your company’s stock, or any other stock, make up more than 5% of your retirement portfolio. You will never get compensated for risk that could have been diversified away.

One Final Thought About Risk

There is a limit to what you can expect from the world’s markets. Most economists guess, based on past experience and years of data, that the expected returns from equities might vary between 8% and 11% over the long term. You must resist the temptation to take on more risk than the diversified global portfolio offers in the hopes of increasing your returns.

You can easily increase your risk—and thereby potential returns—by using leverage, concentrated stock positions, or market timing. Although a few people will win using such extremely aggressive strategies, most of them will have substandard returns, and a few will blow up their retire accounts completely.

Although it might seem like the only way to recover from a late start or another financial disaster, you try to outperform the worldwide market averages at your peril.

If you liked this Element, you might like the book by Frank Armstrong, III and Paul B. Brown, Save Your Retirement: What to Do If You Haven’t Saved Enough or If Your Investments Were Devastated by the Market Meltdown, (ISBN: 978-0-13-702900-6).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2011 by Frank Armstrong, III and Paul B. Brown

Published by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-248611-3

ISBN-13: 978-0-13-248611-8

For more information, please contact us at info@ftpress.com

FTPress Delivers Elements

An e-burst of inspiration for business and life.

Retirement Isn’t the Only Option

You don’t have to retire! Learn how to choose from the unprecedented number of alternatives now available to you.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705332-2

$1.99

Determining Living Expenses for Retirement

Be prepared: a realistic, indispensable new look at what you’ll really be spending when you retire.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705334-6

$1.99

Dealing with X, Y, Zs

Surprising and important new insights into managing Gen X, Gen Y, and Gen Z.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705335-3

$1.99

Getting to What’s Next in Planning Your Retirement

Frank Armstrong, III and Paul B. Brown

Some people have known from the minute they started work what their retirement would look like. They can give you each and every detail of the cottage they are going to buy on the Maine coast, or what kind of furnishings their condo near the Gulf of Mexico is going to contain. Not only that, they can tell you in detail how they are going to spend their days after they are no longer employed. The rest of us can use a little help picturing what the next phase in our life is going to look like.

One way to start is by answering the following questions. They will help identify what is truly important to you. Seeing the answers in black and white (and in your handwriting) might make it easier to plan for and achieve a life that you have only imagined.

Ready? Begin.

If you could do anything, time and money aside, what would it be? Spend time with family, buy a vacation home, start your own business, whatever it is—write it down here.

________________________________________________

________________________________________________

________________________________________________

What would you like to add to your life? More time, more money, or something else?

________________________________________________

________________________________________________

________________________________________________

What would you like to reduce or eliminate from your life? Debt, job stress, or the alarm clock?

________________________________________________

________________________________________________

________________________________________________

What have you always wanted to do? (Need a hint? It could be change careers, start a new business, continue doing the work you love free of some of the headaches.)

________________________________________________

________________________________________________

________________________________________________

Are there hobbies you want to pursue? Restore an old car, make quilts, garden, write a novel, learn to play the piano, act....

________________________________________________

________________________________________________

________________________________________________

Volunteer work. Many people tell us they love their jobs, but wished they had more time to give something back. Retirement will give you that time. What do you want to do? Build homes for the homeless; volunteer for a political party; teach people to read; clean up a specific area; help out a local church/synagogue/mosque?

________________________________________________

________________________________________________

________________________________________________

Learning. It is no surprise to us that college towns are popular places to retire. Do you want to go back to school, learn another language, get your pilot’s license...?

________________________________________________

________________________________________________

________________________________________________

Relaxing and enjoying life. Do you want to travel, spend more time with the kids/grandkids, read more, savor quiet time?

________________________________________________

________________________________________________

________________________________________________

Who do you want to spend time with? Maintaining social connections can be challenging throughout our lives. Young parents are often surprised by how much they miss just talking to adults. The newly self-employed might miss the “water cooler,” and the loss of work friends is the most unforeseen challenge of retirement. It’s important to take an active role in building and maintaining your support network of friends, family, and acquaintances throughout your lifetime. Which people would you like to spend more time with?

________________________________________________

________________________________________________

________________________________________________

Spouse or partner. Consider new activities you might want to participate in together.

________________________________________________

________________________________________________

________________________________________________

Family. How far away are your parents, children, and grandchildren? What activities do you like to do together?

________________________________________________

________________________________________________

________________________________________________

Friends. How much do you like to entertain and stay socially active?

________________________________________________

________________________________________________

________________________________________________

New friends. Do you want to meet new people? How are you going to do it? (Consider classes, clubs, and organizations.)

________________________________________________

________________________________________________

________________________________________________

Where do you dream of going? Just about everyone we know has one (or more) special destination(s) in mind. Where is it? Who do you want to go with?

________________________________________________

________________________________________________

________________________________________________

Where do you want to live? Where you want to live is an important part of your vision of the future. Do you want to be part of a community? Do you want to try a new climate or lifestyle? Do you want to live in multiple locations? Move closer to the kids or your parents? Move to a place that would be perfect to start that new business? Head up to the mountains so you will have more time to ski...?

________________________________________________

________________________________________________

________________________________________________

How do you intend to stay healthy and active? As your lifestyle and your health change throughout life, think about how you will take care of yourself. Consider it in broad terms, including mental as well as physical well being.

________________________________________________

________________________________________________

________________________________________________

How do you want to make a difference? Sometimes dreams can include helping others. Think about the people that matter to you, what you hope the future holds for them, and how you might help them realize their own dreams. What organizations or causes represent your values? How do you want to support them now and in the future? Think big.

________________________________________________

________________________________________________

________________________________________________

One Last Thought

Dreams are going to remain just dreams unless you do something about them. Our suggestion for turning them into reality? After you have identified the dream (or dreams) you want to fulfill, follow the STAR technique: Make it specific, time-bound, actionable, and relevant. Then, prioritize your dreams and work to develop your plan and track your progress along the way. If you follow this course of action, you will find yourself asking such questions as the following:

• What do I need to do to make my dream a reality?

• What will it take to keep me on track?

• What is all this going to cost me?

You must put in this work, because unfortunately it takes more than wishing to make dreams come true.

If you liked this Element, you might like the book by Frank Armstrong, III and Paul B. Brown, Save Your Retirement: What to Do If You Haven’t Saved Enough or If Your Investments Were Devastated by the Market Meltdown (ISBN: 978-0-13-702900-6).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2011 by Frank Armstrong, III and Paul B. Brown.

Published by Pearson Education. Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-248610-5

ISBN-13: 978-0-13-248610-1

For more information, please contact us at info@ftpress.com

FTPress Delivers Elements

An e-burst of inspiration for business and life.

Retirement Isn’t the Only Option

You don’t have to retire! Learn how to choose from the unprecedented number of alternatives now available to you.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705332-2

$1.99

Determining Living Expenses for Retirement

Be prepared: a realistic, indispensable new look at what you’ll really be spending when you retire.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705334-6

$1.99

Dealing with X, Y, Zs

Surprising and important new insights into managing Gen X, Gen Y, and Gen Z.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705335-3

$1.99

Are You on Track for Your Retirement?

Frank Armstrong, III and Paul B. Brown

It’s expensive to retire. But just how much will it take, and how will you pay for it?

To figure out how much income you will have coming in, begin by checking out the Social Security Benefit Calculator on the Web (www.ssa.gov/planners/calculators.htm). They have an amazing amount of information to help you understand the program and maximize what you will receive. You will be able to get a very close approximation of all the benefits you and your family are entitled to under many different scenarios.

If you are fortunate enough to have a defined benefit retirement plan at work, ask your employer for an estimate of your benefits, or take your benefit booklet and work through the calculations about what you will receive based on your income and years of service. These are relatively simple calculations that shouldn’t intimidate you. At most you will have to multiply three numbers together and subtract a little for Social Security if the plan has an offset. Your “summary plan description” will give you the formula. Add in any other fixed income you expect to receive in retirement from things such as rent, royalties, military pension, and so on.

Where All That Money Is Going to Go

After you total those figures, the obvious question is this: Will this be enough to get you through your retirement? At fifteen years away from your retirement, you should have an idea of the lifestyle you want to have after you stop working.

One easy way to figure out whether you are going to have enough money to fund your retirement involves really simple math. As we talked about earlier, you probably don’t want to withdraw more than 4% of your retirement savings in any given year. If you do, you run the very real risk of outliving your money.

So, to determine whether you will have sufficient funds, multiply the amount of money you think you will need from your portfolio by 25. The answer will tell you whether you have saved enough.

Let’s use an example. Say you think you will require $75,000 a year to fund the way you will want to live in retirement. And we will assume that you will have $20,000 a year coming in from Social Security and will be receiving another $5,000 annually from something like a pension. That means you’ll need to generate $50,000 a year from your retirement savings.

Assuming you are going to withdraw 4% of your money each year, you would multiply the amount of money you will need—$50,000—by 25. In this case, you will need to have $1.25 million in retirement savings to fund your lifestyle in retirement.

(If you were to use a more aggressive 5% withdrawal rate, and we don’t recommend going above that, you would multiply your expenses by 20 and discover that you would “only” need $1 million in savings.)

The difference between what you know will be coming in and the amount of money you will need in retirement will have to come from the money you have put away. Our Retirement Nest Egg Calculator, found at www.Save-Retirement.com, will give you a rough idea of what you will need to save.

After reading all this, we invariably get the following four questions. Let’s deal with them each.

• I was on track, but the market just creamed my investment accounts. What do I do now?

This is the situation that Bob and Heather find themselves in.

The financial meltdown of 2008 wasn’t pretty. However, before you panic, remember you have lots of time for the market to recover. Your retirement is 15 years away. Meanwhile, while the market is depressed, you can buy lots of shares at ridiculously cheap prices. Later on, when the market is substantially higher—and at some point we firmly believe it will be—you will be glad you did. So at the very least, continuing to fund your retirement accounts at the previous level and count on time and compound interest (more on this in just a minute) helping you out.

• I’m behind, but we can’t seem to save much. What should we do?

Many couples are experiencing financial hardships and truly can’t save much. This is the situation that Carolyn and Bob find themselves in. The reasons might vary—there might be kids in school, alimony to pay, and/or aged parents to support—but the pressures are very real. Retirement planning isn’t an option when meeting the day-to-day bills seems to be a struggle.

Still, if you have savings, you can optimize what you have by applying smart tactics and taking the right amount of risk for your situation. For example, eliminate all consumer debt because it will drown you in fees and interest charges. For others, saving more is possible. Many day-to-day expenses are optional. The now clichéd advice about cutting out your daily latte and saving the money you would have spent is right. But consider it a metaphor for all the nonessential things you are spending money on (for example, do you really have to go out to eat so often?)—money that could otherwise be shifted to retirement savings without seriously affecting your quality of life.

However, you might be the kind of person who doesn’t have the discipline to budget and save. Frank, one of your coauthors, falls in this category He describes himself as “a 64-year-old infant; one who demands instant gratification and is addicted to all the new toys.” The only salvation for people like Frank is to save first and then live on what’s left over. Frank is honest enough to know that if he were to try to save what remains at the end of the month, there never would be anything to save. So, he maxes out his retirement plan by having the money automatically taken out of his paycheck. (Then he shamelessly spends the rest.) Frank never sees the money he saves, so he doesn’t miss it. It more or less painlessly goes into his retirement accounts and is automatically invested in an appropriate asset allocation plan that meets his needs at this stage of his life.

Just about all the major financial services firms offer mutual funds that do this—they are usually called “lifecycle,” “targeted,” or “age-based” funds. They all work the same way: The fund invests in stocks, bonds, and cash and becomes more conservative in its allocation as your retirement date draw near. These funds are an acceptable solution if you simply can’t be bothered to manage your account, but we actually think you can exercise more control over your asset allocation by following our suggested plans.

If you are not fortunate to have a quality 401(k) or 403(b) at work, consider an IRA or Roth IRA. If you are self-employed, you can have almost any kind of pension or IRA you want.

You might be pleasantly surprised when you see how little an increase in your 401(k) or 403(b) contribution will affect how much you take home. Check out our “Retirement Contribution Effects on Your Paycheck” calculator at www.Save-Retirement.com. If you or your spouse have a good plan at work, stash a little more there.

Time is still on your side, and it would be a wonderful idea to make the decision to increase your savings to take advantage of the magic of compounding. To see how much those dollars will grow, check out our “401(k) Savings Calculator” at www.Save-Retirement.com. As you will see, the power of compounding is the only thing that can save people who haven’t yet started to save for retirement.

• I’m not on track, because I haven’t started yet. Is it hopeless?

For those who haven’t done anything, there’s still time—but just barely. If you don’t get very serious now, it’s unlikely you can retire in 15 years and still retire the way you imagined. You will have to develop a Plan B, and Plan B isn’t as nice as a Plan A—ever. There is always something substantial that you have to give up when you go with your fallback position.

The younger you are, the more time is your ally when it comes to saving for retirement. That’s true for two reasons. First, you have more years to save—you can accumulate a lot more cash when you start saving $3,000 a year at age 25 as opposed to 45. And second, you gain all those years when you can earn money on your money through the wonders of compound interest.

But, as you grow older, time becomes the enemy. Each year you put off beginning to save and invest, the task becomes a little harder.

A quick glance at Figure 1 shows what we mean. Figure 1 shows the average deposits necessary to accumulate $1 million, assuming you earn 8% a year on your money.

Figure 1 The earlier you start saving for retirement, the longer the power of compounding can work you.

With 15 years until your retirement date, you will need to save $34,101 each year—daunting to say the least. However, if you wait five years to begin, the amount climbs to $63,916.

As you can see in Figure 2, the vast majority of total accumulations for the people who start early comes from earnings on their deposits. The longer you wait to begin, the more money you must actually contribute out of your own pocket.

Figure 2 The earlier you start saving, the more compound interest works for you.

Who Wants to Be a Millionaire?

There is a reason that Albert Einstein once said, “Compound interest is the most powerful force in the universe.” The reason is shown in Figure 2, which shows how much you have to contribute to become a millionaire, based on how much time you have to achieve your goal.

As you can see, with 15 years to go, you will need to contribute slightly more than half of your goal, and Figure 2 shows that figure grows dramatically each year you delay.

The takeaway from these figures is clear: No matter how you look at it, starting early eases the burden of paying for the kind of retirement you want. If you start too late, you will never be able to accumulate your million dollars. The annual deposits required would just be too great.

For an additional view of this tailored to your exact situation, see our “Don’t Delay Your Savings” calculator at www.Save-Retirement.com.

• Despite everything, it looks like I am on track. Can I (finally) stop worrying about how I am going to fund my retirement?

This is the pleasant situation that Dave and Debbie find themselves because they started saving early and are not huge spenders.

If you are on track, congratulations. Our only advice: Don’t be too smug. Even if you are doing well, it never hurts to increase your savings if your situation permits. Few people arrive at retirement having far too much money. And it is important to note that if you plan to have exactly what you need (and not a penny more) on the day you retire, you might find yourself short of your goal on retirement day if the market hits a sudden and substantial downdraft. So, it’s never a bad idea to have a little padding. Consider stepping up your contributions. Most likely you are in your peak earning years and can afford to salt away a little extra. We certainly can’t guarantee that markets will perform as they have in the past. It’s unlikely, but still possible, that the next 15 years might produce little or no growth in even the best designed portfolio, so extra contributions give you an extra safety margin. Folks retiring in 2008 or 2009 will most probably wish that they had had a little extra in their accounts.

However, even if all goes better than we expect, you don’t want to just get by during your retirement, you want to LIVE! That’s why you want to save more if you can.

Conversely, make sure you are not taking unnecessary risk. Do you have too much money—more than 5% of your total assets in company stock? Are you diversified enough? Do you own the stocks not only of U.S.-based companies, but also those of companies around the globe?

A good part of your equity holding should be in foreign-based stocks. We recommend putting as much as 50% of your stock holdings in companies based outside of the U.S.

Review your entire portfolio with an eye to reducing expenses and tax exposure, as well as managing risk.

Catching Up

If fifteen years from your retirement just happens to arrive on your 50th birthday, we have some good news for you, and we aren’t referring to a newly minted AARP card.

Recent tax changes allow employees over 50 to make additional tax-deferred contributions. These are widely referred to as catch-up contributions designed to encourage older employees to save more heavily for their retirement. In 2009, the 401(k)/403(b)/457 catch-up limits are $5,500, and the amount will be adjusted in future years for inflation.

If you make the entire $5,500 annual catch-up contributions between age 50 and 65, you can stuff an additional $82,500 into your plan. Of course, your spouse can, too. With growth, that’s a lot of extra income you could have for the rest of your life.

Even if you haven’t reached 50, you can and should take advantage of the new higher limits for almost all plans. Here are the limits for 2009:

• For both traditional IRAs and Roth IRAs, the contribution limit is raised to $5,000 per year, with an additional $1,000 catch-up. You can put $16,500 into a 401(k)/403(b)/457, and self-employed people are able to save $49,000.

Depending on your income limits, a highly motivated, charged-up future retiree could do both an IRA and 401(k)/403(b)/457 elective deferrals.

Advice for Everyone 15 Years Away from Retirement

Fortunately, by age 50 many folks find their family obligations are under control and are actually starting to decline. For example, the kids might be out of the house and/or done with school or soon will be. By this age, most of us are making more money that we ever have, too. Some of the financial pressures might be reduced and additional savings are a distinct possibility. But how should you employ those savings for maximum impact?

• If you have a decent 401(k), 457, or 403(b) plan, max out your contributions and don’t forget that past age 50, you can use catch-up contributions to allow you to save more than you ever could before. The limits change each year, so be sure to check in 2010 and beyond. The easiest way to do this is to Google the phrase “Pension Plan Limitations for 2010” (or whatever year you’re interested in).

• If your pension plan isn’t so hot, perhaps your spouse’s plan is better. Max that one out if you haven’t already. A good pension plan has low expenses (less 1.5% of the money invested) and the capability to provide true global diversification to match your needs.

• If neither of you have a decent retirement plan, consider maxing out your traditional or Roth IRAs. Remember, even a nonworking spouse can have an IRA and can fund it to the maximum. And again, there is a catch-up provision for people age 50 and older. Your maximum contribution goes up from $4,000 to $5,000 a year, depending on your family income.

• If you are self-employed, you can have your own individual 401(k) plan. These are cheap and easy to establish. Just contact one of the major financial firms, such as Vanguard.

You can still retire on time at your desired date. However, now is the time to get serious and make it happen. Save lavishly, invest wisely, and you will meet your goal.

If you liked this Element, you might like the book by Frank Armstrong, III and Paul B. Brown, Save Your Retirement: What to Do If You Haven’t Saved Enough or If Your Investments Were Devastated by the Market Meltdown (ISBN: 978-0-13-702900-6).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2011 by Frank Armstrong, III and Paul B. Brown

Published by Pearson Education, Inc,

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-248977-5

ISBN-13: 978-0-13-248977-5

For more information, please contact us at info@ftpress.com

FTPress Delivers Elements

An e-burst of inspiration for business and life.

In Turbulent Times, You Can’t Expect Others to Save You

Develop the mindset and skills to recover when your career “boat” capsizes—because, in today’s whitewater economy, chances are it will!

Gregory Shea Ph.D. and Robert E. Gunther

ISBN: 978-0-13-706118-1

$1.99

Retirement Isn't the Only Option

You don’t have to retire! Learn how to choose from the unprecedented number of alternatives now available to you.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705332-2

$1.99

Determining Living Expenses for Retirement

Be prepared: a realistic, indispensable new look at what you’ll really be spending when you retire.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705334-6

$1.99

Think About Your Retirement NOW!

Frank Armstrong, III and Paul B. Brown

It’s impossible to overemphasize the importance of starting early to save for retirement. You know that without being told. Retirement is expensive. Retirement planning is all about accruing enough capital to support us for what could be almost a third of our life without a paycheck. And just like any other venture, being undercapitalized greatly increases the chance of failure.

Here is another view of the importance of starting early. Let’s say you and your spouse both resolve to fully fund your IRAs each year. That’s $10,000 per year. If you contribute for 40 years and receive an average return of 8%, you will accumulate $2,590,565. However, if you wait five years to start, you end up with $1,723,168. The $50,000 you didn’t contribute in the early years ends up costing you $867,397!

At this stage of your career, time is your ally. The power of compound interest means that your early contributions will be much more valuable than later ones because they will grow to relatively large sums over the time until you retire. Take advantage of it.

In our experience, almost everybody wishes that they had saved more and started earlier by the time they finally stop working. However, a funny thing happens on the way to retirement. We place a higher importance on things that we want right now than we do on things for later. That shouldn’t surprise us. We do it all the time in other parts of our life. We want to lose weight, but that ice cream cone is just irresistible. We can diet tomorrow. So, naturally we go for the new iPhone, BMW, or long weekend away, even though we really want to retire in style later. We just seem to be hard wired this way.

It’s hard to change bad habits even if we recognize how harmful they can be—just ask any smoker. That’s why we advocate tricking ourselves into saving through some sort of automatic plan that makes us save first—it removes temptation.

Removing temptation is a good thing. If the ice cream is not in the freezer, we can’t eat it. If we send off part of the paycheck before we ever see it, we can’t spend the money that has been automatically saved.

Perhaps the best thing about our 401(k) system is that for people who use it, it’s an automatic save-first program. After it’s set up, savings happen automatically every pay period, and the participant lives on what is left over. The participant doesn’t have to make the mental effort and exercise the discipline to decide to save and budget hundreds of times a day. The money is taken out of your paycheck before you ever have the chance to spend it.

If you don’t have a high-quality 401(k) or similar employer-sponsored plan to participate in, set up a payroll deduction plan with a good mutual fund company and have them automatically debit your checking account each month, putting that money in the retirement investment of your choosing. Any automatic savings plan has a much higher chance of actually working than trying to save what’s left over at the end of the month. Temptation being what it is, there will seldom, if ever, be anything left over.

In the end, it’s much less important whether we invest in an IRA, Roth IRA, 401(k), or taxable brokerage account than that we actually invest enough and early enough to meet our goals. The most tax efficient, effective, lowest cost investment plan won’t do you any good unless you actually contribute to it, and only you can make that happen.

We really don’t have much sympathy for the idea that you can’t save. Because the thought is so important, let us repeat something we said before: No matter how much or little you make, somewhere there is a person making only 80% of what you are, and they are living a full and satisfying life. So, you could save 20% and live a full and satisfying life, too.

However, there is a good chance that if you are not saving much or anything today, a 20% goal might not be possible at first. However, many 401(k) plans are helping their participants ease into savings painlessly by adopting an escalating contribution scheme. The employee starts off at some tolerable level of contributions; for instance, 3% of their compensation. But the brilliant part of the plan is that the employee agrees to contribute some portion (for instance, half) of all future raises to his 401(k). So, each time he gets a raise, his contributions increase, and he has more take home pay, too. Before long, the average employee is contributing 14% or so and not missing it. If your employer’s plan doesn’t offer this feature, which is often called “save more tomorrow” or a SMART plan, ask them to do so. If they don’t, you can do it yourself.

The Safe Road to Take

It’s highly unlikely that you will be able to forecast a retirement budget when you are this far away from retirement. You will experience inflation and career progression, so it will be difficult to imagine a lifestyle decades in the future. However, you can set a savings goal so that when the time arrives to retire, you will have provided a nest egg to support yourself. Long experience shows that if you consistently save 20% of your income, you will achieve financial security.

Of course, each penny saved must be invested at the right level of risk for your stage of career and time to retirement. At this point, with so many years to retirement, you should be very comfortable with high levels of equities in your portfolio. The probability that you won’t be handsomely rewarded for bearing market risk over that time frame is very, very low. In fact, going back to 1926 (which is as long as we have good records), no one has ever lost money over a 15-year period in the stock market. So, you should be confident that stocks are the way to go during your early and middle career.

If you have been investing heavily in equities up until now, you might not be too pleased after the stock market meltdown of 2008. Looking at your portfolio today might give you a distinctly unpleasant feeling. It’s hard to see your account balance decimated by forces beyond your control. But, believe it or not, it’s a good thing for you. You should be dancing in the street. The world’s markets are offering you fire sale prices, which might very well be the buying opportunity of this century. Increase your savings to take advantage of the good deals. You will be glad you did at retirement time.

(Important) Odds and Ends

Watch those expenses. You should always be conscious of your investment costs. Remember our previous example where your IRAs grew to $2,590,565 over 40 years? If you lost just 1% due to investment costs and instead compounded your account at 7%, the total shrinks to $1,996,351. So, that 1% difference adds up to almost $600,000 over time. This is not pocket change in our house. That’s one reason we so strongly recommend low-cost index funds for your investment program.

The same math holds true for investment returns. If you lose 1% over your career because you invest too conservatively, you get the same disappointing result as if the investment costs were too high. Especially early in your career, it’s important to load up on global equities to get you the growth you need for your retirement lifestyle. Time is your ally here, as well. The longer you hold equities, the higher the probability that they will outperform the “safe” alternatives.

Changing jobs? Our fathers expected to have the same job for at least 30 years and to retire with a guaranteed pension. Today, the average job tenure is 3.5 years. That hurts in a couple of ways. First, you lose the eligibility to participate in your employer’s plan when you first join the company. Depending on how the plan is written, you might not be allowed to make a contribution your first year, and you won’t receive the company’s contribution, either. When you leave, you might lose all or part of the company’s contribution under the plan’s vesting rules.

A quick check of your company plan’s eligibility rules and vesting schedules might allow you to time your departure to preserve some of those benefits that might otherwise be lost. For an example, many plans require an employee to be employed on the last day of the year in order to participate or earn a year’s vesting. You might want to start that new job on January 2 instead of December 31.

So, make sure that you fully fund your IRAs or make other savings contributions in years in which you lose benefits due to job changes.

Whatever is left in your retirement plan when you leave your employer is eligible to be rolled over into an IRA. Some plans will allow you to remain in them, but most will want to rid themselves of the administrative burden of holding your account. (Our Web site at www.Save-Retirement.com has some comprehensive articles covering your options when changing jobs.) You probably will decide to roll over into an IRA. This will allow you to control costs, administer all your accounts in a central location, and create the investment mix to meet your exact needs. Whatever you do, resist the temptation to take the money and blow it. Systematically raiding your accounts is a ticket to poverty in retirement. Keep that money at work and keep time on your side.

Don’t lend to yourself. Borrowing against the pension plan is another variation on the theme of raiding your future benefits. Don’t do it unless your children are starving. We consider pension accounts to be sacred funds that should be treasured, protected, nourished, and allowed to grow so that you can enjoy the retirement of your dreams.

If you liked this Element, you might like the book by Frank Armstrong, III and Paul B. Brown, Save Your Retirement: What to Do If You Haven’t Saved Enough or If Your Investments Were Devastated by the Market Meltdown (ISBN: 978-0-13-702900-6).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2011 by Frank Armstrong, III and Paul B. Brown.

Published by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

This item is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this item. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this item.

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-248978-3

ISBN-13: 978-0-13-248978-2

For more information, please contact us at info@ftpress.com

FTPress Delivers Elements

An e-burst of inspiration for business and life.

In Turbulent Times, You Can’t Expect Others to Save You

Develop the mindset and skills to recover when your career “boat” capsizes—because, in today’s whitewater economy, chances are it will!

Gregory Shea Ph.D. and Robert E. Gunther

ISBN: 978-0-13-706118-1

$1.99

Retirement Isn't the Only Option

You don’t have to retire! Learn how to choose from the unprecedented number of alternatives now available to you.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705332-2

$1.99

Determining Living Expenses for Retirement

Be prepared: a realistic, indispensable new look at what you’ll really be spending when you retire.

James W. Walker and Linda H. Lewis

ISBN: 978-0-13-705334-6

$1.99

Determining Living Expenses for Retirement

Planning How to Live Well in Your Post-Work Life

James W. Walker and Linda H. Lewis

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, many people 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.

How Much Do You Need?

“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?” To answer the question, you could start from scratch and project what you anticipate your living expenses will be when you retire.

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 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, for instance, 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.

Lifestyle Spending

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.

Are you willing to change your lifestyle and future plans 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 that 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 people 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.

Health Care

“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 of you. Costs have risen significantly and continue to rise. While many people 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, people 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), copayments, 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.

Long-Term Care

“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 or 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.

References

AARP (2006). In Their Dreams: What Will Boomers Inherit? Washington, D.C.: AARP.

AARP (2006a). Boomer Wealth—Beware of the Median. Washington, D.C.: AARP. Data Digest #143.

Bernstein, A. (June 5, 2006). “When boomers cash out.” Business Week.

Carlson, R.C. (2004). The New Rules of Retirement: Strategies for a Secure Future. New York: John Wiley & Sons.

Chatzky, J. (September 21, 2006). “Just when you thought it was safe to retire.” CNNMoney.com.

Cullen, T. (October 12, 2006). “Fiscally fit: A policy to live by.” Wall Street Journal.

Deloitte (2005). Annual 401(k) Benchmarking Survey. New York: Deloitte.

Duhigg, C. (July 8, 2007). “For elderly investors, instant experts abound.” New York Times, pp. 1, 14.

Eisenberg, L. (2006). The Number: A Completely Different Way to Think About the Rest of Your Life. New York: Free Press.

Federal Reserve Board (March 22, 2006). “Recent changes in U.S. family finances: evidence from the 2001 and 2004 Survey of Consumer Finances.” Federal Reserve Bulletin, A1–37.

Greene, K. (July 29, 2006). “Will my medical benefits still be there in retirement?” Wall Street Journal, pp. B4.

Kennickell, A.B. (2003). A Rolling Tide: Changes in the Distribution of Wealth in the U.S., Table 10. Annandale-on-Hudson, NY: Bard College, Levy Economics Institute.

Lim, P. J. (August 20, 2006). “Take my nest egg, please.” New York Times.

Lowenstein, R. (October 30, 2003). “The end of pensions?” New York Times.

Machan, D. (September 12, 2006). “Stay rich.” SmartMoney.com.

Merrill Lynch (2004). Retirement: The American Dream. New York: Merrill Lynch.

Merrill Lynch (2005). The New Retirement Survey. New York: Merrill Lynch.

Munnell, A.H., Buessing, M., Soto, M., and Sass, S. (July 2006). Will We Have to Work Forever? Center for Retirement Research at Boston College, Issue in brief, Series 4.

National Association of Insurance Commissioners (2003). A Shopper’s Guide to Long-Term Care Insurance. Kansas City, MO: NAIC. http://www.naic.org.

Novelli, W.D. (May 2006). “The future of pensions.” AARP Bulletin.

Opdyke, J.D. (November 4, 2006). “New Rx for long-term care.” Wall Street Journal, pp. B1.

PBS (2006). “Interview: Jack VanDerhei.” www.pbs.org/wgbh/pages/frontline/retirement/interviews/vanderhei.html.

Porterfield, B. (September 25, 2006). “Retiree health care could be a back-breaker.” San Diego Union Tribune, pp. 1.

Powell, E.A. (December 10, 2006). “Boomers’ retirement boom.” San Diego Union-Tribune, pp. H3.

Rix, S.E. (2004). Aging and Work—A View from the United States. Washington, D.C.: AARP.

Spectrem Group (2007). Affluent Market Report. www.spectrem.com.

Towers Perrin (2003). Back to the Future: Redefining Retirement in the 21st Century. Stamford, CT: Towers Perrin.

U.S. Trust (2006). What the Wealthy Think: The U.S Trust Annual Survey of Affluent Americans. http://www.ustrust.com.

Vernon, S. (2004). Live Long and Prosper. New York: Wiley.

Ware, C. (2006). Rightsizing Your Life. New York: Springboard Press.

Watson Wyatt (May 3, 2006). New Analysis Shows Largest U.S. Companies Continued Shift to 401(k) Plans in 2005. Arlington, VA: Watson Wyatt. Press Release.

Watson Wyatt (2006). Retiree Health Benefits: Time to Resuscitate? Arlington, VA: Watson Wyatt.

If you liked this Element, you might like the book by James W. Walker and Linda H. Lewis, Work Wanted: Protect Your Retirement Plans in Uncertain Times

(Wharton School Publishing, ISBN: 978-0-13-235464-6).

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2010 by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-705334-7

ISBN-13: 978-0-13-705334-6

For more information, please contact us at info@ftpress.com

FTPress Delivers Elements

An e-burst of inspiration for business and life.

Life Happens

How to prepare financially for what might happen—so you won’t be blindsided if it does.

Gregory Karp

ISBN: 978-0-13-705285-1

$1.99

Start Your New Job with Confidence

Got a new leadership job? Take charge with confidence—no matter what happened in your previous position!

Martha I. Finney

ISBN: 978-0-13-705889-1

$1.99

Credibility

A complete, realistic, and proven process for rebuilding lost credibility, one step at a time—no matter why you lost it.

Sandy Allgeier

ISBN: 978-0-13-703782-7

$1.99

Vice President, Publisher: Tim Moore

Associate Publisher and Director of Marketing: Amy Neidlinger

© 2010 by Pearson Education, Inc.

Publishing as FTPress Delivers

Upper Saddle River, New Jersey 07458

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

ISBN-10: 0-13-269224-4

ISBN-13: 978-0-13-269224-3

For more information, please contact us at info@ftpress.com

Table of Contents

Table 1

Table 2

Figure 1

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Figure 2