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Calculating What to Save for Retirement
Barbara O’Neill, Ph.D., CFP®, AFC, CHC Rutgers Cooperative Extension
Webinar Objectives • Discuss 4 key retirement decision-making questions
• Discuss sources of retirement income
• Discuss the process of calculating retirement savings
• Discuss retirement planning resources
Introductory Activity
Important Retirement Factors
• Worker’s and spouse’s health
• Family considerations (e.g., aging parent)
• Employment options
• Pension benefits and eligibility
• Access to and cost of health insurance
• Status of investment portfolio
• Personal choice
Sobering Statistics • Chances of a 65-year old living to ages 85 and 90
– 20% and 41% for men and 53% and 32% for women – https://personal.vanguard.com/us/insights/retirement/plan-for-a-long-retirement-tool
• EBRI: A retiring couple living to average life expectancy could need as much as $295,000 for health insurance and out-of-pocket medical expenses
– http://www.ebri.org/pdf/briefspdf/EBRI_IB_07-20061.pdf
• 49% of retirees left workforce earlier than planned (2014 RCS)
– http://www.ebri.org/pdf/briefspdf/ebri_ib_397_mar14.rcs.pdf (p. 27)
• NEFE: “About 50 million at-risk middle American households” (Journal of Financial Planning, July 2009)
– http://www.nefe.org/what-we-provide/primary-research/retirement-decumulation-key-concepts.aspx
OR
“If it is to be, it is up to me”
Question #1 What is your clients’ biggest concern about retirement?
Common Retirement Planning Errors
• RPS (Retirement Postponement Syndrome)
• Banking on unsure things – Profit on sale of a home or business
– A certain investment account balance
– An inheritance
• Counting on an “econo-retirement” – Spending by retirees often increases
– Go-go, Slow-go, and no-go phases
• Not saving as much as possible and taking maximum advantage of employer matching
• Not getting help, when needed
Many People Can Expect to Spend What Percentage of their Lives in Retirement?
Answer: 25% or more
Average American life expectancy at age 65 (2014):
Age 86.6 for men and 88.8 for women (Society of Actuaries)
http://www.bankrate.com/financing/senior-living/the-new-mortality-tables-are-here/?ic_id=News1
Trends in Retirement Flexibility in retirement planning
– Some pensions allow retirement at 55
– Social Security benefits available at 62
– Extra SS credits for work beyond FRA
– Many jobs allow work through age 70+
– Mandatory retirement only for certain jobs
More Retirement Trends
• Senior Citizens’ Freedom to Work Act (2000)
– Repealed earnings limit on FRA workers
– 2014 and 2015 earnings test income limits under FRA: $15,480 and $15,720 ($1 for $2 reduction)
• More DC plans: greater incentive to work longer (to contribute more and grow savings)
• Greater life expectancy, medical advances
Still More Retirement Trends
• Some workers retire gradually
– “Bridge jobs” with less pay/responsibility
– Partial or phased-in retirement
– Transition to self-employment/consulting
– Flexible schedules
• Retirement may be a gradual process rather than a single event
Era of “Broken Promises” • Increasing numbers of private and public employee
benefit plans are being deemed “unsustainable” and are being overhauled
– Defined benefit (DB) pensions; vesting periods
– “High-three” average salary DB pension benefit formulas
– Retiree pension benefit COLAs
– Employee/retiree health insurance subsidies
• Workers can’t even count on terms in current labor contract, not to mention promises made decades ago
Retirement Decision-Making: 4 Key Questions
• Can I afford it?
• Is this the right time?
• How will my spouse and family be affected?
• Do I want to retire?
#1: Can I Afford It? • Many current bills will keep coming whether
you retire or not
• There may be some new expenses
• Physical assets (e.g., car) will wear out
• Ditto for body parts (e.g., knees)
Sources of Retirement Income
Source: Social Security Administration chart from Focus on Personal Finance (2010)
Social Security
Company pension
Part-time work
Spouse's pension
Savings 12%
27%
Other 9%
401(k) 7%
7%
18%
IRA
8% Home equity 5%
7%
About Social Security • FRA has been increasing
– Born in 1938- age 65 + 2 months – Born 1943-1954- age 66 – Born in 1960 and later- age 67
• Review SS benefit estimate – Can correct for up to 3yrs, 3 months, 15 days – http://www.socialsecurity.gov/myaccount/ – Mailed estimates resuming at 5 year intervals (age 25 to 60)
• Over a third of recipients pay tax on SS – Single: $25K-$34K (50%); $34K+ (85%) – Married: $32K-$44K (50%); $44K + (85%)
Employer Salary Reduction Plans: 401(k), 403(b), 457 Plans, TSP
• Tax Advantages- Tax-deferred earnings on deposits made with pre-tax dollars – Example: $40,000 gross income; $3,000 contribution;
$37,000 federal taxable income
• Automation- Deposits deducted from pay – A common form of dollar-cost averaging
• Matching Contributions- % of workers’ pay – Common in 401(k) plans; some 403(b) plans, some TSPs
• Portability- Can take money when leaving a job – Example: Rollover IRA
Thrift Savings Plan (TSP) • Defined contribution plan for service members and
federal employees
• Agency match for civilian workers
• Can join immediately upon starting work
• 5 individual funds and 5 Lifecycle (L) funds
• L funds comprised of G, F, C, S, and I funds
• Default is 100% G Fund; bill passed for L fund switch
• VERY low expense ratios (0.024% to 0.025%)
• Web site: www.tsp.gov
Individual Retirement Accounts
• Regular (Traditional)
• Roth
• Rollover
• Spousal
Small Business Retirement Accounts
• Simplified Employee Pension (SEP-IRA)
– Funded by freelancers and small business owners
– Annual contributions up to $53,000 (2015)
– Simplest retirement plan for the self-employed
• SIMPLE Plans – $12,500 worker contribution + $3,000 catch-up (2015)
• Keogh Plans – Annual contributions up to $53,000 (2015) – Most difficult plan to administer
What If There’s Not Enough Money to Retire?
• Postpone retirement – Builds benefits from company retirement plan
– Have more years to save and invest
– Fewer years requiring retirement income
• Plan for Part-time Work
• Reduce Lifestyle Expectations – Lower-cost housing and/or geographic area
– Eliminate expensive luxuries
#2: Is This The Right Time? • The “best time” to retire is a very personal decision
– Professionals differ from blue-collar workers
• Some key factors:
– Ability to perform up to current job standards
– Economics of working (e.g., SS earnings limit)
– Personal health status
– Early retirement incentives
– Other job options and/or life passions
Question #2
Do you plan to retire? If so, at what age?
#3: How Will Spouse and Family Be Affected?
• Forgone salary
• Adequate financial benefit for survivors – Is joint/survivor annuity and/or retirement savings adequate?
• Loss or reduction of group term life insurance – Check to see if conversion is possible
• Medical coverage: self and dependents
• Spouse’s Medicare Part B premiums
• Spouse’s retirement plans
Health Benefits • Many workers lose benefits at retirement
– Medical insurance – Dental insurance – Vision care plan – Disability insurance – Life insurance
• Some employers continue medical coverage – May have age and/or service requirements – Supplemental to Medicare after age 65? – Often have cost-sharing obligations
Options For Workers Losing Medical Coverage
• Get coverage through spouse’s employer plan • Get coverage through a trade association plan • Get coverage through an ACA marketplace • Purchase an individual policy (private market) • COBRA group coverage for 18 months
– Must pay full premium + 2% • Convert group plan to individual plan IF a conversion
option exists • Go without coverage (NOT recommended)
#4: Do I Want to Retire?
• Do I like what I do (job)?
• How central is work to my life?
• Do I know what I want to do next?
• Can I smoothly transition to something else?
– New job or small business
– Volunteer work (boards, clubs, politics, service roles)
– Spending more time with family and friends
Early Retirement • Time is an enemy (twice) for early retirees
– Fewer working years to accumulate personal savings, pension benefits, and SS
– More non-working years to finance • The years just prior to full retirement age are usually
period of peak earnings • By retiring early, peak catch-up period from age 55
to 65 is reduced • Consider penalties on early distributions
Beware of “Stampedes” • Employees “head for the door” in a panic that
employers will cut future benefits
• Employers can cut benefits anyway (no guarantees that you’ll be “grandfathered”)
• Examples: – NJ state workers, teachers, uniformed personnel
– Federal workers
• In many cases, longer service will mitigate benefit reductions (e.g., loss of COLAs)
Early Retirement: Reduced Benefits
Defined Benefit Pension – Final compensation amount and years of
service are reduced • Not working during years with potentially highest
pay (e.g., average of high 3 or high 5)
– Check Summary Plan Description for details
Early Retirement: Reduced Benefits
Defined Contribution Plan
– Separate account for participants
– No promise to pay benefit using a formula
– “You get what you save”
– Fewer years of employee contributions
– Fewer years of employer contributions
– Fewer years of investment growth
Early Retirement: Reduced Benefits
Social Security – Full retirement age is increasing to age 67
– Benefits may begin at age 62 but are permanently reduced by 20% to 30%
• Born 1943-54-, benefit is 75% of FRA amount
• Born after 1959, benefit is 70% of FRA amount
– 45% of men and 50% of women take benefits at age 62: http://money.usnews.com/money/retirement/articles/2013/09/09/the-most-popular-ages-to-claim-social-security
– Benefits are indexed annually for inflation
Early Retirement Incentive Programs
• Usually prompted by necessity: budget shortfalls, declining revenues, mergers, etc.
• Often called “Open Window Plans” – Workers have 3-6 weeks to accept offer
• Incentives include: – Enhanced pension benefits – Severance pay – Continued health benefits – Reduction of normal vesting time – Other benefits (career/financial counseling)
How to Analyze an ERI Offer • Eyeball the numbers OR use present value analysis
with a financial calculator (put today’s value on money received in the future)
• Put a dollar value on every benefit gained
• Put a dollar value on every benefit lost
• Net gains and losses= gain or loss
• Is it a positive number?
Simple ERI Computation • Benefits gained by taking ERI offer
– Lump sum payment- $60,000 (BUT this is TAXABLE!!!)
– Pension benefits (5 yrs @ $20k)- $100,000
• Benefits lost by taking ERI offer
– Lost $60K salary (5 years)- $300,000
– Lost $1K raises- $5,000
– Lost $2K bonuses- $10,000
– $5K/yr health insurance premiums- $25,000
Net Loss is <-$180,000>!
• ERI not a good idea in strictly financial terms • BUT there are other factors to consider:
– Opportunities for new employment/economy
– Anticipated living costs
– Health status
– Availability/cost of health insurance
– Stability/profitability of employer
– Non-financial factors (e.g., family, life passions)
Late Retirement (Working Longer)
Financial Benefits – Employee benefits (e.g., life, disability, and health
insurance) remain in force
– Fewer years of retirement income withdrawals to finance
– More years to accumulate additional savings
– More years to increase SS and DB pension benefits
• SS delayed retirement credits until age 70
• 8% for every year worked if born in 1943+
“Retire” While You Work • Standard Strategy #1- Retire at a planned age with less money than
anticipated due to financial downturns and risk running out of money due to benefit cutbacks, increased health care costs, longevity, investment losses, lower home value, etc.
• Standard Strategy #2- Retire later and risk “waiting too long” (e.g.,
after age 65-70) so that death, health “issues,” widowhood, etc. hinder planned retirement lifestyle and/or quality of life.
• New Strategy #3- Keep working BUT use money that had been going
into savings (i.e., suspend or reduce 401(k) or 403(b) contributions) to begin enjoying “retirement activities” NOW without actually retiring.
https://www2.troweprice.com/iws/wps/wcm/connect/d2edab0046d7abf0a87eb899d35c25cc/04779-
Question #3 What tools do you use to do retirement savings calculations for yourself and/or clients?
Retirement Calculation
Process
Five Key Variables in Retirement Savings Calculations
• Age at retirement
• Amount of money currently saved
• Amount of annual income needed (percentage of pre-retirement income)
• Rate of return on investments
• Number of years in retirement (life expectancy)
1. Age at Retirement • Early retirement is desirable to many people...
• …But you lose the tremendous resource of time
• Rule of 72: it takes 9 more years for $250,000 to double to $500,000 at 8% average return
• Lower SS and pension benefits at younger age
• Big factor: post retirement health insurance (gap until Medicare at age 65 and decreasing employer-paid coverage)
2. Amount of Money Currently Saved:
Calculate Your Net Worth Assets (what you own) - Liabilities (what you owe) = Net worth http://njaes.rutgers.edu/money/pdfs/networthcalcworksheet.pdf
3. Amount of Annual Income Needed in Retirement
• 50%? 100%? Each case is different!
• Active phase of retirement is expensive: “go-go”
• Replacement % depends on retirees’
– Goals (e.g., travel)
– Lifestyle choices (e.g., smaller home, work, location)
– Resources (e.g., employer-provided health insurance, inheritances)
• It is dangerous to generalize
Estimate Retirement Living Costs Spending patterns will probably change…
• Some expenses may go down or stop: 401(k) retirement fund contributions Work expenses - less for gas, lunches out Clothing expenses - fewer and more casual Housing expenses - mortgage payment will end if house is paid off Federal/state income taxes will probably be lower
• Other expenses may go up: Life and health insurance unless employer continues coverage Medical expenses increase with age Expenses for leisure activities Gifts and contributions
Inflation will increase the cost of expenses during retirement
Estimate Annual Cost of Living in Retirement
Expenses* Now Spend Expect to Spend
Housing Transportation Food Clothing/Personal Medical/Health Recreation Taxes Savings/ Investments
* Yearly Expenses
Source: Planning a Retirement Budget, Cornell Cooperative Extension, 1984.
Key Budget Factor: Where to Live in Retirement?
WSJ Article (3/21/11): BIG issue among couples; communication is key
What Do I (We) Want to Do? • What gives you deep satisfaction? What will it cost?
– Meaningful relationships
– Helping others
– Learning new things
– Devoting yourself to a cause you believe in
– Applying your skills and experiences
– Achievement
• Do you plan to continue working? • What will a “typical day” in retirement look like?
4. Rate of Return on Investments
• Large company stock compound annual return (1926-2013): 10.1% versus 6% for long-term corporate bonds and 3.5% for Treasury bills
– https://www.plannersfinancialservices.com/918764.pdf
• Mistake to assume 10% return- few investors have 100% stock
• $5.9 trillion sitting in passbook accounts (2011)
– http://www.e-wisdom.com/news/banking/money-market/report-record-amount-of-money-sitting-in-savings-accounts-110210026/
• About half of U.S. households have no equity investment exposure
• http://blogs.reuters.com/counterparties/2014/04/01/us-stock-ownership-fact-checking-michael-lewis/
Retirement Investing Pointers • Invest a much as you can in a Roth or traditional IRA and
tax-deferred employer plan (e.g. 403(b) plan or TSP)
• Earmark a portion of future raises for retirement savings
• Make catch-up contributions starting at age 50
• Maintain some equities in your portfolio to hedge inflation
– New research: Consider a RISING equity glide path
• Assess your TRUE investment risk tolerance
– http://njaes.rutgers.edu/money/riskquiz/
More Thoughts on Investing • You could have a 30-40 year time horizon in retirement
• Diversify your portfolio: different asset classes
• Common guideline: 110- Your Age = % in stocks – 110 – 65 = 55% (moderate risk tolerance)
• Consider consolidating accounts (RMDs start at 70½)
• Consider dividend-paying stocks and mutual funds
• Consider low-cost annuities for a guaranteed stream of income (especially without a pension)
• Track your net worth and asset allocation annually
Time + Money = Magic
Sources: Advantage Publications and National Endowment for Financial Education
The Rule of 72 Source: Garman/Forgue, PERSONAL FINANCE, Fifth Edition
Relationship Between Risk and Return
Risk High Low
Expected Return
High
Low
Cash Equivalents
Bonds
Int’l Bonds
Real Estate
Stocks
Int’l Stocks
For illustrative purposes only. Not indicative of any specific investment.
Diversification from Combining Investments
Investment A
Investment B
Portfolio 1
No Diversification
Investment C
Investment D
Portfolio 2
Complete Diversification
Investment E Portfolio 3
Investment F
Some Diversification
For illustrative purposes only. Not indicative of any specific investment.
5. Number of Years in Retirement (Life Expectancy)
• Life expectancy: average number of years of life for people who have attained a given age
• 65-year old couple: 72% chance of at least one spouse living to 85 and 45% chance of living to 90
– https://personal.vanguard.com/us/insights/retirement/plan-for-a-long-retirement-tool
• Good health habits = high life expectancy = need to save more money
Life Expectancy Reality Check • Enter “Life Expectancy Calculator” into an Internet
search engine (e.g., Bing, Google) • Try at least 3 different calculators • Look for calculators with lifestyle questions • Social Security calculator is very basic; based on
averages
Strategies to Make Up for Lost Time or Money (or Both)
Before Retirement • Increase retirement savings
• Spend less and pay off debt
• “Moonlight” for additional income
• Invest more aggressively to try to earn a higher return
• Preserve lump-sum distributions
• Work longer before retiring
After Retirement • Trade down to a smaller home
• Move to a less expensive location
• Work after retirement
• Reverse mortgage or sale-leaseback of home
• Make tax-efficient asset withdrawals
Question #4 What are your favorite retirement planning online resources?
Resources For Making Retirement Savings Estimates
Links to http://www.ebri.org/surveys/rcs/2000/profiler.htm to take the Retirement Personality Profiler quiz
The Ball Park Estimate • Six easy steps; can do online or download paper worksheet • Can do online at http://www.choosetosave.org/ballpark/ • Flexible annual retirement income and life expectancy figures • Assumes a 3% constant real rate of return
• Available online at http://njaes.rutgers.edu/pubs/publication.asp?pid=FS431
• Downloadable “paper and pencil” worksheet
• 20 steps with choice of time value of money factors
Monte-Carlo Analyses • Use historical investment performance data to estimate the
probability of not running out of money
• A CFP® can provide analyses or people can use an online calculator (Search “Monte Carlo Calculator”)
• Check assumptions and beware of GIGO
Key Question: How Long Will Retirement Savings Last?
• “It depends” on two key factors:
– Rate of return earned on retirement savings
– Percentage of portfolio assets withdrawn
• Nest egg will deplete faster if rate of withdrawal exceeds rate of return
• Worst case scenario: Retiring during a severe market downturn and selling stocks/growth mutual funds for income
– Nest egg is severely eroded by market losses
– Withdrawals deplete it further
– Should have a 3-5 year cash “cushion” to avoid this
Retirement Savings Withdrawals • Backed up by 2 decades of research
– http://www.moneysmartsblog.com/4-percent-withdrawal-rule-for-retirement/
• Withdraw 4% of retirement assets annually with annual inflation adjustment
• High probability of money lasting 30 years
• Example: $200,000 of savings – $8,000 in year 1 ($200,000 x .04)
– $8,240 in year 2 ($8,000 + $8,000 x .03 [$240])
• Assumes that 50% of portfolio is in stock – Older retirees (70s and 80s) can withdraw > 4%
– More conservative investors should withdraw < 4%
The 4% Rule With Numbers For every $1,000 of desired monthly income (above SS and/or a pension), you need $300,000 saved
– $300,000 x .04 = $12,000 – $12,000 ÷ 12 = $1,000
•$2,000/month = $600,000 •$3,000/month = $900,000 •$4,000/month = $1.2 million •$5,000/month = $1.5 million
RMD Tax Rules Trump Any Percentage-Based Guidelines
• Must begin required minimum distributions (RMDs) from tax-deferred retirement plans no later than April 1 of the year after the year that you reach age 70 ½
• “Still working exception” for tax-deferred plans with current employer
• Use IRS uniform distribution table to determine RMD: http://njaes.rutgers.edu/money/ira-table.asp
Steps To Take Between Now and Retirement
• Plan to get out of debt before you retire
– Pay off mortgage (prepay principal, biweekly payments, refinancing)
– Eliminate consumer debts
• Assess available retirement benefits
– Employer savings plan and health insurance (self and spouse)
– Social Security (age 62, FRA, age 70)
• Review your insurance needs
– May not need life insurance if kids grown, mortgage repaid
– Consider LTC insurance with freed-up premium dollars
More Steps to Take Before Retirement
• Save aggressively (until it hurts!) – Up to 5,500 in an IRA and up to $18,000 in employer plan (+ catch-up savings if 50+)
– Up to 20% of business net earnings in a SEP
• Educate yourself about pre-retirement issues – NEFE: http://www.myretirementpaycheck.org/
– CFP Board: http://letsmakeaplan.org/
• Invest broadly – Multiple asset classes including international investments
– Low-cost index funds and ETFs
• Consider working longer than originally planned – Boosts Social Security and DB pension benefits; more time to save in IRAs, 401(k)s, etc.
– Fewer years to withdraw money from savings
– Continued access to employer benefits
Different Messages for Different Ages
Teens, 20s, 30s
Time is on your side
Start saving TODAY!
Tax-deferred employer savings plans and Roth IRAs are your BFF
Small savings adds up
Save AND repay debt
40s, 50s, 60s Time is STILL on your side
Keep on saving and save more as income increases or household expenses end
Fully understand your employer retiree pension and health insurance benefits
Consider catch-up strategies, if needed
Military Specific Information: Roth TSP
• Contributions are taken out of pay AFTER income is taxed
• Roth TSP contribution withdrawals are tax-free (because the money was already taxed)
• Roth TSP earnings withdrawals are tax-free if at least age 59 ½ (or disabled) and at least 5 years since first contribution
• Good for people who expect a higher tax rate in retirement
• Great for tax-exempt pay earned in a combat zone
– No tax on either Roth contributions or earnings (as long as you meet age and holding period requirements)
More About the Roth TSP • Traditional TSP account balance cannot be converted to a
Roth TSP
• 2015 elective deferral limit of $18,000 or $24,000 if age 50+ (with catch-up)
• Can transfer Roth 401(k) or Roth 403(b) money to a Roth TSP account- but not Roth IRA funds
• Before-tax dollar account transfers are added to traditional TSP account balance
• Loans and withdrawals are allowed; on a pro rata basis proportionately from traditional and Roth TSP balances
Survivor Benefit Plan (SBP) • Normally a one-time choice with life-long implications • Provides up to 55% of Service Member’s retired pay
to eligible beneficiary upon death of SM; has COLAs • Lifetime annuity based on percentage of retired pay;
partially funded and operated by government • Military retiree pays SBP premiums upon retiring • Works like life insurance but better: also protects
survivor against possibility of outliving benefit • Big Issue: must elect at retirement, SMs often in
middle age; hard to foresee future life events – (e.g., death or divorce of spouse, remarriage)
More About the SBP • Protects SM’s retired pay against 1. early death, 2.
the survivor outliving benefits, and 3. inflation
• NOT a complete retirement plan; SMs still need insurance and investments (e.g., TSP)
• However, insurance and investments without the SBP may be inadequate
• Four key factors: SM’s age, gender, and health compared to beneficiary; marriage stability
• Often attractive; provides subsidized lifetime inflation-protected income for surviving family
Military Retirement Resources • Military OneSource - 4 Things to Consider When Retiring From the Military:
http://www.militaryonesource.mil/f?p=MOS2:PROGRAM_B:0::::EKMT_ID:36.18.80.content_id%3D268674
• U.S. Department of Defense - Retirement: http://militarypay.defense.gov/retirement/index.html
• U.S. Department of Defense - Survivor Benefit Plan: http://militarypay.defense.gov/Benefits/SBP.html
• U.S. Department of Defense - Military Compensation - Retirement Calculators: http://militarypay.defense.gov/retirement/calc/index.html
• Defense Finance and Accounting Service (DFAS) - Survivor Benefit Plan: http://www.dfas.mil/retiredmilitary/provide/sbp.html
• Federal Retirement Thrift Investment Board - Thrift Savings Plan - Forms & Publications (especially the booklets, “Managing Your Account”, “TSP Benefits for Uniformed Services Members”, and “Roth TSP: A New Element”): https://www.tsp.gov/forms/formsPubs.shtml
Key Take-Aways • 4 key questions can guide the retirement decision-
making process
• Social Security is a base of retirement income to build on
• Tax-deferred retirement savings plans vary according to type of employer or self-employment
• There are 5 key variables in retirement savings calculations
• A variety of resources are available to calculate retirement savings
Key Take-Away Applications • Ask yourself (and clients) the 4 key questions:
– Can I afford it? Is this the right time? How will my spouse and family be affected? Do I want to retire?
• Review a current Social Security benefit estimate • Start or increase contributions to employer or self-
employment retirement savings plan(s) • Determine your 5 key retirement savings variables
– Age at retirement, amount of money currently saved, amount of annual income needed, rate of return on investments, and number of years in retirement
• Try one or more retirement savings tools
