ByDYAN MACHAN
A RETIRED ARMY LIEUTENANT
colonel and Vietnam vet, Ben Moberley isn't a chatty man in the best of times, says Chris, his wife of 43 years. And as Ben neared the end of his career at a defense contractor and started crunching the numbers for their future, his somber silence spoke volumes. Their ideal retirement had included cruises and regular scuba trips to the Caribbean, and a move from Dumfries, Va., to the San Antonio area to be closer to family. But when Ben added together his pension, Social Security and the income he expected from putting most of his savings into an annuity, retirement for the two certified divers looked like it might be underwater. There simply wouldn't be enough money.
But the Moberleys won't be shark chum after all. They learned that if they rolled their 401(k) savings into a portfolio made up mostly of stocks, their future would brighten their plan B would generate a higher income than an annuity could offer. If the Moberleys structure their portfolio correctly, they'll sustain that higher income even if the market drops for a spell. "It was a tremendous burden off our shoulders," Chris says.
It's human nature to fret about the future. But for millions of Americans, much of that brow-furrowing concern might be unnecessary because in truth, we're a lot better off than we realize. In terms of savings, the ranks of the well-heeled (those with north of $500,000 in investable assets) swelled 7% last year, to a record 14 million, according to Chicago consulting firm Spectrem Group. Better still, Americans are getting smarter about setting aside those savings for their golden years. Retirement assets now account for more than one-third of household assets, up from 23% in 1985, according to the Investment Company Institute. And personal retirement savings, including funds held in IRAs and defined-contribution plans like 401(k)s, reached $8.8 trillion in 2005, two and a half times greater than a decade ago.
But if getting rich seems to be getting easier for many of us, the trick today may be staying rich. Indeed, when it comes to building wealth and sustaining it for a lifetime, the demographics of the baby-boom generation are rewriting the rules. The days are long gone when seniors could fund their retirement by simply collecting interest from T-bills. For starters, we're living longer. Today's 60-year-old has a better than one in four chance of living to be 90, meaning she needs to figure out how to make her portfolio last 30 years instead of 15. And this longevity comes at a price: Workers and retirees face steep increases in medical expenses for as far as the eye can see. As a percentage of GDP, health care costs will double in the next 30 years, says Robert Avery, a senior economist at the Federal Reserve. "How we deal with them could change the calculus" of wealth and retirement, he says.
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For some people, solving this conundrum will mean keeping more money in the stock market long past the age when conventional wisdom would have steered them into fixed income. Others will find they need to do more to bolster themselves against illness their own, or their parents'. And although unprecedented wealth, about $25 trillion over the next four-plus decades, will change hands through inheritance, figuring out whether you can rely on it will take intricate planning.
All told, while a wealthy retirement is more attainable than ever, it's still no slam dunk. That's why SmartMoney has powwowed with experts and talked to people on the cusp of retiring to find out what it takes to stay rich (and to get there in the first place). We'll discuss how much money you'll really need to fund the retirement you want. We'll showcase strategies for shielding yourself against the ups and downs of the stock market, inflation and the cost of health care. And we'll explain how to rearrange your investments to accommodate the New Math of extended longevity. You've worked hard to build that nest egg: These tips can keep it from cracking.
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Getting Rich
Edmond Walters, founder of the financial software firm eMoney Advisor, likes to play a game when he and his wife watch TV let's call it "Pessimistic Ad Bingo." Almost invariably, a certain type of commercial comes on: Viewers see, for example, a man brimming with sadness, sitting alone, his cane leaning against his plastic chair. Walters knows such pathos must mean it's an ad for financial services in this case, an insurance company selling long-term-care coverage. "Score!" he shouts; he wins again. In Walters's opinion, financial firms have a lot to gain by instilling panic. No one talks about good news, he says, "because it doesn't motivate people to buy."
Granted, some of the pessimism about retirement has roots in cold reality. Much of the population either hasn't been prudent enough to save, or simply can't afford to; according to the Center for Retirement Research at Boston College, 43% of American households risk not having enough savings to maintain their living standards. But it doesn't take a Nobel Prize in economics to recognize the financial-services industry's incentive for accentuating the negative. The 78 million baby boomers, born between 1946 and 1964, hold about $11 trillion in investable assets everything from mutual funds and stocks to savings accounts and CDs. If financial firms could collect a 1.5% fee for managing every dollar, it would add up to a $165 billion annual payday.
But put aside the alarmism, and you'll find that the path to wealth boils down to a few key, battle-tested tactics. In fact, you can think of it as a 21st-century approach to what used to be called the "three-legged stool" of long-term planning: personal savings, mployer pensions and Social Security. Unglamorous as it sounds, the savings component is more important then ever, as David Albert has learned. Albert, 51, is a partner in a construction-management firm, and he'd long insisted that his retirement would not include selling his tree-shrouded home in Danville, Calif., which faces Mount Diablo or "eating beans." Problem was, he needed to save for his teenage daughters' educations as well. He realized that to retire at 59 on the equivalent of his current salary, he'd need to boost his savings rate by 70% putting aside an extra $2,500 every month. Having his own business gave Albert some advantages: He gave himself a raise. More important, he has the $2,500 deducted from his paycheck "If I have it, I tend to spend it," he says and zipped directly into a savings account invested mostly in stock mutual funds. He's on his way to saving $3 million, to fund a life without canned legumes.
The second leg of the wealth stool has undergone a major shift, as employers have pulled the plug on traditional defined-benefit pensions. That change, and the effects of the defined-contribution savings accounts that are replacing pensions, are making a huge impact on who wins the wealth-building game. A lifelong career with one company no longer guarantees retirement security. Self-employed people, on the other hand, are gaining an advantage they can save up to three times as much money in tax-deferred retirement accounts as someone who works for a salary. And because assets in 401(k)s and similar accounts are portable, workers no longer get penalized when they change jobs to pursue better pay or opportunities.
Although participation is still lower than it should be, we're certainly warming to the 401(k): To date, we've saved $2.2 trillion in such plans, up from $860 billion 10 years ago, according to the Investment Company Institute. And a well-managed 401(k) is very likely to outperform a pension. If a 44-year-old who has $24,000 in savings and makes $59,000 a year contributed 9% of his income to a 401(k) and earned an annual return of 8.5%, the portfolio would grow to well over $500,000 by age 65, the Vanguard Group has calculated. Such a portfolio would throw off more income than a defined-benefit pension, which replaces only 18% of the average worker's final pay, according to the Employee Benefits Research Institute. And unlike most pensions, 401(k) savings can be passed to heirs.
Mario and Lori Brassini, 47 and 40, of Mendham, N.J., are arguably much better off today than if they had relied on an old-fashioned pension. Formerly employees at Verizon, they always invested enough in their 401(k) to earn the company's 6% matching contribution. They were exceptional savers in other ways, too: They banked Lori's entire salary for seven years. "You need good advice and discipline," Mario says. They figure that when Mario retires 12 years from now, their combined savings will throw off the equivalent of the six-figure income he earned at his peak at Verizon. And because they aren't tethered to a pension, they've had the flexibility to downshift their careers. After they had twin sons, Lori was able to stop working. And today, as the director of operations for a baking company, Mario has a 10-minute commute and gets home every day for a 5:30 dinner with the family.
To reach the retirement goal line, you need to figure out how to recognize it. One crude way to calculate how big a nest egg you'll need is to multiply your expected annual spending, including taxes, by 20. If you spend $80,000 a year, you'll need $1.6 million. The presumption is that you'll meet your expenses by withdrawing 4 or 5% of the portfolio each year, while the rest keeps earning. But that rule of thumb leaves out many nuances the biggest of which is medical expenses. "Health care is the wild card," warns Elizabeth Jetton, a financial planner with Mercer Advisors in Atlanta. Jetton recommends that couples put aside between $150,000 and $175,000 for out-of-pocket medical costs, to be invested along with their nest egg. People with chronic health problems may need to save even more.
If your target seems daunting, you might be erring by thinking only of what's liquid, the cash in the bank. Savers forget about the value of life insurance, or about the income they can get from selling a business or a property. Most significant, they forget about Social Security, the third leg of that savings stool. While its future deficits a mind-boggling $4 trillion over the next 75 years are a big cause for concern, Social Security is not about to go belly up with little X-marks on its eyes. In the government's current worst-case scenario, benefits around the year 2040 might be 20 to 30% less than current projections. But that doesn't mean they won't help you. Let's say that you'll be eligible for $23,000 a year in Social Security benefits by the time you retire. To get the same income from an annuity, you'd have to pay around $300,000. In effect, even a weakened Social Security is as valuable as several years' savings.
Many near-retirees also overestimate what they'll spend. Most retiree spending follows the pattern of a snake swallowing a mouse. For the first three years there is a bulge as folks indulge: "We always wanted to renovate the kitchen! Build a tree house! See the pyramids!" After that, the snake digests the mouse and spending flattens out, to between 70 and 80% of what people spent while working. Retirees "don't buy as much clothing or have dinner out as often," Jetton notes. And while many pursue desires they've put off their whole lives, plenty of those activities practicing tai chi, volunteering, smelling the roses are free.
Staying Rich
Scott Smith of Philadelphia is the quintessential sensible type, from Pennsylvania Dutch stock, no less. He's been married to Martha for 41 years, and he managed a life insurance sales office for 31 years before retiring. According to the old rules of investing, he should currently have 64% of his portfolio a percentage matching his age invested in bonds and cash. But Smith's father is 92 and going strong, and his mother also lived into her 90s. So now being sensible means that Smith has 65% of his portfolio in the stock market. "We have longevity in our family," Smith says, "so I need the growth."
There is a new paradigm for investing, driven by those soulless actuarial tables that say we are living longer. In order to support an extra 10 or 20 years of happy retirement, the nest egg must sport a higher rate of return. So the old asset-allocation rules have, if not turned upside down, at least seriously shifted. Having more in bonds feels safer, you argue? It's going to cost you. Let's say you're shooting for the ultimate stress-free portfolio, one that would let you live on the earnings without ever drawing down the principal. And let's say you've saved $1.2 million. Based on historical returns over the past 80 years as calculated by research firm Ibbotson Associates, if your portfolio is 75% invested in bonds, you'll be able to withdraw only $35,000 per year. With a 75% concentration in stocks, you could withdraw $80,000 a year. What would it take to get the same $80,000 income from bonds? A $3 million portfolio, estimates David Yeske, a financial planner at Yeske & Co. in San Francisco. And obtaining income by buying annuities a popular move among market-wary seniors comes at a high price. To earn $80,000 a year starting at age 65, you'd have to sink $1 million into an annuity. And if you died shortly after buying it, your heirs would be left with nothing.
So how much should you have in the stock market, and where? Is 65 the new 25 when it comes to investing? Not exactly. In young adulthood, you'll want at least 80% of your assets in a globally diversified stock portfolio; in retirement, the stock percentage could drop as low as 60%. Within that stock portfolio, Dan Moisand, a financial planner with Spraker, Fitzgerald, Tamayo and Moisand in Melbourne, Fla., recommends a broad index fund for your core equity holdings 30 to 50% of your stock portfolio. Of the balance, 10 to 30% should be invested in small-cap funds, and 10 to 30% in foreign funds a crucial component, since foreign securities often do better when U.S. stocks flag, says Martin Siesta, of Compass Wealth Management in Maplewood, N.J. Siesta says investors should allocate 5 to 10% of their portfolios to emerging-market funds and natural-resources stocks. He also recommends that investors get less-expensive exposure to certain sectors by buying exchange-traded funds: He's fond of the iShares S&P SmallCap 600 Index and Vanguard Health Care ETFs.
Alan "Ace" Greenberg, chairman of the executive committee at investment house Bear Stearns, has one word of advice on staying rich: Diversify. He practices what he preaches. Back in 1985 his multimillion-dollar stake in the firm dominated his portfolio; he has since whittled it down drastically. Most fortunes that decline dramatically do so because all their eggs are in one basket, says Greenberg: "A company can go to nothing in six months." But too few investors follow Greenberg's guidance. In 401(k) plans that allow employees to own company stock, 22% of assets consist of that stock, according to Hewitt Associates. Think Enron, and get the heck out. Pension reforms recently passed by Congress allow any employee with more than three years' tenure at a company to sell his stock.
Fixed-income holdings make up less of the 21st-century retiree's portfolio, but they need to be allocated just as thoughtfully. Dan Moisand argues for only investment-grade bonds, advising clients to stay clear of high yield. "It's called junk for a reason," he says. He also advocates owning only bonds with maturities of up to five years: Longer-term bonds currently don't pay enough interest to reward you for the risk that they'll lose value to inflation. High-grade foreign bonds, meanwhile, should make up 10 to 30% of your bond portfolio. Moisand likes the Pimco Global Bond dollar-hedged fund because its fees are low and its charter doesn't let its managers buy junk.
Uncle Sam's bonds play another role in your portfolio: protecting you against inflation. Like ordinary T-bills, Treasury Inflation-Protected Securities, or TIPS, yield interest every six months and pay the principal when they mature. The difference? Interest and underlying principal are automatically hiked to compensate for inflation, as measured by the consumer price index. They are the safest of the safe, and advisers like Moisand recommend they make up 20 to 30% of your fixed-income portfolio. But be aware that Uncle Sam counts the annual increase in principal as taxable income, so TIPS are best held in a tax-deferred account.
Withdrawing money from a retirement stash can involve as much strategy as building it. One tip from planners: Each year liquidate all the assets you'll need for the year in one fell swoop, and put them in a low-fee money-market fund. Doing so will cut down the costs associated with selling off securities. It'll also help you resist any temptation to time the stock market or to pull money out in a panic during a market dip.
Keep taxes in mind as you plan withdrawals. If the lion's share of your savings is in tax-deferred accounts, like 401(k) plans or IRAs, you could find yourself paying taxes at the same rate as when you were collecting a paycheck. And when you reach age 70 1/2, tax laws require you to take annual distributions that may be larger than you actually need; that, in turn, could push you into an even higher bracket. While conventional wisdom advises retirees to live off after-tax savings before tapping tax-deferred accounts, planner David Yeske notes that many retirees could find themselves getting smacked with higher taxes in their later years, when other expenses like medical bills may make them harder to bear. But if you've got substantial savings in accounts funded with after-tax dollars, including Roth IRAs, you'll have the flexibility to lower your tax bills. Yeske's approach: Draw down taxable and nontaxable accounts simultaneously. You could, for example, take out as much as you can from your IRA without climbing into a higher bracket, and then take the balance of your yearly nut from after-tax sources.
Protecting Your Riches
It took about a year for Carl and Denise Marchant to go from retirement riches to rags. After Carl sold his security business in Covington, Ga., in 1999, he was supposed to collect a steady income stream from the buyers, but the new owners ran it into the ground. Meanwhile, the Marchants' stock broker invested huge chunks of their savings in big-name stocks like Coca-Cola, Cisco and Microsoft just in time for the bear market. By the end of 2000, the Marchants had lost $500,000. "I was questioning my decision making and doing a lot of praying," Carl says.
Life happens. And keeping more of your net worth in stocks means you're more heavily exposed to short-term market risks. Diversification offers a safety net, but there's another way to play defense with your portfolio: paying for the first five years of retirement with bond laddering. A laddering strategy essentially assembles a coordinated package of short-term fixed-income investments. Let's say your portfolio needs to generate $25,000 a year. You put $25,000 in a low-fee money-market account, to live on during year one. To pay for year two, you buy a one-year CD that sweats off some interest. For years three through five, you buy shorter-term corporate bonds that pay you when they mature. And by the end of year five, the rest of your portfolio should have earned enough to let you safely draw from it, says John Sestina, a financial planner in Columbus, Ohio. Sestina's research found that five-year ladders would have helped retirees preserve their savings even in periods when the ladder ended during a market downswing. "It's worked great for 40 years," he enthuses.
A choppy market isn't the only threat to your nest egg: With nursing-home costs running anywhere from $60,000 to $100,000 a year, long-term-care insurance has become vital to protecting your financial health. Comprehensive policies pay up to $250 a day for nursing care, and since nursing costs are likely to keep climbing, it's worth paying extra for a policy that's automatically adjusted for inflation. Premiums for such policies cost around $3,700 a year for those who start buying at 50 and $4,900 for those who start at 60.
Should bad times or a misspent youth put you in a financial hole while you're still working and healthy, trade a defensive mindset for an aggressive one. Tax rules can help you catch up. Investors 50 and over can put away as much as $20,000 a year in a 401(k) and $5,000 a year in an IRA; for younger savers, the limits are $15,000 and $4,000, respectively. Deciding to work longer can also revive your savings. Planner Jetton sketches out the example of a couple that retires at age 60 and has a $1.4 million nest egg. If they don't work and spend $100,000 a year, they have a 64% probability of outliving their money. If they earn $36,000 annually between ages 62 and 68, their chance of falling short falls to 24%.
Kevin Spleid, of New York City, is a perfect candidate for catch-up strategies. An expensively unsuccessful marriage and a love of travel meant Spleid reached the age of 52 without saving a dime. "I am cursed with feeling young," he says. "Therein lay the problem." Luckily for Spleid, he earns a six-figure income as a computer consultant. After he received his retirement wake-up call, he started a plan known as a SEP-IRA that permits him to put 25% of his gross income, currently up to $44,000 a year, into a tax-deferred account. If he puts away the maximum every year, he can catch up relatively quickly. "I have no problem working until I'm 70," says Spleid.
The Marchants didn't feel the same way and despite their bad luck, they won't have to rejoin the working world. They pulled their decimated savings out of their broker's clutches and invested them in diversified mutual funds. Over the past four years, their respectable 14% annual return has helped them recover, and their portfolio now earns them $72,000 a year. To emphasize their freedom, the Marchants sold their home and used the proceeds to buy a new one a 45-foot luxury bus fit for a touring country-music star. "We're going to hit the road until we get tired," says Carl.
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