Turning fifty used to be a milestone for retirement - you could plan to sock away much more money. That reality has changed dramatically. It is no longer true that:
- You’ll be in your peak earning years at age 50. Baby boomers may not enjoy their fifties as their top wage earning years after all with the fiscal crisis and the recession hitting right at the same time.
- Your kids will be out of the house. With 15.8 million adult children currently living with their parents, and 59% of Baby Boomers providing financial support to adult children who are no longer in school, Baby Boomers are not experiencing an empty nest.
- Your wealth will be higher than it was a decade ago. The “lost decade” of the 2000s continues, with $19.2 trillion of household wealth lost according to the U.S. Treasury.
- You can count on your company pension. Even if you have a pension in place, it doesn’t mean it will be there forever. Ford Motor Company wants to get out of the pension business altogether. They announced earlier this year that they were giving retired workers a choice to either keep their pension or take a lump sum payout. Ford was the first major company to make an offer like this—other companies may follow suit or change payout options altogether.
- You can count on Social Security. Social Security for those under age 55 is up in the air. In order to make sure Social Security is funded for everyone, we could see means testing or pushing out the minimum Social Security ages even further.
- Your expenses will decrease in retirement. Health care expenditures have increased over tenfold since 1980 to $2.6 trillion dollars. Many companies have stopped offering retiree medical benefits, and even discontinued retiree medical benefits for workers who were already retired. This trend of cutting back on retiree medical benefits is even spreading to cash-strapped state governments like Illinois.
Times have certainly changed. In today’s economic environment, once you pass the milestone of your fiftieth birthday, you have to be very careful not to make financial mistakes that you can’t correct. There are a few seemingly benign financial and lifestyle moves that can actually derail your retirement plans – watch out for these:
Refinancing your mortgage: The low interest rate environment has made it very appealing to refinance your mortgage. Employees who call our financial coaching line are regularly asking for our financial planners to compare options for them. Most are focusing almost solely on the interest rate and their monthly savings but ignoring a seemingly obvious point – they are extending the life of the loan. Refinancing to reduce rates is generally a good idea especially when rates are hovering below 4%. But you have to be careful, if you are five years into a 30 year mortgage and refinance for another 30 years, you just added another 5 years to your term. We may never see these low rates again in our lifetime, but tread carefully when refinancing.
Tip: Either keep the term of the loan the same, or coordinate the payoff date with your estimated retirement date.
Investing in your 401(k): The mistake people make is not that they invest in their 401(k) but that they invest only in their 401(k). Successful retirees diversify their income streams by investing in income producing vehicles such as investment properties to provide an alternative income stream in retirement. With interest rates so low right now, and a continued inventory of foreclosures and short sales, purchasing rental property may be an alternative investment for pre-retirees who don’t mind owning tangible assets and managing them.
Investment property owners get tax breaks along the way, too. Expenses such as depreciation and property management fees may be deductible, and if modified adjusted gross income is $150,000 or more, the losses are suspended but they carry forward to offset future rental income or capital gains when the property is sold. If the property has been held for more than one year, gains are taxed at favorable long-term capital gain tax rates.
Tip: Invest in, but also “think outside,” the 401(k). A Roth IRA provides tax-free income in retirement. Taxable accounts have advantages, too. With individual securities and mutual funds, you can “harvest” losses—matching your long-term losses against any long-term capital gains—to reduce tax liability. You can’t do that with a traditional pre-tax 401(k)—every dime you withdrawal is taxable at the higher ordinary income tax rates.
Projecting: “Don’t assume” is a common phrase used in business to remind us to challenge our thinking. As humans, we tend to look at the future through today’s lens. Because of this, pre-retirees often make false assumptions. Behavioral finance experts call this kind of a phenomenon “inappropriate extrapolation” - we assume today’s market conditions or events will continue indefinitely. How this affects pre-retirees is when we are in our 70’s and 80’s we look at money much differently than in our 50’s. People become much more anxious, concerned, and risk averse.
Eric Johnson of Columbia University, in collaboration with AARP and the American Council of Life Insurers (ACLI), studied how retirees’ reactions to loss compared to the general public. They found that retirees had “hyper loss aversion” and were up to five times more loss averse than the average person. Despite their aversion to loss, retirees were also resistant to products designed to minimize loss such as guaranteed lifetime income products. Johnson believes this resistance to products with more protections and guarantees is due to retirees’ unwillingness to give up control and the ability to withdrawal funds at will, thus making it difficult to find suitable retirement income solutions.
Tip: Understanding that anxiety or elevated concern around money may likely happen, pre-retirees may want to explore other options such as longevity annuities where you invest a lump sum now to provide a guaranteed lifetime payout starting at age 80 (if you don’t have an issue with control) or “bucketing” assets for specific spending strategies (e.g. spend this asset in my 70’s and this one in my 80’s) as a mental and financial framework for retirement income. Anticipating anxiety and concern over money as you age will significantly improve your retirement planning.
Neglecting health. You wouldn’t think this was a financial move at first glance but many are finding the cost of health care as one of the greatest threats to their financial security in retirement. Fidelity estimates that a 65-year-old couple retiring in 2012 would need about $240,000 in today's dollars to cover medical expenses throughout their retirement. You can research the best health care and the most cost effective Medicare supplemental plans, but the best thing pre-retirees can do now to reduce health care costs in retirement is to get healthy and stay healthy in their fifties.
According to a U.S. study on disease prevention, one of every five U.S. health care dollars is spent on caring for people with diagnosed diabetes. People who increased physical activity (2½ hours a week) and had 5 to 7 percent weight loss reduced their risk of developing type 2 diabetes by 58 percent regardless of race, ethnicity, or gender. Annual health care costs are $2,000 higher for smokers, $1,400 higher for people who are obese, and $6,600 higher for those who have diabetes than for nonsmokers, people who are not obese, or people who do not have diabetes. There is a direct tie between good health and the out-of-pocket cost of care.
Tip: Follow the lead of corporations and enroll in a physical wellness program offered through your employer, or get healthy on your own. Open a Health Savings Account (HSA) if offered through your employer to offset the cost of care. The HSA is the only account that allows a pre-tax contribution going in and a tax-free withdrawal coming out (if the funds are used for qualified medical expenses) that doesn’t have a “use it or lose it” provision. The funds in the HSA can carry forward year after year into retirement.
Not understanding risk. Pre-retirees can’t afford another 2008. Many investors were invested much more aggressively in the mid-2000’s than they realized because when a few strong years in the market finally came, many investors didn’t adjust their asset allocation making a moderate portfolio grow into an aggressive one.
Another challenge was that many pre-retirees invested in target date funds that had more aggressive allocations than they thought. One reason is some target funds have increased their equity allocation at retirement age. According to a study by Ibbotson, a 65 year old investor in a Fidelity target fund would have had about 30% in equities in 2001. By 2010, a 65 year old would have had almost 50% in equities - same fund family, same retirement age, but different allocation when the retirement age hit.
The other thing to watch for is how aggressive your fund is in general. Let’s take a look at Vanguard’s target date funds. For example, a 45-49 year old might choose the Target Retirement 2030 Fund which has 79% in equities. A 60-64 year old might choose the 2015 fund which still has 55% in equities. If you are a conservative investor, even the 2015 fund might be too aggressive for you.
Tip: Understand the potential volatility of your investment. If you own a mutual fund, look at the beta of the fund to get a sense of how volatile the price is relative to a benchmark or an index. A fund with higher price volatility (what is often considered more risky) will have a beta over 1.0, while a fund with less price volatility (i.e. less risky) will have a beta below 1.0. For an explanation, click here. Other ways to prevent your portfolio from becoming too aggressive is to set your portfolio up for automatic re-balancing on a quarterly basis, or use managed funds.
Retirement planning these days, like many things in life, is harder than it seems. There are so many unknown variables such as longevity, interest rates, market appreciation, and health care costs. Fifty year olds today have to be very careful since they have had the chair pulled out from under them financially in the last ten years. The “lost decade” in the stock market and the real estate crisis wiped out much of their home equity right in the middle of their retirement saving years. The key now is not to make it even more difficult by making mistakes later in life that are more challenging to overcome.