Bankruptcies among seniors soaring
The average age for filing bankruptcy has increased and the rate of bankruptcy among those ages 65 and older has more than doubled since 1991, say researchers Teresa Sullivan of the University of Michigan, Deborah Thorne of Ohio University and Elizabeth Warren of Harvard Law School.
Expensive health care costs from a serious illness before a patient received Medicare and the inability to work during and after a serious illness are the prime contributors to financial crises among those 55 and older. But even among those 75 to 84 and receiving retirement, Social Security and Medicare benefits, the rates soared—from just 1.8 percent of all filers in 1991 to 5 percent in 2007.
Most Americans have two major assets: their homes and their retirement plans. And borrowing against those assets can present new risks when home values and stock markets decline, Sullivan and colleagues say. In some cases, older Americans trying to help children and grandchildren, borrow too much, putting themselves at risk.
Related: Boomers Face Retirement – Retirement Tips from TIAA CREF – Saving for Retirement
Retirement planning is a huge financial need and one of the areas where financial literacy can pay off very well. Understanding the incredible power of compound interest can be used to start your retirement savings early and provide you with a huge benefit. Understanding the risks of inflation can guide your investment decisions. The recent Business Week Retirement Guide is very good. In Spending Safely, they explore how to spend while preserving your capital in retirement.
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Bengen now suggests that the 4% figure – actually 4.1% for a 60/40 portfolio of large caps and bonds and 4.5% if you toss in small caps – merely seems impressive when plugged into Excel (MSFT) spreadsheets. In practice, the strategy, which Bengen stopped using with his own clients about three years ago, is inflexible and unrealistic he says – and the formula is too stingy.
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Flexibility is factored into Bengen’s revised approach, which permits withdrawals to fluctuate within guidelines. His “floor-and-ceiling strategy” suggests that an initial withdrawal rate of 5.16% would be appropriate if a retiree pares back subsequent withdrawals by as much as 10% of the initial withdrawal during hard times (the floor). On the other hand, a retiree could withdraw extra cash equaling up to 25% of the first-year withdrawal (the ceiling) when the market is strong.
This adjusted thinking is correct I believe. People want simpler answers but some things just require a more complex understanding.
Related: How Much Retirement Income? – Add to Your Roth IRA – Retirement Tips from TIAA CREF – Our Only Hope: Retiring Later
Many Retirees Face Prospect of Outliving Savings, Study Says
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Middle-income Americans entering retirement now will have to reduce their standard of living by an average of 24 percent to minimize their chances of outliving their financial assets, the study found. Workers seven years from retirement will have to cut their spending by even more — 37 percent.
This is one more study pointing out how many people are failing to take the most basic steps to manage their finances. Saving for Retirement is not very complicated. The details can get a bit complex but some of it is really basic like saving at least 5-15% of your earnings each year (or more if you fall behind) in tax differed savings accounts (IRA, 401(k)…). Many people just choose to sacrifice their future to buy more toys today.
There are different strategies but the minimum you should be doing (in the USA where social security will provide a portion of retirement savings) is saving, in a 401k, IRA or something similar: 5% in your 20s, 8% in 30s, 10% in your 40s, 11% in your 50s, 12% in your 60s. If you save more earlier you may be able to save less later. And if you fall behind you will have to save more. To retire earlier, than say 68 (today, or say 70 by 2020, and if you assume life expectancy rates will continue to increase you need to plan on working longer or saving more for a longer retirement), you should save more.
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Graduates should put off living large after college
The key, experts say, is a simple one: Live like a poor college student for a couple more years. While you’re doing that, you can pay off your debt, start a savings plan and embrace healthy habits that will serve you well for life.
This is exactly what I did. Outside of paying for college, extra living expenses in college were small. Just retaining the spending habit of college gets your personal finances off on a good start.
Patty Procrastinator lives a little better when she first gets out of college and doesn’t start saving in the 401(k) until she’s 32. From that point, she also saves $500 a month, her employer adds $250 a month, and she earns a 9% return — just like Sallie. But at age 65, Patty will have only $1.7 million. That decade of delay will cost Patty $2.4 million.
Incidentally, Sallie contributes from her own money just $60,000 more than Patty does. The rest of the difference comes from employer contributions and investment returns.
By immediately starting to save for retirement and other needs you create a great foundation for your finances. Start saving for a house, a new car, create an emergency fund… Then you can create a situation where the only loans you need to take are for a house and maybe a new car – avoiding credit card debt or other personal loans.
Related: Personal Finance Basics: Health Insurance – Initial Retirement Account Allocations – Why Americans Are Going Broke
Half of Gen X Doesn’t Expect to Retire
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“They are earning money and paying into Social Security and yet they fear they may never see the payback,” said Moloney. “They feel they deserve it, but it looks like a financial black hole to them right now.”
The government certainly is failing to pay for future obligations today instead choosing to raise taxes on the future. But Social Security itself is actually in better shape than most think. We really do need to move out the benefit payment date (when it began projected life expectancy was almost the same as the date payments would start – which would mean moving the retirement date more than 15 years later, I believe). Going that far is not needed but it should be moved back. But really social security is in good shape for 30 years or more. First, it isn’t going to go from good shape to failed in a day. And second, they will make adjustments as they have in the past to make it work (the adjustment they made in the last 15 years helped a great deal so now they can just add some additional delays in when it starts paying out… and extend the good condition of Social Security without too much trouble).
Medicare is the huge problem. The country either needs to stop paying an extra 50-80% for health care than other countries do (and thus reduce the cost of Medicare liabilities) or massively cut benefits or massively increase taxes. Likely a combination of all 3.
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The title of a recent article asks: Are you a sucker to invest in a 401(k)? The answer is an emphatic: No.
But what if instead you had bought that tax-efficient stock fund outside your plan? Wouldn’t your tax bill be lower? Yes, but that’s the wrong way to look at it. If you skip your 401(k) in favor of a taxable account, you must first shell out taxes on that $10,000, which leaves you with just $7,200 to invest (assuming the same 28% bracket).
Plus, over the next 20 years, you’ll have taxes on any dividends and gains the fund pays out. Even though you will get a lower 15% rate on your gains when you sell, you end up with $28,950, or about $4,600 less than with the 401(k). A tinier final tax bill can’t make up for having to pay taxes all along.
This is a very good short simple personal finance article. It explains an issue that might be tricky for some to understand. Those that read it can learn more about personal finance. And it has several points – some of which, I can imagine, might be hard for some to understand. But it does a good job of explaining things simply. And a few points, made well in the article, are often overlooked or under-appreciated:
tax rates will go up – we are passing higher taxes onto the future by not paying our bills now
the tax deferral is a huge benefit – often minimized when people discuss the benefits of IRAs
401(k) employer matches are another huge benefit
As I have said before, learning about personal finance is a long term effort. If you don’t understand everything in an article that is fine, over the years you want to learn more and more. Hopefully this is a useful step on that journey.
Related:
Roth IRAs a Smart bet for Younger Set – Saving for Retirement
One of the most important financial moves you can make is to start investing for your retirement early. This post is directed at those in the USA (but you can adjust the ideas for your particular situation). Retirement accounts with tax free growth, tax deferred growth and/or even tax deductible contributions can add to the benefits of such an investment. And matching by your company can give you an immediate return or 100% or 50% or some other amount. With 100% matching if you invest $2,000 your company adds $2,000 to your retirement account. For 50% they would add $1,000 in the event you added $2,000.
In other posts I will cover some of the other details involved but some people can be confused just by what investment options to chose. Normally you will have a limited choice of mutual funds. Hopefully you will have a good family of funds to choose from such as Vanguard, TIAA-CREF, American, Franklin-Templeton, T.Rowe Price etc.). If so, the most important thing is really just to get started adding money. The details of how you allocate the investment is secondary to that.
So once you have made the decision to save for your retirement what allocation makes sense? Well diversification is a valuable strategy. Some options you will likely have include S&P 500 index fund, Russel 5000 (total market index – or some such), small cap growth, international stocks, money market fund, bond fund and perhaps international bonds, short term bonds, specialty funds (health care, natural resources) long term bonds, real estate trusts…
Just to get a simple idea of what might make sense when you are starting out and under 40 and don’t have other substantial assets in any of these areas (large mutual fund holdings, your own house, investment real estate…) this is an allocation I think is reasonable (but don’t take my word for it go read what other say and then make your own decisions):
25% Total stock market index (~Wilshire 5000)
25% international stocks
20% small cap stocks
10% real estate
10% high quality short term bonds in a Euros, Yen…
10% short term bonds (or money market)
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A house is where you live–not an investment
Very good point – as long as you fall into that category of living there until you die. True for some people but far from all. Also, even for those people, it is not a complete view of the financial situation.
A reverse mortgage will allow you to sell the house and get paid for the rest of the time you live there. So you can build up equity over 20,30,40 years and then take a reverse mortgage and get payments every month (based on your investing in your house). Reverse mortgages, like many financial tools, can be applied poorly and is I would guess unethical behavior related to them is fairly high (so be very careful!). If you think of such an option you need to do your research and actually understand what you are doing – you can’t afford to be like the many ignorant mortgagors. The AARP offers information on Reverse Mortgages.
Additionally, you lock in a large part of your housing cost (you still have maintenance and taxes but you do not have every increasing rent. Now ever increasing rent is not a certainty but for many it is very likely rent will go up on average over the long term. Ownership of your home removes the risk of being priced out of the area you want to live by increasing rental prices over time. You also lose the potential of benefiting if rent prices fall over time, but I would say the more valuable of those options is avoiding the risk of rising rental prices.
Related: How Not to Convert Equity – Housing Inventory Glut – articles on home ownership and real estate
If you haven’t added money to your Roth Individual Retirement Account for this year yet – go ahead and do so now. Given the state of retirement planning for the vast majority of those in the USA there is a good chance your retirement is the area of your financial life that will most benefit from more resources. The other action that is likely worthwhile is to cut your spending but we will leave that for other posts.
If your employer offers matching on your 401(k) or 403(b) that may well be an even higher priority. There is almost never a decent reason not to add at least 5% of your income to a retirement account matched by your employer. Make sure, as the amount grows above $100,000 that it is invested in a diversified manor (not all in the stock of your employer or…).
For 2007 the most you can add to your Roth IRA or just IRA is $4,000 ($5,000 for those 50 years old or older). Next year that maximum increases to $5,000 ($6,000 for those 50 and up). If you have already added the maximum that is matched to your 401k and have added the maximum to your IRA for this year get ready to add the $5,000 to your IRA for 2008 in January (you do have to make sure you don’t earn too much to be eligible to add funds – pretty much you have to be over $100,000 in income, $150,000 on a joint return, before you have to worry but look up the details yourself). By adding the money to your IRA early in the year you will get another year or tax free growth (for the Roth or tax deferred growth from the regular IRA).
For more details on the rules on IRAs see the links we provide on the Curious Cat Investment Dictionary IRA page.
Related: Saving for Retirement – Roth IRAs a Smart bet for Younger Set – Our Only Hope: Retiring Later
The Motely Fool is one of the best web sites for learning about investing (it is one of the sites included in our investing links – on the left column of this page). A recent article on the site is worth reading – Ways to Retire Sooner:
Embrace stocks Saving more is great, but there’s only so much you’ll be able to put aside. You have to make the most of what you have. People are often too conservative in their retirement investments. Despite the sometimes-violent ups and downs of the stock market, the long-term return on stocks far exceeds that of less risky investments like bonds and bank savings accounts.
These are not exactly earth shattering recommendation but so many people fail to take even the most basic steps to assure a economically viable retirement the simple advice needs to be re-enforced. No one piece of advice can assure success but by educating yourself about investing and retirement planning and taking steps when you are in your 20s, 30s and 40s you can succeed. You can also succeed without doing anything in your 20s it just means you have to do more work later. Those that get started earlier get a huge advantage.
Related: Saving for Retirement – Retirement Tips from TIAA CREF – Retiring Later, Out of Necessity – investment risks – IRA (Individual Retirement Accounts)