Can You Afford to Retire ... Ever?

Buried in all the bad news is an elegant, if slightly frustrating, fix to this retirement challenge. Work a few more years — retire at 67 rather than 62 — and you could have at least 30 percent more retirement income to live on when you do stop working. Stretch the R-day out to age 70 and keep saving through your 60s and you could have 80 percent more retirement income. No smoke and mirrors are at play here, just simple math. Here’s what happens when you work longer: You lengthen the number of years your money has to keep growing; you tuck more cash into your savings; you shorten the number of years you’ll be relying on your nest egg to support you, and, by waiting to draw on Social Security, you get a larger benefit than if you’d opted for a reduced benefit at an early age. Every year you delay drawing your benefit from age 62 to age 67 entitles you to an 8 percent increase in your ultimate benefit.

As onerous as it may sound, working an extra five years still means more years in retirement than previous generations enjoyed. A 45-year-old man today has an average life expectancy of 34 years (translation: 50 percent of 45-year old guys today will still be around at age 79). A 45-year-old woman has an average life expectancy to age 83. That’s 10 years longer than the average life expectancy in 1955. And plenty of us should plan on extra longevity; nearly 1 in 5 men and 1 in 3 women who are 65 today will live into their 90s.

Take Action: In an age of modest returns, what you put into your retirement plays a larger role in what you will have to take out than it did in bull-market days. “Whether you save in a Roth IRA or a traditional IRA isn’t nearly as important as whether you save, period,” says Christopher Jones, chief investment officer at Financial Engines, an independent investment adviser specializing in 401(k)s. Let’s start with the low-hanging fruit: Financial Engines took a look at nearly one million 401(k) accounts from 82 plan sponsors and found that about one third of participants don’t contribute enough to get the maximum employer match; thereby passing up free money. Max out on that match. No excuses. And push yourself to invest more. This year you can stuff $16,500 into your 401(k) ($22,000 if you are over 50). Yet according to Financial Engines less than 10 percent of plan participants get to within $500 of their contribution limit.

After maxing out on the 401(k), push yourself to contribute to an Individual Retirement Account. If you qualify for a Roth IRA (single filers with income below $105,000 in 2009; joint filers with income below $166,000), great; tax-free gains look even better in a world in which tax rates must rise to pay off the $13 trillion (and growing) national debt. If your income is too high for the Roth, tuck the money into a nondeductible IRA this year. Beginning next year, everyone, regardless of income, will be able to convert a regular IRA into a Roth IRA. You will owe tax on the gains from a conversion, but if you make the move in 2010 the IRS will let you pay the bill over two years.

Over the next 10 years the first wave of retirees heavily dependent on their 401(k) savings will start to draw down their assets. And that’s cause for new concern among retirement experts. Just as participants have struggled to make the right investing moves during the accumulation phase, so too are we expected to founder at managing withdrawals in retirement; what’s known as the decumulation phase. “The notion that the average person can manage their own retirement portfolio is akin to suggesting that anyone can just step in and fly an airplane or operate on their appendix,” says William Bernstein, author of The Four Pillars of Investing and co-founder of Efficient Frontiers Advisors.

While we will continue to see more tweaks to 401(k)s designed to help us invest smarter — increased use of target-date funds as a one-stop solution, automatic enrollment, and automatic increases of contribution rates — there are also changes coming that will affect how we handle our 401(k) distributions in retirement.

Mark Iwry, a leading retirement-plan expert who recently co-authored the automatic IRA plan in the Obama administration’s 2010 budget proposal, was appointed to the new post of Deputy Assistant Treasury Secretary for Retirement and Health Policy in late April. Prior to landing the Treasury gig, Iwry had been pushing for the introduction of a new 401(k) procedure that would automatically shift a portion of retirees’ 401(k) assets into an annuity that generates a fixed monthly income stream (investors would be allowed to opt out). It sounds a lot like an old-fashioned defined-benefit pension, and the similarity is intentional. In short, Iwry wants to help retirees avoid running out of money. Adding a “lifetime income” component to 401(k)s is a long way from implementation, but it is now getting serious face time in D.C. with one of its architects sitting at the head of the policy table. (Download the paper in which Iwry and a co-author first outlined what could be the 401(k) of the future.)

Take Action: The truth behind the 401(k) annuitization push is that it’s very hard to manage a nest egg so that it generates the income you need for as long as you might live. In a 2008 MetLife survey, 43 percent of respondents said they thought a 10 percent annual withdrawal rate seemed reasonable. It isn’t. Assuming a portfolio split between stocks and bonds, such a drawdown rate could empty your account in just nine years, and unless you smoke like a chimney and scarf down Twinkies, nine years won’t cut it. For a sustainable income stream over 30 years of retirement, plan on a 4 percent annual withdrawal rate from your retirement accounts — adjusted annually for inflation. That of course means you need to start with a bigger lump sum at retirement. The best way to arrive at retirement with that bigger lump sum may be hard to implement, but it’s easy to understand: Save more and start now.

A generation ago, retirees typically had two sources of retirement income beyond regular savings: Social Security and a company pension. Now the defined-benefit pension is a dinosaur, replaced by 401(k)s and IRAs — plural being the key here. According to the Employee Benefit Research Institute, in more than a quarter of families with income over $100,000, the head of household has at least four retirement accounts. Throw in the fact that married couples will also have a few more accounts in the spouse’s name and the likelihood that, with the demise of career employment, you’ll probably collect a few more 401(k)s along the way, and you could retire with a dozen accounts. Most people have trouble coming up with the proper asset allocation in one account.

Take Action: When you leave a job, you have the flexibility to move your 401(k) into an IRA. Multiple 401(k)s can be rolled into the same IRA. Voila, you’ve just reduced your complexity. Same is true with IRAs; as long as you consolidate apples with apples (traditional IRAs in one account and Roth IRAs in a separate account) you can amalgamate into one account all those stand-alone IRAs you collected like baseball trading cards in the 1990s. Fund companies and discount brokerages are achingly hungry for assets; that means they will gladly jump through hoops to help you consolidate accounts under their roof. Typically you just fill out a simple rollover-transfer form, and the fund company or brokerage will handle the logistics. Just be sure to authorize a direct transfer so the IRS doesn’t view it as a withdrawal.

One more tip: Even once you consolidate, you are still bound to have a few different accounts; a married couple could both have 401(k)s at their current employer as well as a few rollovers. That makes investing more complicated: “Honey, I thought you were buying stocks?” To maximize your potential return and minimize your expenses, Atlanta financial planner Brian Preston recommends creating one uber-allocation strategy across all the different accounts. The advantage to this approach is that it frees you up to make the most of the limited choices within a current 401(k), and then use the freedom of an IRA to round out your investments. If your plan is riddled with high-fee portfolios, Preston says search for the cheapest fund available and pile all your money into that. Then adjust your allocation in other retirement accounts accordingly. “There’s no rule that says each account you own must be perfectly allocated across asset classes. Look at the whole of your investments,” says Preston. “That’s what matters.”

That and, of course, saving like mad starting now. Did we mention that?

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