PLANNING FOR RETIREMENT

People are living longer and are more active in their retirement years. Some of us will live to be 100. Should this become a trend, your years of retirement will be a bit longer than those of your ancestors, which means, if you retire at 65, your retirement could last 15 years or longer (if you are curious about life expectancy, see the table; this was complied by one set of actuaries). Thus, your retirement years will be about 1/3 the life of your working career, and the years of retirement will probably have several phases, each with different needs and requirements (one of which might include long term health care insurance).

Living longer may be a little frightening – especially when you try to assess how much money you will need to support the life-style you want to have during retirement. After all, you want to do more than just live long: you want to live with financial security.

Some will tell you that during retirement your annual income should be 70% to 80% of what you are currently making. Though there is an element of truth in that rule of thumb, keep in mind that everyone has different goals and needs, and the reality is, you will not be prepared to meet your needs during retirement unless you do a bit of planning.

Before you can even begin to predict how much money you’ll need in retirement, you need to decide what kind of life style you want. In addition, you will have to estimate your cost of living based on today’s costs, for there is no basis for knowing the cost of living 20 years from now. You should then add an inflation factor of 3 – 5% per year (multiply your annual expenses by 1.03 or 1.05), which will factor the loss of purchasing power caused by inflation, for every year from now until when you retire, and for every year thereafter.


DEFINE YOUR OBJECTIVES

There are two basic questions which must be answered at the outset: first, where do you want to live? Some want to live in more than one place. Second, how well do you want to live? Knowing where you want to be financially and geographically during retirement is the first step towards defining your retirement goals. By evaluating your current financial position, and estimating how much money you’ll need for your retirement, you can begin to build a long-term investment plan to help you reach your objectives. The worksheet exercise1 is intended to help assess your financial needs. Thus, you should try to put a price tag on your retirement goals, which means, first estimate what you will be spending.

After you determine the expenses you will need during retirement, you must then assess your own resources: presumably, there will be some sort of social security payments available to you, and the Social Security Administration will give you an accounting of what you will be paid at various ages, when you retire (request “Your Personal Earnings and Benefit Estimate Statement” (a PEBES) from the Social Security Administration, using SSA-7004, available for download at http://www.ssa.gov/, and mail the same to P. O. Box 3600, Wilkes-Barre, PA 18767-3600; further details on this form are available on the Internet. The maximum social security benefit for most workers who have attained maximum earnings, for the year 2002, is $1,660 per month. The amount you will actually receive depends on the amount of contributions you have made to the Social Security program. To these monthly benefits, you should also add any pensions you will receive, and any other sums to be paid to you from 401K Plans, tax sheltered annuities, IRAs, 403B Plans, and the like.


SOME THOUGHTS ON SAVING

If your retirement income is less than your projected retirement expenses, then you need to begin a savings program so as to supplement your retirement resources (the tables can help you compute what you need to save to accumulate a specific amount). There are many types of savings programs – but the two basic saving strategies used by most persons are investments in bonds (including certificates of deposit, and corporate and treasury bonds) and investments in stocks. Bonds, for purposes of this article, include certificates of deposit, corporate bonds, savings bonds, treasury notes and bills, and treasury bonds – and for purposes of the investment triangle (discussed below), also include life insurance, real estate, and other assets which do always produce income. The average income produced from bonds is about 5% per year. Stocks are at the other end of the investment spectrum; they usually pay dividends, which are probably less than 3% per year. However, stocks usually grow in value, such that you can reasonably expect growth in a stock investment (consisting of dividends and increase in value) of about 10% per year (for the past three years, the stock market has exceeded growth of 10% a year). For planning purposes, however, and in order to be conservative, you should use a more conservative growth rate. In order to assist you for planning purposes, the tables illustrate the effect of investing $1,000 at one time, $1,000 per year, and $100 per month. The tables also will give you an idea of how much you should have in savings, should you spend $100 a month over different periods of time.

Most persons do not directly invest in stocks – rather, they purchase mutual funds, which are securities (as are stocks and bonds). There are thousands of stocks available for investment, and there are also thousands of mutual funds offered for sale. Since mutual funds own a variety of investments, some of them have characteristics of a bond investment, some resemble pure stock investments, and others are designed to achieve a combination of investing in both stocks and bonds. Just as there are no guarantees on how much, if any, may be made on the purchase of an individual stock, there are also risks involved in investing in mutual funds. 


THE INVESTMENT TRIANGLE

There is no perfect investment program, because we are imperfect ourselves, and by definition, we cannot create an investment model or strategy that will always work. However, the traditional investment program suggested by the investment community is this: if you prepare a statement of your net worth, including real estate, stocks, bonds, mutual funds, personal property, collectibles, registered animals, certificates of deposit, bank accounts, minerals, intellectual property such as patents and copyrights, and assign values to each category of property, your net worth ought to be apportioned as follows: 5-10% of your net worth should be in cash or cash equivalents, 40% of your net worth ought to be in stocks, and 50% of your net worth ought to be in bonds. If each category were depicted in a triangle, stock investments, which have the highest risk of loss, would be at the top of the triangle (the triangle cannot stand on its peak – it would topple over), then bonds would be the next layer of the triangle (for purposes of this triangle, bonds would include insurance, your home, real estate, CDs, and bonds) and the base of the triangle would consist of cash or cash equivalents (which have the lowest risk of loss).

The shape of your investment triangle will change as you approach your actual retirement; during retirement, you will be more interested in receiving income, than in having a stock portfolio which may not produce any income. By age 65, most couples should entertain the notion of having an investment triangle consisting of 5-10% cash and cash equivalents, 20% stocks, and 70% bonds. Using this concept, you can determine not only your net worth, but in the tables, you will be able to determine how much income and principal can be withdrawn from investments, over various periods of time, so as to meet your financial needs.

As you develop an investment strategy, keep in mind there is always an element of risk in any investment – to illustrate this point, the tables depict different rates of return, based on higher interest rates. The higher the risk, the greater reward – for you should never forget that in any investment, there is always a risk that you will not achieve a higher rate of return, due to the risky nature of any given investment. In order to formulate your own investment program, and understand more completely the risks of an investment, perhaps the most sensible solution is to find an investment advisor (or advisors, as the case may be) with whom you are comfortable, and use professional advice and counsel to formulate a program which will achieve your objectives, within your own comfort level of investments.

The following is an illustration of the investment triangle, though no triangle is shown – only a chart. The higher risk investments should be depicted at the top of an imaginary triangle, and the lower risk investments located at the base of the triangle. The chart depicts an asset allocation pattern for a person before retirement, and after retirement. Before retirement, an investment portfolio is usually riskier than after retirement.

Pre-Retirement Allocation of Assets Level of Risk
Cash10%Low
Bonds40%Medium
Stocks50%High
 100% 
   
Retirement Allocation of Assets  
Cash10%Low
Bonds70%Medium
Stocks20%High
 100% 

An alternative to the “investment triangle” is using a formula: subtract 100 from your age. For example, if you are 55 years old, 100 less your age is 45. Using those two numbers, you would allocate 55% of your portfolio in bonds (or investments that pay income on a fixed basis), and 45% of your portfolio in stocks or equities. Each year you will have to adjust your portfolio, to achieve an appropriate ratio. The theory in this investment formula deals with aging: as you grow older, you will more interested in certainty, and consequently, will want to shift from the speculative nature of equities, to more conservative investments, such as bonds and certificates of deposit (or perhaps fixed annuities).

LEGACIES AND INHERITANCES

A final consideration in retirement planning deals with your children: determining what amount you will leave them, and determining at what ages they will inherit your estate. It is sometimes easier to make an arbitrary decision as to what you will leave them; if your resources are insufficient to meet that objective, then you should consider purchasing life insurance to supplement that part of your retirement plan.


CONCLUSION

In conclusion, planning for retirement ought to be done as soon as possible. The best age to begin such planning is probably about 35 – but effective plans can be made at any time. We wish you good luck in this very important planning process. You might complete the retirement budget worksheet1, then use the life expectancy tables, to determine if you have enough income to retire. If you don’t have enough, use the tables as a means of determining what you need to save in order to meet your retirement objectives. Or better yet, consult with a good financial planner.