Monday, November 16, 2009

Retiring when You Can

Chances are, the lesser your wage will working, the more dependent you will be on Social Security when you retire. While at first glance this might seem a sad state of affairs in terms of a retirement plan, it is not beyond your abilities to change this outcome before you retire. If you are aged 50-years, the ability to put together a viable plan is doubly difficult. But, even considering that, it is not impossible.

Several things need to be adjusted prior to that arbitrary date.

Retire when you can
Most of us have not been very successful with our retirement planning. We have begun late in many instances and have failed to utilize our options to the fullest. Many of us have not used these plans long enough to see the benefits. Long-term investing still needs thirty years or longer to work. The vast majority who have plans have used them less than 16 years.

During this time frame, often thrust upon us as your company changed from a pension plan to a 401(k) or you changed jobs repeatedly during that period, we experienced the shock of having to educate ourselves about what our options were and then set a plan that was previously managed for us to one that was defined by us.

For numerous folks, this meant doing the wrong thing first, then, as time passed, correcting those mistakes.

Default Investing
Up until several years ago, the default investment in your 401(k) could have been anything from a simple index fund to a money market account. The later simply parked your money, and while you never lost any of it, you never were able to take advantage of market ups and downs.

Now, new employees will be defaulted into target date funds (pick a retirement year or have one picked for you). And some, after the debacle that was 2008, have switched their retirement money to just such a fund in the hopes of recovering enough invested dollars to regain some of what you may have lost and preserve what was left.

The jury is still out on whether these funds will provide what you need to get where they say they will take you. Target date funds are navigating uncharted waters with a promise to do what never has been attempted. Unlike balanced funds (usually offering a 60/40 split between stocks and bonds), target date funds re-allocate your investment over time moving from more aggressive to less with the idea that this will protect your investment over time.

Over 50 Dilemma
If you are over 50, this strategy may prove to be the wrong one. In most cases, you are entering your largest income producing years. If you are contributing more as you earn more, you may be leaving a great deal of potential on the table as these funds try and protect those invested dollars instead of growing them.

While stocks are considered risky in this period, they should not be ignored. The best structured retirement plan will separate your investments into categories. If you are currently contributing 6% of your pre-tax income to your retirement plan (and this is not enough), you need to increase that amount to the point of causing you to rethink your daily budget needs.

Each pay raise should signal an increase in contributions. And each increase should go to a more conservative investment while leaving the initial 6% fully invested in stocks. This sort of self allocation will give some risk for old money invested and less risk for new. Shifting to a target date fund does not allow for this, taking much of the potential for risk off the table.

When and How
If you can wait to take a distribution from your 401(k), it will allow it to grow further. To do this, you will need to enter retirement without a mortgage, with your financial house in order (this means adequate savings, only the minimum in credit card debt and the all important emergency account). Your expenses will not decrease in retirement. The cost of maintaining insurances as well as your property will not go away. Your health could prove to be a factor as well and should be accounted for (and worked on while you are still employed) before you retire.

Many of these costs rely on projections. While these are difficult to make with any accuracy, they are not impossible to plan for. Inflation will increase by about 3% suggesting that each year, your expenses will go up, even the fixed ones (because inflation makes your dollar worth less). Insurances might increase on average 5-10%. And taxes will depend on how much income you have but basing your projections on current income rates might prove foolhardy. Add an estimated increase of 3% per year (this includes property taxes as well).

Arriving at retirement with any outstanding debt means one thing: you will have to continue to work just to keep up with the increases. The other option, of course, is to get used to these financial burdens while you are still working. Living a little bit more frugally now will offer you the opportunity to experience what life post-work will be like.

So the three basic tenets of investing apply: get your financial house in order, channel as much money as is possible into your retirement plan (without increasing the risk of creating more debt as you scrimp) and take some risks with your invested dollars. The first tow will offset any problems you might face with the last suggestion and allow your invested dollars to do some work that too conservative approach will not permit.

It's not too late. But the strategies are different.

Paul Petillo is the Managing Editor of and a fellow Boomer.

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