The transition from full-time work into retirement is a time of promise. But it also can be a time of challenging financial decisions. For years, those nearing retirement have been urged by financial experts to "save, save, save" – and pay down debt. But after the nest egg is built come some complicated questions. Is that nest egg big enough to retire now? How much can I spend each month? Should I convert some savings into an annuity?
For millions of Americans, notably the baby-boom generation that began turning 60 this year, the time to address such questions is near.
They will be following the path of people like Craig Hayden of Glendora, Calif. He retired three years ago after a career as a business analyst at 3M (formerly Minnesota Mining and Manufacturing Co.).
Unlike most of today's employees, who are only offered defined-contribution retirement plans such as a 401(k), Mr. Hayden retired with a defined-benefit plan paid for by his employer. Currently, that traditional pension and Social Security provide most of the income for Hayden and his wife. "Without the pension ... I would have had to put a lot more into a 401(k)," he says.
But for those about to retire, having enough money to maintain living standards is becoming more difficult. The Center for Retirement Research at Boston College recently developed a "national retirement risk index" that gauges how many Americans are at risk of a lower standard of living in their retirement. The index has been rising – a negative sign for millions of people. Some 43 percent of Americans are on track to fall short, by 10 percent or more, of the goal of replacing about three-fourths of their preretirement income after they stop working. That number, based on Federal Reserve data for 2004, is up from 38 percent in 2001 and 31 percent two decades ago, the center calculates.
The reasons for this trend include:
•Increased longevity, so nest eggs must last longer.
•Fewer traditional pensions and more 401(k) plans, where saving is voluntary and the payout is not guaranteed for life.
•Low rates of personal savings.
•Leaner returns on investments.
•Rising healthcare costs, outpacing the average change in the price of other goods.
Such trends not only make it more difficult for workers to build savings, they also create more uncertainty as they near retirement age. Here are some pointers that financial planners are offering those about to retire.
For people about to navigate from full-time work into retirement, this may be a time to get some extra help.
"Having objective professional advice is important at that point," says Rick Miller, a planner who owns Sensible Financial planning in Cambridge, Mass. "One is making an enormous decision when one decides to retire,"
A financial professional's skills should mesh with your needs. Some planners know more about estate planning than others do, for example.
Many planners also derive their earnings in part from selling insurance, annuities, and other investment products. Some experts argue that the most objective financial advice may come from those without such financial ties.
"I would be the last person to suggest that you can't get through life without having a financial planner," but many people do benefit greatly from such a strategy, Mr. Miller says.
Before taking the retirement plunge, closely examine your annual spending habits – and forecast how well your retirement income will cover those expenses.
"Is the mortgage paid off? What are your costs for real estate taxes, maintenance for your house, and other operating expenses?" asks Jim Pinney of Pinney & Scofield, a financial planning firm in Cambridge, Mass. Add in the "optional" things you hope to spend money on, such as substantial monetary gifts to grandchildren, he says, and consider where that money will come from.
Once ties are severed with a full-time employer, returning to work remains an option, but finding the same level of pay is tougher, Miller says. "The value of one's human capital is going to drop."
Many Americans opt to retire early, before age 65. But it often is wise to wait a few years. Two advantages: People can then earn full Social Security benefits, and they have fewer years of retirement to fund.
Many planners offer this rule of thumb: Draw down your financial assets by no more than 4 percent in your first year of retirement. After that, the amount can increase with the rate of inflation, so that the purchasing power of your drawdowns remains the same each year.
Sticking to that 4 percent figure generally gives people about a 95 percent chance of having their assets last as long as they live. Withdraw more savings – even just 1 percent more – and the risk of running out of money rises sharply, experts say.
Social Security provides the most solid income stream for most retirees. But they often supplement that with savings held in a variety of investments. For many, the nest egg is divided into a mix of stock or stock mutual funds and fixed-income instruments.
One key question retirees face is what percentage of assets to keep in stocks. The answer depends heavily on an individual's circumstances and goals. Stocks are riskier, but offer greater growth potential than bonds and other savings tools.
For guidelines, consider the portfolios of age-targeted mutual funds. For people retiring last year, the Vanguard Target Retirement 2005 fund held about 42 percent of its portfolio in stocks. The T. Rowe Price Retirement 2005 fund assigns a larger stock percentage: about 56 percent.
Another key question: Do you annuitize a portion of your savings and if so, when? Using a chunk of your nest egg to buy a fixed (not variable) annuity guarantees a stream of income for life and can provide a measure of certainty in an overall plan. The disadvantage: Purchasers lose direct control of that money.
Say a couple buys an annuity using $200,000 of savings, and both spouses die after receiving just $10,000 in payouts. In many cases that would leave $190,000 to the insurance company rather than to their heirs. "We tend to recommend that people not make irrevocable decisions ... immediately" upon retirement, says Ellen Rinaldi, the Vanguard Group's principal of retirement services.
"For many people, it's a very good decision" to buy an annuity, she says, but she urges people to get a few years of retirement under their belt – monitoring income and expenses – so they feel sure of what they're doing.
Vanguard's "Lifetime Income" annuities include an optional inflation-protection feature. The monthly payout will start lower than that of a traditional annuity, but the amount will rise with inflation, as gauged by the Consumer Price Index.
"Inflation is what many people call the silent killer of retirement income," Ms. Rinaldi says. Only a small fraction of Vanguard customers choose this option, but its popularity has risen in recent months, thanks to reports about rising inflation, she adds.
Other financial advisers see no problem with starting to annuitize some assets immediately upon retirement. But people can choose to buy small annuities every year or so rather than one big chunk, because annuity prices are constantly changing with prevailing interest rates.
Some planners and financial firms offer tools to help you track whether you're hitting your income and spending targets. Fidelity Investments, for example, offers an "income management account" that provides retirees with up-to-date cash-flow charts.
For many people, the home is not just their dwelling but also a major portion of their net worth. Downsizing to a smaller residence can provide additional funds for retirees. And in the longer run, the home can be a financial backstop. If finances get tight, a reverse mortgage can provide owners with steady income in exchange for declining equity in the home.
In the end, retirement involves more than just money. There are dreams of travel as well as devoting more time to hobbies, family, and charitable activities. Starting off with a solid financial plan can help to make those dreams come true.