Getting Back on Track: How to Salvage Retirement Plans

So much for retiring early.

David Bakeman, 61, had planned to begin a leisurely retirement at the end of the year. But a few months back, he invested a significant portion of his cash reserves in the stock market--just in time to participate in the biggest market meltdown in more than a decade.

“It doesn’t look like I’m going to retire at all, ever,” Bakeman said melodramatically. “My comfort level went out the window.”

In reality, Bakeman probably will delay his retirement just three years or so, until he’s 65. By then, he hopes to have repaired enough of the damage from his rash market foray that he can enjoy his golden years in comfort.

Count Bakeman among the millions of Americans being forced to adjust their retirement plans to reflect today’s diminished investment returns. Investors who thought the heady stock market gains of the late 1990s were the norm are relearning the old lesson that stock prices can go down as well as up.

That realization is particularly painful for investors such as Bakeman who are nearing the end of their working years and thought the soaring market would allow them to retire in comfort--or even take off a few years early.

The bad news is that there’s no guarantee the stock market is near bottom. And even when it finally turns around, a repeat of the 20%-to-30% annual returns of the late ‘90s isn’t likely, many experts say.

How do you cope if retirement is approaching? There are three main strategies you can follow to get your plans back on track. For many people, the solution will be some combination of these:

* Delay the Date: Of all the options, delaying your retirement for a few years is by far the most powerful.

“It works from two ends,” said Katharine A. McGee, a fee-only financial planner in Davenport, Iowa. “You [can] continue to add to your 401(k), IRA and other personal savings, but you are also shortening the amount of time that you need to pull money out of the pot.”

After all, the idea of retirement savings is to have enough money to supplement other post-employment income, such as Social Security and a workplace pension, if you have one. If you figure you’ll live to 90, and you retire at 60, you have to plan on financing 30 years of retirement costs. Quit work when you’re 65, and the time frame shrinks to 25 years.

As a bonus, your money has more time to generate investment returns while you keep working.

Consider Max, who retires at 60 with a $250,000 nest egg. Assuming the money earns a 5% annual return, Max can withdraw $1,342 a month and not run out of savings until his 90th birthday.

But if he delays retirement until 65, the $250,000 nest egg will have become $320,839. Now, Max will draw monthly payments for 25 years, again assuming a 90-year life span. The monthly withdrawal can be $1,875 a month, or nearly 40% more.

What’s more, if Max saved an additional $1,000 a month while working from age 60 to 65, his savings would have grown to $388,845 and his monthly withdrawal rate then could be $2,273--69% more than if he’d quit working at 60.

Of course, it’s easy to argue for working longer. For many people, physical and health issues can make the choice much tougher. And in a slowing economy, job security and availability become bigger issues.

Still, if you can delay retirement, there are other good financial reasons to do so: Working longer affects your Social Security benefits as well as payments from workplace defined-benefit pension plans.

If you start receiving Social Security benefits at age 62 instead of 65, your monthly payment is reduced by more than 20% from your so-called primary insurance amount. For example, retiring three years early reduces a full benefit of $1,500 a month to $1,174.50, said Social Security spokeswoman Leslie Walker.

Even that understates the effect of early retirement, because wages tend to rise with inflation and experience--and Social Security payments are based on a worker’s 35 highest-earning years. Thus, the average primary insurance amount rises several percentage points between ages 62 and 65, Walker noted.

The same holds true for defined-benefit pensions--the type that pay a set monthly stipend for life. Although such plans are less popular now, about 40 million American workers still are covered by them. And the plans generally pay higher benefits to workers with more years of service.

* Save More Now: Can’t stand the thought of working until you’re 65? Try saving more during your last years in the labor force.

This is often more feasible than it sounds. By one’s late 50s and early 60s, other financial obligations--such as sending kids to college and paying for weddings--are probably in the past, says Ellen Hoffman, author of “The Retirement Catch-Up Guide.”

This strategy helps in two ways: It increases the amount of money you’ll have to retire on, and it conditions you to live more frugally, also a useful skill in retirement.

Saving more also makes sense for younger workers who saw their retirement plans run off the rails right along with the Nasdaq composite index. Saving twice as much won’t quite make up for earning half the annual return you were expecting, but it can come close.

People nearing retirement who opt to save more need to make sure their investment portfolios fit their goals. For some investors, that means making sure they avoid repeating the mistakes they made over the last few years.

If you’re close enough to retirement age that the bear market ruined your exit plans, your investment strategy is probably wrong.

Money that’s needed in the next five years should never be invested in stocks, financial planner McGee said, adding that’s true even if Nasdaq is rising 90% a year.

People close to retirement should have diversified portfolios that keep a substantial portion of their savings in more stable investments such as bonds and bank certificates of deposit.

“Yes, you give up some yield, but it’s buying you some insurance,” McGee said. “You need to diversify enough to weather any storm. Then when this sort of thing [the stock market’s plunge] happens, which is inevitable, it doesn’t faze you. You get on with your golf game.”

Of course, some portion of your portfolio should remain in stocks even in retirement years. You won’t be tapping some of your savings for decades, and the superior long-term returns from some stocks can help ensure that you won’t outlive your nest egg.

* Plan to Spend Less Later: Some people whose retirement accounts had grown substantially in the last few years concocted grand ideas of what they were going to do when they retired, said Elaine Bedel, a fee-only planner in Indianapolis.

Now that the market is in a swoon, people might realize they have to scale back their dreams, Bedel said.

They might not have to cut day-to-day expenses, but they’ll need to be a bit more careful about the big things, like vacations, remodeling projects and second homes, financial planners said.

One of Bedel’s clients is in this situation. He planned to spend $100,000 to $200,000 building a home when he retired, and he had been giving his kids $10,000 checks every year.

But when the company stock that accounted for a large part of his fortune fell from $60 to $33 a share, the house-building plans bit the dust. If there’s no stock recovery in sight, the annual gifts to his kids may have to stop too.

Those who can scale back their living expenses, especially in the first few years of retirement, would be wise to do so for the sole reason that less of their savings would be depleted, planners said.

“We would look at their lifestyle and determine what is discretionary spending and what’s fixed, mandatory spending,” said Eric Hananel, a financial planning partner at BDO Seidman in New York. “You see if they can adjust their lifestyle to get it more in line with the income that’s coming in the door.”

Deciding what expenditures you could or must cut may not be pleasant, but it will help you understand what your true priorities are in life, planners said.

And if the stock market surprises, producing great returns in coming years, it will be easy enough to enjoy that windfall. It just isn’t a good idea to bank on it anymore.

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What Will Your Nest Egg Be Worth at Retirement?

The size of your retirement nest egg will depend on how much you save and your rate of return. The multipliers in the chart at right can show you how much your current savings will grow over time at various rates of return. Of course, your total would be boosted by additional money you save between now and retirement.

How to use this chart

Simply multiply your current savings by the number that corresponds to your expected average annual return and the years you plan to have the money invested. Example: If you have $30,000 saved today and expect to earn an average of 8% a year on that money over the next 15 years, multiply $30,000 by 3.31 and you get $99,300. That’s how much you’d have at the end of that period. The numbers assume monthly compounding.

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Time to Estimated annualized rate of return retirement 5% 6% 7% 8% 5 years 1.28% 1.35% 1.42% 1.49% 10 1.65 1.82 2.01 2.22 15 2.11 2.45 2.85 3.31 20 2.71 3.31 4.04 4.93 25 3.48 4.46 5.72 7.34 30 4.47 6.02 8.12 10.94 35 5.73 8.12 11.51 16.29 40 7.35 10.96 16.31 24.27

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Time to Estimated annualized rate of return retirement 9% 10% 11% 12% 5 years 1.57% 1.64% 1.73% 1.82% 10 2.45 2.71 2.99 3.30 15 3.84 4.45 5.17 5.99 20 6.01 7.32 8.93 10.89 25 9.41 12.06 15.45 19.79 30 14.73 19.84 26.71 35.95 35 23.06 32.64 46.18 65.31 40 36.11 53.70 79.83 118.65

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What’s a realistic rate of return?

Historically, the Standard & Poor’s 500 index, often used as a benchmark for the U.S. stock market, has posted an average annual return of about 11%, while long-term government bonds have returned about 5%, according to Ibbotson Associates. For a diversified portfolio, then, a realistic overall rate of return might be about 7% or 8%.

Inflation caveat

This chart can tell you what your current savings would be worth in current dollars. But even modest inflation erodes the value of money over time. A $50,000 nest egg in 10 years won’t have the same purchasing power as a $50,000 nest egg today.

Source: Times research