BUSINESSWEEK ONLINE : JULY 17, 2000 ISSUE
COVER STORY

Here's What Not to Forget
Workers often fail to account for inflation, taxes, and other savings drains

Sally and Frank Rager, both in their mid-50s, plan to retire in two years. So they sat down recently with their financial planner to crunch some numbers. The Clarksville (Tenn.) couple toted up all their expected expenses--from home maintenance and travel to long-term care insurance. They looked at their combined income and, to their relief, determined that they'd be in pretty good shape. ''We'll have enough money to live comfortably until we're 85,'' says Sally, a nurse whose husband is a quality-control manager for an automobile-parts manufacturing company. ''If we live much past that, we may be in trouble.''

The Ragers are among the lucky ones: They've scoped out where the potential dangers lie. Most working-age Americans haven't any idea how much income they're going to need in retirement. A survey by the Employee Benefit Research Institute (EBRI) released in May found that only half of American workers have bothered to analyze their retirement needs. ''People are saving, but they're saving blindly,'' says Don Blandin, president of the American Savings Education Council, an affiliate of EBRI. Even those who do work out a retirement budget tend to be overly optimistic: ''Most people rely on outdated projections and unrealistic assumptions, and they fail to plan for contingencies,'' says Ronald Roge, a certified financial planner in Bohemia, N.Y.

SNEAK PEEK. Your own retirement may be decades away--but if nothing else, a sneak peek at what it will take to replace your current income in the future's inflated dollars is likely to spur your savings. Indeed, 88% of those who have worked out a retirement budget are setting money aside, according to the EBRI survey, compared with only 61% of those who haven't done the math. ''Clearly, it helps to have a goal,'' Blandin says.

But once you leave your 40s, you need to replace rough estimates with detailed figures. The first step is to determine, as closely as possible, the kind of retirement lifestyle you hope to have. ''You need to ask yourself, 'Where do I plan to live? Do I want to have a second home? What hobbies and interests will I want to pursue?''' explains Jeffrey Rattiner, a certified financial planner in Englewood, Colo. The more specific you can be, the better, ideally including even such costs as club memberships and trips to visit the grandkids.

Although conventional wisdom has long held that retirees will spend between 70% and 80% of their current expenses, many planners now believe that's a bare-bones estimate, particularly for self-indulgent baby boomers. While some expenses such as housing and child-related costs may go down, others--such as travel during the active retirement years and health-care costs later--are likely to increase. So you should plan on spending roughly as much as you are now, at least during the first 10 years or so of your retirement. ''Who wants to ratchet down their lifestyle?'' asks Joel Davis, a certified financial planner with American Express Financial Advisors in Augusta, Maine. ''Everyone I know wants to be at least as well off--even better off--than they currently are.''

Miscalculations, of course, can land you in big trouble. A common one is forgetting to account for inflation, which most planners project at an average 4% annually. You should calculate for inflation when you figure your expenses, your income goal, and your investment returns. So if your income goal in 10 years is $200,000 in today's dollars, aim for $296,000, which includes 4% inflation compounded annually.

You should also consider the impact of taxes on your retirement income. ''Retirees tend to think they're better off than they really are,'' says Roge, because they forget that distributions from their tax-deferred individual retirement accounts, 401(k)s, and pension plans are taxed--and don't enjoy the lower capital-gains rates assessed on many investments. Planners suggest preparing sample tax returns--state as well as federal--based on your projected income to get an idea of how much to earmark for taxes.

Another common mistake: Underestimating life expectancy by relying on outdated actuarial tables. ''Most of my younger clients have a hard time envisioning themselves living past 85,'' says Davis. ''But with today's medical advances, most of them probably will.''

While you obviously can't predict your destiny, new tools exist to help you make an educated guess. Experiment with the longevity calculators on the Internet (table). After you provide vital statistics and answer health questions, these sites compute an estimated age of death. Use several and compute the average for planning purposes. A more conservative approach favored by many planners is to accumulate enough savings that you can live to age 95 without running out of money.

EMERGENCIES. Your savings needs will vary depending on your assets, level of risk tolerance, and even factors like your proximity to family and other support systems. And while you obviously can't plan for every contingency, the more possibilities you take into account, the better prepared you'll be. Smaller expenses, such as home repairs and auto maintenance, should also be figured in. Planners recommend setting up an emergency fund (anywhere from $1,500 to $3,000) for unexpected large expenses such as new appliances.

On the income side, don't count too much on Social Security: The entitlement program currently provides only $17,196 annually for the highest earners retiring at age 65. And be careful not to overestimate the rate of return on your investments. ''People tend to look at how their portfolio has performed in the past five or ten years, and that's very deceiving,'' says John Feeney, a certified financial planner with Noble Financial Advisory in East Sandwich, Mass.

A realistic calculation is to figure the rate of the return based on long-term analysis. For stocks, that's about 11% annually, and it's between 5% and 7% for bonds and money-market accounts. Feeney suggests estimating a 7% to 8% return on a balanced portfolio.

Whatever you do, make sure to create a cash reserve that, suggest some planners, will cover from 18 months to two years of living expenses. That protects you from having to dip into a stock portfolio for living expenses when the market is down.

Finally, when you do make a budget, revisit it regularly so you can rework and refine. Planners recommend reevaluating once every five years when you're in your 40s and once every two years as retirement draws near. If you have a clear sense of how much you'll need, it will be easier to take the next step: figuring out how to finance your dream retirement.

By MARY HICKEY

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