|BUSINESSWEEK ONLINE : JULY 17, 2000 ISSUE|
It's Never Too Late to Make a Plan
Three tales of people who got serious about retirement
Twentysomethings are becoming millionaires, teenagers are playing the stock market on their home computers, and a television ad for a brokerage house features football players in a huddle talking about price-earnings ratios.
A third of U.S. households have individual retirement accounts (IRAs). Contributions to 401(k) plans have grown an average of 18% per year since 1990, to total more than $1.4 trillion at the end of 1998. More Americans than ever own stocks. The Internet, the baby boom, the bull market--the interactions of these phenomena have caused an explosion of financial interest and activity that would have been impossible to predict a decade ago. Yet a 1997 study by Public Agenda, a nonprofit research organization, found that 46% of Americans aged 22 to 61 have saved less than $10,000 for retirement. The rate of personal savings has been spiraling downward from 9% of disposable income in 1982 to 0.5% in 1998. And an American Association of Retired Persons study reports that only one-fifth of baby boomers aged 36 to 54 have more than $25,000 in assets. Clearly, a lot of Americans need to catch up on their saving for retirement.
In a bygone, simpler era, the strategies for ensuring financial comfort in retirement were pretty straightforward. If you were lucky, you or your spouse worked for a company or government agency that guaranteed a pension. You knew that when you attained a certain age, after a certain number of years on the job, you could count on receiving that regular pension check. If you didn't have a traditional pension, you had one other option: put all of your extra cash into savings accounts, stocks and bonds, or real estate. Until the creation of IRAs in 1974, the federal government didn't even offer most Americans any tax incentives to save for retirement.
Early in the 21st century, it's clear that in addition to increased longevity, many factors have combined to make the whole business of saving for retirement more complex. Among them: the decline in access to traditional pensions; the shift to IRAs, 401(k)s, and other tax-advantaged retirement vehicles that challenge you to make a constant stream of investment decisions; and the intense competition in the financial-services industry to manage your retirement funds.
How do I figure out how much money I'll really need when I retire? Can I count on receiving Social Security? How much risk should I take when I am investing my retirement money? Is it too late for me to save for retirement? Many people are so scared by these questions that they put off planning for retirement altogether. At 40, 50, 60, or even older, they may suddenly realize their retirement prospects are grim. They may even think their situation is hopeless. But those of us who haven't planned or prepared adequately can make up for lost time at any age--even those of us who are already retired.
Since there's no shortage of financial advice available, rather than give a textbook lesson in financial planning, this book shares the real stories of people who have used those strategies and techniques successfully. The people interviewed had to play catch-up for a myriad of reasons: poor money management, credit-card debt, losses in a divorce settlement, a business failure, bad investments, or just plain low income.
What was most surprising: the number of people living a solidly middle- or upper-middle-class lifestyle, with expensive cars and capacious homes, vacations overseas, and children in private school, who are very unprepared financially for retirement. They have only the most general idea about what they need to do to remedy their situation. Even some people who are quite sophisticated about investing in the stock market have no idea how much Social Security they might receive, let alone how to create what Richmond (Va.) financial planner Duke Grkovic calls a ''road map'' to follow from their current assets to a target they have set for retirement assets. Yet despite these uncertainties and knowledge gaps, everyone described in this book was consciously taking steps to catch up on saving for retirement. Most of the people started to adjust their financial habits when they were in their 40s or 50s. But there are also stories about people who may have been retired for a decade or more and who realized only after they stopped working that they hadn't saved enough to maintain the lifestyle they wanted.
Every story in The Retirement Catch-Up Guide is true. But all the names and, in some cases, facts such as the individuals' jobs or where they live have also been changed to protect their privacy. What follows are three stories that give valuable lessons about saving for retirement.
Give Your Future a Reality Check
People often harbor subconscious assumptions about their retirement life. Even in the 21st century, many women hold the unspoken belief that they will meet and marry the perfect provider who will take care of their economic needs for the rest of their life. Of course, the older we get, the less likely it is this will happen. At some point, women who think this way realize they must provide their own financial resources for retirement. Here's the story of one woman who confronted that reality at age 41.
For nearly two decades, Rita led an incredibly exotic and adventurous life. She lived or traveled extensively in Latin America, becoming fluent in Spanish and indulging a strong interest in handicrafts and folk art. What started as an avocation became a business. Until recently, she was selling $1 million of imported goods a year, employing more than 60 people, and attending a seemingly endless round of trade shows to connect with buyers.
Before starting the business, she had worked for a foundation and a civil rights organization. In those years, she recalls, ''I didn't care at all about saving money or banking and stocks. For most of my life my priorities have had to do with education, travel, and professional growth and development.''
On one overseas business trip, Rita found herself dining with a stockbroker from the U.S. The conversation turned to money, and he told her: ''I'm so tired of hearing smart people tell me that they have nothing to retire on. They are stupid and deserve anything they get.'' Rita, who at this time had neither retirement plans nor savings, asked: ''What do you mean?'' The stockbroker's reply was to the point: ''You put money into an account. There is something called compound interest. If you leave the money there, then 20 years later you will have money to retire on.''
Rita remembered this conversation, even as she continued to reinvest all the company's returns back in the business. Then, at 41, she had a crisis. ''I was taking stock of my life. I realized that all along I had the fantasy that I would marry a professional man, that he would have a good salary, and we would have a house and family. Suddenly it became clear that at 41, there were no options for marriage in sight. I realized I was all alone in the world. I had to make my own choices.''
Soon after that, Rita bought a house and consulted with a stockbroker about how to save for retirement. ''We assumed that my house would be paid off. I would drive a very modest car. I'd like to go to Europe once a year for a month. I thought that with $30,000 a year I could live happily ever after.'' The broker said she would need to put away $500 per month to achieve that goal. This seemed like more than she could afford, but interest rates declined, she refinanced her house, and Rita decided to have the $300 per month she was saving on the mortgage deposited in her brokerage account automatically.
Even though she has decided to close down her business and start another career at 52, Rita feels good about her future. ''My anxiety is tremendously reduced knowing that I am doing this,'' she says. ''Had I understood the principle of compound interest earlier, I would not have waited to save until after I was 40 years old. I would have started saving from the beginning. If I'd done that, I would have incredible freedom now because my financial worries would have been taken care of.''
Shift from High-Interest Credit Cards to a Mortgage or Home Equity Loan
When you face a constant barrage of credit-card finance charges and the debt never seems to go down, it can be hard to squeeze out a monthly contribution to your retirement account. That's why sometimes the first step toward building up your savings is to pay off the credit cards--or come up with a plan that allows you to reduce the debt and save for retirement at the same time.
At 49, David was a self-employed lawyer with about $100,000 in credit-card debt. About $10,000 was on a card that charged 14.9% annually. The rest was on cards with finance charges of 17%. A divorced father who has custody of his son, David had piled up the debt after a costly divorce settlement, buying out a business partner, and paying bills his ex-wife had incurred from TV shopping channels.
That left him stuck trying to pay off the debt, create a college fund for his 10-year-old, and add to the $120,000 he had put into Keogh and IRA retirement accounts. These goals were not easy to achieve, because his income fluctuated widely--from $17,000 in one recent year to $150,000 in 1999.
A financial adviser recommended two steps David could take to reduce his monthly expenses: First, wrap some of the credit-card debt into a loan that would refinance his house. Then, consolidate the remaining debt on cards with lower rates.
David owed about $125,000 on his mortgage and was paying a rate of 7 7/8% per year. When he asked his bank for refinancing, the answer was: ''When you originally got this mortgage, you had two incomes. But now you're single, and you're an entrepreneur with a sole proprietorship.'' They considered it too risky to give him the new mortgage. The second mortgage company David approached had a very different attitude: ''We know that if you default on this loan, you'll lose your license'' to practice law, they said, so they didn't see him as a serious risk. Within a month, he had increased his mortgage to $195,000. The house was worth well over $200,000, so the lender allowed him to wrap $70,000 of credit-card debt into the new mortgage, which he pays at a 7 3/4% rate.
The next step was to reduce the finance charges on the other $30,000 of debt. When David called up the credit-card company, he asked for a 9.9% rate, which he knew they were offering. To his surprise, they offered to guarantee him that rate ''in perpetuity.''
Just two or three years before, David seemed to be mired in financial disaster. Although he had a nice start on building up retirement savings, his debts were so high that he couldn't imagine taking money out of cash flow to save for the future. But by refinancing the house, wrapping in some of the credit-card debt, and getting a lower rate on the remaining debt, ''I've reduced my out-of-pocket expenses by about $1,500 a month,'' a tidy $18,000 a year. With the divorce and changes in his business completed, David's earnings went way up in 1999, enabling him to pay off $15,000, or half of his remaining credit-card bills, and to fully fund his son's college education by contributing to a program offered to residents of his home state.
David is reaping yet another bonus: a much lower tax rate in a year when his income was high. That's because the credit-card interest shifted to the mortgage is now deductible, as are the large costs he spent on dissolving his business partnership. And now, after years of uncertainty and crisis, David is in a position to use his higher earnings to catch up on contributions to his retirement account--instead of on finance charges to credit-card companies.
Retire in a State with Low Property and Income Taxes
While we're working, we may grouse about paying taxes but not put much effort into reducing them. But when the time comes to retire, and income tends to flatten out, taxes become a much bigger factor in your budget. The couple in this story did not focus on choosing a low-tax state when they first retired. But their story shows how you may not need to play as much catch-up with your savings as you thought if you're willing to move to a state where you can reduce your annual tax bills by several thousand dollars.
Norma and Brent, now 67 and 70, respectively, made a snap decision to retire to a town in North Carolina in 1985. His work with a U.S. government agency had taken them to live in various countries in Asia and Africa. They had vacationed on the coast and in the mountains of North Carolina, and they found the state beautiful. ''So when we found a house we liked, we bought it and moved there,'' Norma recalls. ''But it was a mistake. We hadn't done any research, and we sort of blindly bought a house and settled in.''
Soon the negative aspects of their choice surfaced. About 17 miles from a major town, ''the little area where we lived was hardly even a village. Every time we wanted to go shopping or see the symphony, it entailed driving. And as we got older, we realized we were driving 34 miles to see a movie.''
Taxes were also a problem. ''Property taxes became a big factor. We got very little relief from the state government. And then county taxes started going up as well. We were living on a fixed income. As all these taxes increased, it meant we could afford to do less and less,'' Norma explains. They started to search in other Southern states for another retirement location--an area with a full-service golf club, which was important to Brent, as well as one with lower taxes.
After visiting venues in Texas, Arkansas, Georgia, and Florida, one day they noticed an item in a magazine about the benefits Mississippi offers to retirees. Norma and Brent admit they were skeptical at first: Their image of the state as one that lacked amenities and had widespread poverty simply did not comport with their vision of comfortable retirement living.
Nevertheless, they responded to the advertising blurb and received both written information and phone calls from volunteers who participate in ''Hometown Mississippi,'' the program designed to attract residents. ''We had a lot of questions about the medical services, the cost of living, the traffic situation, and of course the taxes,'' says Norma. One particularly attractive feature was that Mississippi exempts retiree income--including Social Security, private and government pensions, and annuities--from state income taxes.
Their interest piqued, Norma and Brent traveled to Mississippi and decided to settle in a college town that shows its respect for the older newcomers by offering, among other things, low-cost courses on topics such as computer skills and the Civil War. The sale of their four-bedroom house in North Carolina paid for another four-bedroom home in Mississippi. But the new home is ''much nicer, with a better location, and the yard is better landscaped,'' Norma says. In addition, their utility bills are about $1,000 a year lower.
What really makes a difference in their retirement budget, however, is Mississippi's low taxes. Brent estimates they are saving $2,000 a year in state income tax, and $1,000 a year on property taxes. (They pay about $825, vs. $1,850 in North Carolina.) Added to lower utility costs and a lower cost of living, the tax breaks have helped reduce financial pressure on this couple. Besides, now they only have to drive four miles to go to the movies.
This adaptation is from The Retirement Catch-Up Guide ( Copyright 2000 by Ellen Hoffman). It is reprinted by permission of Newmarket Press, 18 E. 48th St., New York, N.Y. 10017.
By ELLEN HOFFMAN
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