Sunday, January 15, 2006

personal financial planning for retirement

The first step in sound financial planning for retirement is to recognize early in life that a systematic buildup of funds is essential, and that Social Security alone is not sufficient to support a comfortable retirement. While it is never too late to begin saving for retirement-whether through a company pension plan, buying an annuity, IRA, or Keogh, or other means-ideally retirement saving should start no later than the late thirties or early forties, or sooner if possible. The average person who retires at 65 can expect to live another 20 years (about three years more for women and three years less for men), so funds set aside to provide income during the retirement years must be substantial.
Too many Americans have made the mistake of assuming that Social Security should provide their entire retirement income when in fact it was always intended that individuals should supplement Social Security with their own retirement saving plans. (People who wish to know their probable monthly Social Security income can obtain this information by contacting regional Social Security offices). Social Security makes an excellent financial foundation for retirement because it is government guaranteed and comprehensive in its coverage, but it should be realized that it replaces well below half of the pre-retirement earnings of the majority of individuals. The table on page 181 shows the percentage of a single person's pre-retirement income replaced by Social Security.
Financial advisers point out that Social Security makes a good starting point for planning retirement income because it is usually unnecessary to replace 100 percent of the income that one had prior to retirement.
Among the reasons for this are the following:
• Social Security itself, which represents anywhere from about 7.5 percent of every paycheck for employees up to about 15 percent for the self-employed, is no longer deducted from one's income. Instead of being withheld, Social Security is now paid over to the retiree.
• Other pensions contributions, either in the form of employer pension plans, personal savings, or both, which may constitute 5 percent or more of income, are no longer deducted, and, like Social Security, now become sources of income.
• Expenses related to holding a job, such as commuting and automobile costs, meals, clothing, etc., are no longer required.
• Standard deductions from income taxes may Increase.
• Residential mortgages and household expenses (buying a refrigerator, washing machine, etc.), along with childrearing expenses (school and college, family health insurance, food and clothing for dependents) are often unnecessary.
Financial experts note that living expenses, which are often at their peak during one's forties and fifties when mortgages are not yet paid off and children are in college, tend to decline in the sixties and after. They estimate that these reduced costs all together can easily mount up to 25 percent to 30 percent of the income one received during one's forties and fifties. Consequently, many retired individuals manage successfully on about 70 percent of the funds they received earlier in life.

Individuals who have maintained private savings need to estimate how much to withdraw from these annually so that their nest egg will last as long as they believe necessary- typically, this might be the 20 to 30 years that they and their spouse can expect to live. For example, if one had $50,000 in certificates of deposit at retirement, one would spend down the entire amount in little more than five years if one thoughtlessly drew out 20 percent, or $10,000, per year. Consequently, some lower withdrawal rate would normally be desirable.
But, if one has savings designed to stretch out for 10 or more years, one also needs to take into account the effect of inflation, now running at from four to five percent per year. As Peter Weaver and Annette Buchanan point out in What to Do with What You've Got, a book written under AARP auspices, the dreaded inflation monster can destroy a lifetime of careful planning for financial security in old age because the "Rule of 72" takes effect. This rule is that one divides the inflation rate into 72 to find out how soon one will have to double one's income in order to stay abreast of inflation-if one assumes an inflation rate of 4 percent per year, then one would have to double one's income in 18 years (72/4 = 18) in order to offset inflation. While Social Security offsets inflation through annual cost-of-living adjustments, inflation can be beaten in other ways. It is possible to take an inflation rate into account when estimating how long one wants one's savings to last if one assumes an inflation rate and a specific growth rate for one's savings under a definite withdrawal plan.
The chart below shows how many years one's money will last at specified withdrawal rates.
In order to get a general idea of the effect of inflation, add an assumed inflation rate to the withdrawal rate. For example, someone Besides this, annuities and certain employee pension plans provide choices of income options that allow recipients to take the effects of inflation into account. For example, a full annual payout under a plan might be $8,400 per year, but if the individual chooses to receive only $5,000 per year, then the difference ($3,400) could be reinvested to produce a higher rate of income in future years. Some public pension plans for government employees also include an annual increment that may partially offset inflation. Social Security, of course, is adjusted annually for inflation.
While financial advisers outline various ways besides saving and pension contributions to make financial ends meet in retirement (i.e., smart shopping at the supermarket, part-time or temporary employment, an eye for thrift in clothing purchases, etc.), one idea frequently proposed is to "trade down" one's home. Under this plan an individual would sell a still-mortgaged larger home that was bought to house an entire family, and purchase a smaller home with no mortgage and a lower maintenance cost. If the former home was not mortgaged, or part of the funds realized from this transaction remained after purchasing the new home, then the surplus could be invested-in securities, mutual funds, an annuity, government bonds, or other sources-to produce additional cash for retirement income. Whatever the individual's personal financial circumstances-and these vary almost infinitely-it is obvious that a well-thought-out plan for retirement income is essential. In spite of the variety of individual circumstances, attention to the few areas and principles outlined above will do much to assure a comfortable and secure retirement for most people.
Babson-United Investment Advisors. United Mutual Fund Selector. Vol. 21:12, Issue 516 (June 30, 1989).
Quinn, J. B., "Saying the Big Goodbye." Newsweek (October 9, 1989).
Luciano, L., and Fenner, E. "Having to Play Catch-Up." Money (June, 1991).
Tucker, E. "Annuity Fundamental." United Retirement Bulletin (September, 1989).

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