Five years later we have weathered the storm, but when stock prices plummeted and home values followed, we all became acutely aware of risks. It could happen again.
By Joseph Hight
Setbacks Happen
Your retirement savings are accumulating nicely when the stock market drops precipitously. Much of your retirement assets can be gone suddenly. To avoid the worse of this, stay diversified in stocks of many companies, and in bonds. Don’t panic and sell low in a downturn. Wait for the upturn that usually follows.
You lose your job. You borrow from your 401(k). Now the funds are not there to profit from a market upturn.
You have educated your kids and they are now adults. Catastrophe hits. One or more of them suffers a nasty divorce settlement, loses their job, comes down with serious illness, or needs financial help. Do you turn your back, or do you dig into your retirement assets to help, even at your own financial peril? You get hit on the other side of the generations. Your elderly parents find themselves in financial difficulty and may need help, putting stress on your own finances.
You or your spouse’s health takes a turn for the worse. Health care expenses eat into your budget. Nursing home or in home nursing care may be necessary. If you have long term care insurance, be thankful, otherwise you will need to use your own resources that you have hopefully put away for this contingency.
Back then we were horrified. Not knowing where to turn, many of us pulled 401(k) and Individual Retirement Account assets out of stocks and poured into bonds or certificates of deposit, only to suffer very low returns.
Home equity melted away. Charts at the website of the Center for Regional Analysis at George Mason University show average sales prices of homes in Northern Virginia began a precipitous decline at the end of 2007. Double digit percentage declines in sales prices of homes in the region continued throughout 2008, with declines only tapering off towards the middle of 2009.
The 2007-09 steep downturn in stocks, housing values and the economy in general was a time of deep stress.
Marjorie Fox, CEO of Fox, Joss & Yankee, a financial planning and investment firm in Reston, agrees, “It was a very difficult time.”
Stephan Cassaday, president of Cassaday & Company Wealth Management in McLean, says it was a time when you needed financial advisors with nerves of steel.
The recovery
Fortunately, the economy slowly improved and stocks rebounded. On July 19, 2013, the Standard & Poor’s 500 index was at a record 1692.09, fully 224 points higher than it had been at the end of December of 2007. As for housing, Lisa Sturtevant of the CRA at GMU says that by June 2013 Northern Virginia home prices had returned to more than 90 percent of peak levels.
Fox says that it helped to have a financial advisor. Almost all of her firm’s clients stayed invested and profited from the recovery.
Norman Kamerow, co-founder of Capital Financial Group/HBeck in Bethesda, Md. agrees. He says, “Those who used professional financial planners were whole again in eight or nine months.”
But many investors were so traumatized by the fall in stock prices during the 2007-09 downturn they never got back in the market and missed the upswing. In September 2012, Reuters reported, “Those who missed much of the rally did so because they reduced equity exposure after the benchmark S&P index plummeted 57 percent between late 2007 and March 2009.”
At press time, Congress was preparing to vote on a bill that funds the government until Jan. 15 and pays our debt until Feb. 7. A deadline of Dec. 13 for the House and Senate to work out a deal on a long-term strategy for spending and tax policies for the next decade should help American’s get their own financial houses—and retirement planning—in order.
What to do?
Cassaday says, whenever you ask a question of a financial advisor or planner, the answer will often begin with, “It depends.”
Fox says what follows—the analysis, the laying out of the pros and cons of various options and the conclusions—is the important part.
In your early 30s you have time on your side. Cassaday advises, “Start saving early, even if a relatively small amount at first. Sacrifice now in order to have significant dollars for retirement later.” That is the mantra you hear often, but it’s true.
If you are in your 40s or 50s, it is urgent to assess where you are today, to readjust plans if your savings and investments will fall short. Increase 401(k) contributions and contribute to IRAs if you are eligible.
In your 60s you should have a good idea of how and when you expect to retire, and what your retirement income is likely to be.
For those closer to retirement, Kamerow advises, “The important things to do to get set for retirement are to make sure that your financial situation is in a conservative mode and that, along with Social Security and any pension plans, you will have enough income to last your retirement years.”
How much is enough? Kamerow says retirement income equal to about 85 percent of current income is a good target.
Fox reminds us, “It depends.” Some clients may need more in retirement than when they were working. What if they have an agenda and tastes for expensive travel?, she asks.
Also, plan for higher out of pocket health care expenses in retirement.
Cassaday says Medicare doesn’t cover everything. There will be co-pays and deductibles that are likely to keep rising faster than the rate of inflation, and expenses that may not be covered at all, such as hearing aids, eye care, care from chosen specialists and optional health treatments. Kamerow echoes the sentiment, “Health care expenses have to be figured in, and increases each year are to be expected.”
A big concern is the increasing cost of nursing care. Long-term care insurance should be considered. Fox says long-term care insurance should be carefully compared to the option of self insurance for those with the financial means. She adds that often a client who could profit from long-term care insurance ends up not being insurable because of existing health issues.
Should you avoid all risks in your investments as you approach retirement? Cassaday says it is a misconception that those who are close to, or who are already in their retirement years, should avoid all risks. Even then, he says one should count on the higher average returns on stocks to help protect against inflation. In his 36 years in the business, Cassaday says he has yet to have a client call and say that she needs all of her money now. Instead, they typically withdraw sums over time and can weather the downturns in the market by temporally drawing smaller sums and then profit when the market turns up again.
Social Security as a base
Social Security is an important part of retirement planning. At the Social Security web site, ssa.gov, create a personal account by clicking on the ‘my Social Security’ tab. Once you have an account, access your Social Security earnings records to get an estimate of your future Social Security retirement benefits. The estimate will account for your earnings thus far and a projection of future earnings based on past earnings. It assumes that the current Social Security law remains intact.
At the beginning of 2012, the average monthly Social Security benefit was $1,230. The maximum monthly benefit in 2013 was $2,533. Monthly benefits are inflation protected, increasing as the cost of living increases. There have been proposals that may reduce the amount of future inflation adjustments, but none of these suggestions would do away with inflation adjustments entirely.
For most of us, Social Security should not be counted on to be enough. It will need to be supplemented with other sources of retirement income.
Defined Benefit Retirement Plans
Defined benefit plans, usually referred to as a pension, offer a retirement benefit that is based on years of work for the employer. They are rarer than in the past, so unless you are a senior worker who has worked for one employer for most of your career and are now close to retirement, chances are you are not covered by one. They are also more prevalent for teachers, career military and law enforcement and other public sector employees who work for government. If you are covered by a defined benefit plan, pay attention to how the promised benefit amount is determined, how much you are likely to get, and start thinking about how you will supplement that from other sources.
The 401(k)
No matter your age, know the ins and outs of the 401(k) plan offered by your employer. Study the investment options your plan offers. If you need help in choosing your options seek it out at your human resources office at work, or from the administrator of the plan, and consider seeking advice from a financial advisor or planner.
Contribute to your 401(k) so as to at least maximize the matching contribution from your employer if there is one, otherwise you are passing up free money.
Consider maximizing your 401(k) contribution to the amount allowed to you by the Internal Revenue Service. In 2013 the maximum annual amount an individual could contribute to a 401(k) was $17,500 ($23,000 for those over age 50). You don’t pay current income taxes on 401(k) contributions; you pay the taxes as you withdraw funds during retirement. In the meantime, all your money in the account earns a tax-free rate of return.
If you change employers don’t pull funds out your 401(k). You can keep them in your former employer’s plan, but it may be best to transfer them to your new employer’s plan in order to consolidate your the money in one place. But before doing so you may want to compare the pros and cons of the plans, as all 401(k) plans are not equal, especially regarding the number and variety of investment vehicles offered. But Cassaday says it is an advantage to consolidate. It will be easier to keep track of your retirement savings and decreases the chances of a mistake.
It is possible to borrow money from your 401(k) if you get into financial difficulty, but for the sake of your retirement, avoid this if at all possible. Cassaday offers point blank advice on this: “Don’t do it. Get it into your head that the money is sacrosanct. Never, never get at it.”
Helen Modly, executive vice president of Focus Wealth Management, Ltd. in Middleburg, advises that one advantage of 401(k) funds over IRAs is that early retirees can begin taking distributions from 401(k) funds as early as age 55 without a 10-percent penalty, while withdrawals from traditional IRAs are subject to the early withdrawal penalty beginning at age 59 and a half.
Those who work for government or non-profits usually have access to 401(b) plans, but the rules for these are similar to those for the 401(k)s.
Individual Retirement Accounts
IRAs allow more self-directed investment options for your money than do 401(k) plans offered by employers. Find out if you are eligible to put money into an IRA and whether your contributions to a traditional IRA will be tax deductible. Even if you don’t meet the conditions for tax-deductible contributions to a traditional IRA, the taxes on the earnings from those contributions will be tax deferred. You won’t have to pay taxes on them until the money is withdrawn in retirement. The rules having to do with IRA eligibility can be complicated, so you may need to contact a tax or financial advisor. If you use a tax filing service, a tax advisor, or even tax filing software, you will often get help about your IRA eligibility from these sources when filing your tax returns. But if in doubt, check with a financial advisor or planner.
Some small employers who don’t offer a 401(k) plan may offer their employees a SIMPLE IRA. It can act very much like a 401(k) with contributions via deductions from your pay check. It may even come with employer matching contributions.
As an alternative, or in addition to a traditional IRA, consider investing in a Roth IRA, especially if you are not eligible for tax-deductible contributions to a traditional IRA. Unlike a traditional IRA, contributions to a Roth IRA are never tax deductible, but also unlike a traditional IRA, withdrawals from a Roth IRA can be tax free and they can be withdrawn before retirement without the 10-percent penalty. Again, the rules, and the pros and cons, can be complicated for all of these options.
The new retirement age
Dallas Salisbury, president and CEO, of the Employee Benefit Research Institute, said in a March 2012 interview with Joseph Coombs of the Society for Human Resource Management that data from EBRI retirement confidence surveys show an increasing intention to work longer. Between 2006 and 2010 the proportion of workers 50 and over saying they planned to retire before or at age 62 continued a steady decline, reaching 7.9 percent in 2010. The proportions of those planning to retire at ages 70, 75 and 80 continues to climb.
A June 2013 report of the University of Michigan Institute for Social Research agrees, stating there’s no question that the average age of retirement in the U.S. is rising. The report’s data show that close to 24 percent of men aged 70-74 still work, and one-in-three men aged 65-69 are still on the job. Women are staying in their jobs longer, as well. More than 14 percent of women aged 70-74 are still employed, and one-in-four women aged 65-69 currently work.
If you want to save more before retirement, and you enjoy what you are doing and are thinking of working longer, you are not alone.
But plan, plan, plan.
(November 2013)