Ask Liz Weston

Get smart with your money

Retirement

Who should save 10%

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Dear Liz: I often hear financial planners say you should save 10% of your income, but they don’t go into exactly what that means. Is that 10% separate from retirement or including retirement? Does that include saving for your emergency fund? Is this just archaic advice now? I’m 46 with only $40,000 saved for retirement so I’m in the panic mode that I will never be able to save enough for retirement.

Answer: Saving 10% for retirement is often considered a minimum for those who start saving in their 20s. The older you are when you begin, the more you’d need to save to match the nest egg you would have accumulated with an earlier start. That means saving 15% to 20% if you start in your 30s, 25% to 30% if you start in your 40s, and 40% of your income, or more, if you don’t start until your 50s.

Clearly, the wind is at your back when you start saving young. It starts blowing pretty hard in your face if you wait.

If you can’t carve out a huge chunk of your income for retirement, though, you shouldn’t despair. Save what you can, as anything you put aside will help supplement your Social Security checks. You may find that your expenses drop substantially in retirement, particularly if you have a mortgage paid off by then, so you won’t need to replace as much income as you think.

Another technique for coping with a late start is to work longer. That gives you longer to save, but it also allows your savings — and your Social Security benefits — more time to grow. You will be able to claim early Social Security benefits at 62, but you’ll be locking in a smaller check for life. It’s usually better to wait until your full retirement age, which will be 67, to begin benefits, since each year you wait adds nearly 7% to your check. If you wait three more years, until age 70, your check would grow by 8% each year. That’s a guaranteed return unavailable anywhere else.

One way around early withdrawal penalties

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Dear Liz: My son is 52 and has been unemployed for three years. He has been forced to withdraw money from his 401(k) and pay early withdrawal penalties on it to pay his mortgage and other bills. Is there such a thing as a hardship exception to avoid this tax bill?

Answer: There’s a way to avoid the 10% federal penalty, but not income tax, on early withdrawals from retirement accounts when someone is under 591/2 (the usual age when penalties end). The distributions must be made as part of a series of “substantially equal periodic payments” made using that person’s life expectancy. When these distributions are taken from a qualified retirement plan, such as a 401(k), the person making them must be “separated from service” — in other words, not employed by the company offering the plan.

Your son wouldn’t be able to withdraw big chunks of his savings, however. Someone his age who has a $100,000 balance in a retirement plan could take out about $3,000 per year without penalty. Revenue Ruling 2002-62, available on the IRS site, lists the methods people can use to determine these periodic payments. If he might benefit from this approach, it would be smart to have a tax pro review his calculations.

No match? Save anyway

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Dear Liz: Lately I have been reading a lot about how people aren’t saving enough for retirement. Every article I read talks about the need to put enough into employers’ 401(k) programs to get the maximum possible company match. What do you do when your employer doesn’t match your contribution?

Answer: You contribute anyway, and start looking for a better job.

The advice that people should contribute at least enough to get the maximum match is designed to ensure that workers don’t leave free money on the table. That’s essentially what a match is — a free, instant return on your contributions.

Maximizing the match doesn’t mean you’re contributing enough for a comfortable retirement, however. The match may be 50 cents for every dollar you contribute, but most companies won’t match more than 6% of your salary. Most people need to save more than that — sometimes much more, especially if they got a late start.

If your company’s 401(k) doesn’t offer a match, then you will need to save more to make up for the free money you aren’t getting. Because most plans offer a match, though, it may be worthwhile to look for an employer that offers this benefit as it can make retirement saving easier.

To figure out how much you need to save, use a retirement calculator such as the one at the AARP.org website.

How couples can agree on a retirement plan

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Dear Liz: My husband and I are 56. We need to plan for retirement, but whenever the topic comes up, I find that either we have no idea or we disagree on what we will do during our retirement. Naturally, our activities during retirement will affect the funds we will need. We need help to figure out the things we agree on and where we might want to plan for different individual options. Do you have some resources to suggest?

Answer: You can start with a visualization exercise that some financial planners use to clarify their clients’ values.

Imagine your ideal day in retirement. Start with when you’ll wake up and where — what type of dwelling and in what area. In your mind, walk through your day hour by hour — where you’ll be, what you’ll be doing and with whom. Write it all down, even if you don’t think what you’re visualizing is realistic or even possible. The point is to identify, for yourself and your partner, what’s most important to you: what you want your life to be like and whom you want in it. If you visualize waking up in Paris, for example, it doesn’t mean you need to move there. You may be just as content with a trip to the City of Light or travel to less-expensive destinations.

You each should do the exercise separately and then compare what you’ve written. Don’t despair if you visualize yourself on the Champs-Elysees and he’s fishing off his back porch. As you correctly note, you can have different goals and desires for retirement. Complete harmony has never been a requirement of staying married, and that won’t change when you quit your jobs.

Let’s say you want to get deeply immersed as a volunteer for a local, at-risk school, and your husband wants to spend a year roaming the country in an RV. He could opt to pursue other interests during the school year, and you could take extended trips together during the breaks.

Once you’re clearer about what you want for your retirements, you can start working the numbers and figuring out compromises that work for both of you. Start with your expenses — what you’re spending annually now — and subtract any costs that will disappear or substantially diminish when you retire (such as commuting expenses and work clothes). Add in the amounts you’ll need to pursue your passions. (Will you buy the RV used or new? In retirement or before? Tip: Buying a lightly used vehicle before retirement will give you both a chance to get the hang of RVing and its costs so you can decide whether it’s really for you.)

Compare your expected expenses with your expected income, including Social Security, any pensions and withdrawals from your retirement accounts (which initially should be just 3% to 4% of the total balance, planners say). If there’s a gap, that’s what you’ll need to fill in the coming years with increased savings.

Still at an impasse? Hire a fee-only planner who has experience in “life planning,” or helping clients figure out their life goals. You can get a referral from the Kinder Institute of Life Planning at http://www.kinderinstitute.com/dir/.

Putting off retirement savings is an expensive mistake

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Dear Liz: I have about $16,000 in student loans at 6.8% interest. At the current monthly payment it would take me about 7.5 years to pay them off. I contribute 10% of my income to my company’s Roth 401(k) plan (my employer matches the first 6% contributed). I also contribute 3% to the stock purchasing plan. I am thinking of cutting back my 401(k) contribution to 6% and not contributing to the stock purchasing plan. Applying the extra money to my loans would reduce the payback period to about 2.5 years. After that, I would increase the contribution amount and diversify with a Roth IRA as well and maybe even begin the stock purchase program again. What do you think?

Answer: Not contributing to retirement accounts is usually an expensive mistake. The younger you are, the more expensive it can be.

Every $1,000 not contributed to a retirement plan in your 30s means about $10,000 less in retirement income. That assumes an average annual growth rate of 8%, which is the historical average for a stock-heavy portfolio.

In your 20s, the cost of not contributing that $1,000 is $20,000 of lost future retirement income. The extra decade of not getting those compounded returns makes a big difference.

People have the erroneous idea that they can put off retirement savings and somehow catch up later. Catching up, though, becomes increasingly difficult the longer you wait. A better approach is to save as much as possible starting in your 20s when the money has the longest time to grow. Then you’ll be in a better position to withstand job losses or other interruptions of your ability to save. If those setbacks don’t happen, you’d have the option of retiring early.

Granted, your plan would require reducing retirement contributions for just a few years. But the federal student loans you have are fixed-rate, tax-deductible debt that you don’t need to be in a hurry to pay off. In the long run, you’d be much better off boosting your retirement contributions.

If you’re determined to pay down your loans, however, use the money you’ve been contributing to the stock purchase plan. Continue making at least a 10% contribution to your retirement plan and increase that as soon as you can.

How to start Roth IRAs for your kids

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Dear Liz: I would like to start a Roth account for each of my kids. (They’re in their 30s.) Is it better to start an account in my name with them as beneficiaries or to start the accounts in their names?

Answer: Roth IRAs can be a wonderful way to save, but they’re not custodial accounts. You won’t be able to control the accounts or prevent your adult children from spending any money you deposit.

If you still want to help, though, let your kids know you’ll contribute to any Roths they set up. They can open a Roth if they have earned income at least equal to the annual contribution and their incomes are below the Roth limits. The ability to contribute to a Roth phases out between $178,000 to $188,000 for married couples in 2013 and from $112,000 to $127,000 for singles.

Ideally, you’ll contribute to your own Roth first. The limit on contributions is $5,500 this year.