Ask Liz Weston

Get smart with your money

retirement savings

Can’t afford to save for retirement?

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Dear Liz: Is it reasonable for a 50-year-old single man helping with support of a teenage child and earning a steady $35,000 a year to save for his retirement? Rent alone takes $800 a month; food, car and health costs leave little discretionary money.

Answer: Can you reasonably expect to live on Social Security alone? If making ends meet now is a strain, imagine trying to get by on about $1,230 a month (which was the average Social Security check in 2012). Your check could be higher or lower; you can get an estimate at http://www.ssa.gov/estimator.

If you can’t scrape by with whatever Social Security offers, then you need to find a way to save. You should be able to increase your savings once your child support ends, but you should get started now.

Don’t tap retirement funds to pay kids’ student loans

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Dear Liz: I’m in my 50s. My kids have college loan debts that might total more than $200,000. I allowed them to take out loans because I expected to inherit $300,000 to help them pay off the debt. Now that inheritance will not happen.

I have $250,000 saved for retirement. When I’m 58 1/2 years old, I would like to pull that money out and pay some or all of these debts. Or use home equity. I’ve recently been downsized in employment, but I am looking to increase my income so I can help with their debt. Advice?

Answer: If your goal is to impoverish yourself so your kids will have to take care of you in your old age, by all means proceed with your plan. Otherwise, you need to rethink this.

You’ve been laid off in the middle of what should be your peak earning years. Older workers often have a tougher time than younger ones finding replacement jobs, even in a better economy than this one. You may not be able to replace your former income, which means you may not be able to add much to the amount you’ve already saved. You should be conserving your resources, including your home equity, and not squandering it repaying debts that aren’t yours.

And “squandering” is the right word. You may be able to avoid paying federal and state tax penalties on withdrawals under certain conditions; distributions made after age 59 1/2 avoid the penalties, as do those made if you’re “separated from service” if the job termination occurred in or after the year you turn 55. But you’ll still owe income taxes on the withdrawal, and those can be considerable.

Your children are the ones who will benefit from their educations. Those educations should allow them to earn incomes to repay these loans. The amount of debt they’ve accrued might be excessive — you didn’t specify how many kids, or whether this debt is being incurred pursuing undergraduate or graduate degrees. Ultimately, though, they will be in a better position to pay the debt than you are.

If you promised them help you can’t deliver, sit down with them now to break the bad news and strategize on how they can finish their educations without incurring substantially more debt.

Your story also should serve as a cautionary tale for anyone counting on an inheritance to pay future bills. Until the money is in your bank account, it’s not yours and shouldn’t be part of your financial planning.

Should you take a lump sum now or an annuity check later?

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Dear Liz: My former employer is offering the one-time opportunity to receive the value of my pension benefit as a lump-sum payment. The other option is to leave the money where it is and get a guaranteed monthly check from a single life annuity when I reach retirement age. I am 40 and single, and I have been investing regularly in a 401(k) since graduating from college. I have minimal debt aside from a car payment. When does it make financial sense to take a lump sum now instead of an annuity check later?

Answer: Theoretically, you often could do better taking a lump sum and investing it rather than waiting for a payoff in retirement. That assumes that you invest wisely, that the markets cooperate, that you don’t pay too much in investing expenses and that you don’t do anything foolish, like raid the funds early.

That’s assuming a lot. Another factor to consider is that the annuity is designed to continue until you die. It’s a kind of “longevity insurance” that can help you pay your bills if you live a long life.

Some financial advisors will encourage you to take the lump sum, since they may be paid more if you invest it with them. Consider consulting instead a fee-only financial planner who charges by the hour — in other words, someone who doesn’t have a dog in this particular fight. The planner can walk you through the math of comparing a lump sum to a later annuity and help you understand the consequences of both paths. This is a big enough decision that it’s worth paying a few hundred bucks to get some expert advice.

Working longer means more money overall

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Dear Liz: You’ve been answering several questions about when to start Social Security benefits. Most people who talk about the break-even point seem to fixate on when you’ll end up with the most money, but they’re only considering Social Security money. It’s worth pointing out that if one continues to work until full retirement those wages, for most of us, will add up to much more than the reduced Social Security payments for those first four or five years. So unless a person really hates his or her job, or poor health makes the person no longer able to do that job, working until age 66 or 67 will give a person the highest total.

Answer: That’s a good point, and it’s not just the wages you earn that are important. It’s the fact that you can delay tapping your retirement savings, so that those can continue to grow tax deferred. The effect of delaying retirement even a few years is so powerful that people who have saved substantially over their working lives can actually stop saving in their 60s — and use the extra cash for fun stuff like travel — without increasing their risk of running out of money, according to research by mutual fund company T. Rowe Price. The company has dubbed this approach “practice retirement,” and you can read more about it at http://www.troweprice.com/practice.

Is a 3% withdrawal rate too conservative?

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Question: In a recent column you repeat advice I have often read that withdrawing about 3% of my investment capital will reduce the chances of my running out of money in retirement. But that doesn’t make sense to me. I have been retired for over 19 years and I have sufficient data now to extrapolate that I could live for 100 more years with so meager a drawdown because, through good and bad times, my earnings after inflation and taxes always exceed 3%. If I am missing something, I must be extraordinarily lucky because it hasn’t hurt me yet, and at age 77 I think it unlikely to do so in my remaining years. Can you explain this discrepancy between my experience and the consequences of your advice?

Answer: Sure. You got extraordinarily lucky.

You retired during a massive bull market, which is the best possible scenario for someone who hopes to live off investments. You were drawing from an expanding pool of money. Your stocks probably were growing at an astonishing clip of 20% or more a year for several years. Although later market downturns probably affected your portfolio, those initial years of good returns kept you comfortably ahead of the game.

Contrast that with someone who retires into a bear market. She’s drawing from a shrinking pool of money as her investments swoon. The money she takes out can’t participate in the inevitable rebound, so she loses out on those gains as well. All that dramatically increases the risks that she’ll run out of money before she runs out of breath.

It’s the first five years of retirement that are crucial, according to analyses by mutual fund company T. Rowe Price, which has done extensive research on sustainable withdrawal rates. Bad markets and losses in the first five years after withdrawals begin significantly increase the chances that a person will run out of money during a 30-year retirement.

Some advisors contend that a 3% initial withdrawal rate, adjusted each subsequent year for inflation, is too conservative. If you retire into a long-lasting bull market, it may well be. But none of us knows what the future holds, which is why so many advisors stick with the 3%-to-4% rule.

Most investors under 50 plan to work in retirement

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A new T. Rowe Price survey shows seven out of 10 investors aged 21 to 50 plan to work at least part time during their retirement years, and most (75%) will do so because they want to stay active. Only 23% expect to work out of necessity, because they won’t have saved enough.

T. Rowe Price has been surveying the investment practices of Generation X (defined as people aged 35 to 50) and Generation Y (ages 21 to 34).  Harris Interactive conducted the poll in December, surveying 860 adults aged 21-50 who have at least one investment account.

Gens X and Y are following in the path of the Baby Boomers, a majority of whom have told pollsters over the years that they plan to continue to work. The percentages who expect to do so by choice vary with economic conditions, but the polls show a new vision of an active retirement has emerged, said Christine Fahlund, CFP®, senior financial planner with T. Rowe Price.

Continuing to work into your 60s, if you can do so, can have hugely positive effects on your finances as well, even if you cut back on saving for retirement.

From T. Rowe Price’s press release:

“We believe that beginning to incorporate more leisure in your 60s, when you’re still likely to be in good health can be a fun way to make the transition from work to retirement easier,” she added.  “By working a little longer and playing, investors can maintain earned income to fund their activities, hold off on tapping their nest eggs earmarked for retirement, and defer taking Social Security payments.  Delaying Social Security, in particular, positions people to have potentially considerably higher guaranteed payments – adjusted annually for inflation – for the rest of their lives.”

If you want to read more about how you can work longer and have fun, too, read “Retire without quitting your job.”