Preparing for Retirement, Decade by Decade
Planning for retirement is a universal concern, but it means something completely different to a 20-something than it does to a 50-something. As people go through the stages of their lives, their priorities change, and so do their economic realities.
Want proof? Look at the increasing popularity of the target-date retirement fund. You pick a fund that matches the year you want to retire, and the fund’s managers automatically shift your asset allocations over the course of your working life. Your portfolio slowly morphs from risky to conservative, from growth-producing to liquid-income-generating, to match your changing needs over time.
But this innovation is no substitute for active management of your retirement strategies. In every decade of your life until you actually retire—or until you do whatever you’re going to do instead of retiring—there are wealth management issues that should command your attention.
Participate in your employer- sponsored retirement fund.
Americans are living longer and can now expect to spend up to 30 years in retirement, says Bill Benjamin, CEO of U.S. Bancorp Investments, Inc., in Minneapolis. The easiest way to jump-start that nest egg is to take advantage of years of compound interest. So it’s important for young adults entering the work force to start saving right away. “Early contributions to IRAs and company-sponsored 401(k) plans are terrific ways to get started,” he says.
Joe Brummel, director of retirement plan consulting at Wealth Enhancement Group in Plymouth, agrees. “When you get that enrollment invitation for your 401(k) plan and you’re in your 20s, don’t set it on the edge of your desk at home,” he says. “It will get lost, and years will go by, and you’ve missed out on your opportunity to better prepare for your retirement using marginal decisions.”
Max out the match.
Many employers offer a dollar-for-dollar match on 401(k) or 403(b) contributions up to, say, 5 or 6 percent. Young people in their first job may think they can’t afford to save that much, but they should think again, says Steve Marsich, senior vice president and managing director for BMO Private Bank in Minneapolis.
“If they put 5 percent of their income in, they essentially get a 100 percent return while taking no risks in the market,” he says. “Probably the biggest piece of advice for those who are just starting out and getting their first job is to pay attention to your employer’s retirement plan and make sure you’re not passing up free money.”
At the same time, Brummel says, if you can save more than the amount that is eligible for your employer match, you definitely should. “Don’t be biased by a figure that has nothing to do with you personally being able to retire someday,” he warns. “What you need to do is look at how much you personally need to save to get to that financial freedom of retirement. The minimum I suggest to people is 10 percent.”
Take advantage of your tax bracket.
In many cases, retirement plans are available in either traditional (taxed at retirement) or Roth (taxed at the time of contribution) form. Often 20-somethings benefit from choosing the latter, because they’re probably in a lower tax bracket now than they will be when they retire. They’ll end up paying less overall, and they’ll be happy to have that money tax-free when they’re older.
“I think the Roth is a good thing to consider early on,” says Sharon Olson, principal at Olson Wealth Group in Bloomington. “The tax deduction is less important in a lower tax bracket; but also, you have all those years for the money to accumulate compounding interest return. The more you can invest or maximize, the better.”
Develop good habits.
“Clients in their 20s will typically have cash management issues,” says David Kuipers, private banking group manager and senior vice president at Associated Bank in Minneapolis. Many carry significant student loans or other debts, and they may be trying to purchase a car or even a home.
“Live within your means, not on credit,” advises Marcia Urban, a senior financial planner at Abbot Downing in Minneapolis. “Yes, you want to pay down that debt. But the first thing to do is establish a savings habit.”
Olson adds that the 20s are the time for young professionals to establish a good credit rating. “The way to do that would be by having a credit card in your 20s that you’ve been diligent about, that you’ve paid off regularly, haven’t missed any payments,” she says. “That certainly helps when you go to look for financing for a home.”
Buy a term life policy.
When people are in their 20s, it rarely makes sense for them to buy life insurance, because they often don’t have a mortgage and haven’t started a family. But as soon as that changes, a term life insurance policy becomes a good idea.
“They should be looking for the wealth-replacement term type of insurance, where they can make sure that their family is protected,” Marsich says. “Term life insurance is as inexpensive as it’s ever been because of changes in mortality. [It’s] a very inexpensive way to ensure that if, God forbid, something happened, your loved ones are protected.”
Insure your ability to work.
Olson says the 30s are also a good time to look at long-term disability insurance—coverage that protects your income if you are unable to work. It may be even more important than life insurance, since the chance of becoming disabled during this period of life is between 30 and 65 percent greater than the chance of actually dying.
“Often companies will offer these plans,” she says. “What you want to look at with a disability insurance policy is how they define disability. You want the most liberal definition. Some definitions will say as long as you can be employed in some fashion, you are not considered disabled. We look for policies that would insure your [ability to work within your] own particular occupation or your specialty.”
Visit a lawyer.
Getting married and having children are both major life events that should trigger a visit to a lawyer. “If people get married, we always recommend a prenuptial agreement,” Olson says. “Even though there may not be a lot of money at the beginning, given the fact that the risk [of divorce] is at least 50 percent according to statistics, it makes sense to plan on what you would like to have happen in the event that you died or the relationship broke up.”
It may not seem important now, she says, but people often experience a huge growth in net worth during their 30s. And frankly, the risk of divorce is much higher than many other risks that people insure themselves against. Similarly, she says, people who have children should establish a will or a trust.
“Generally, the will appoints a guardian for your kids. And then also look at beneficiaries on your IRAs and things like that,” she explains. “Younger people may still have their parents as beneficiaries to their 401(k) or their life insurance. Sometimes after divorces, it’s ex-spouses. So just make sure that you’re keeping on top of those beneficiary designations.”
Knock out your debts.
Retirement isn’t just about assets; it’s just as critical to manage liabilities. While people in their 20s are just starting their careers and may not have had enough resources to pay off their student loans, people in their 30s may have more wherewithal. If that’s the case, now is the time to double down, both by devoting more discretionary money to the debt and by managing interest rates.
“Take a look at your sources of lending,” Marsich says. “We find people that might have bought a car and they’re paying 8 percent on a car loan. Now that they’re in their 30s, they’ve accumulated a bit of net worth, they’ve funded their retirement plan, they hopefully have built some equity in their home. Consider using that equity to pay off those higher-interest loans.”
Keep some assets liquid.
Not everyone has more money in their 30s than they did in their 20s. Some may have far more weighty obligations because of family and home ownership, and may struggle to finance purchases such as cars and furniture. So even though Olson recommends continuing to fund retirement plans at the highest level possible, she also recommends channeling some money into vehicles that can offer short-term liquidity.
“You do need some funds available to fund an objective or a goal,” she says. “Because today interest rates are so low, it’s really hard to find a good return on short-term assets. There are ultra-short-term bond funds and ultra-short-term municipal bond funds. There still is some risk to principal with those, because when interest rates go up, the value of bonds may go down. But the risk is lessened when you have shorter-term bonds. They pay you less, but the risk is less also. But if you have just, say, three years before that [purchasing] goal, that may be a good consideration.”
Save for college.
Depending on how early they have children, some people may have to start socking away money for their children’s education as early as their 20s. But one thing’s for sure—by the 40s, the situation is starting to become critical.
People in their 30s and 40s should seriously consider 529 plans “because there are serious tax benefits,” Marsich says. “You’re going to have to pay for college anyway, so you want to find the most economical way. And 529 plans function similar to retirement plans in that you can fund them on a monthly basis with as little as $50. It comes right out of your checking account.”
Revisit and revise.
Legal documents have a way of becoming increasingly out of touch with reality as time goes on. The 40s are a good time to go back to the lawyer’s office, take another look at them, and make sure they’re up to date.
“In the real world, laws relating to gift and estate taxes are constantly changing,” Benjamin says. “And there are complexities that go well beyond having an up-to-date will. Beneficiary designations on retirement plans, for example, should be current. Assets need to be properly titled. The ultimate goal is to maximize the amount transferred to intended beneficiaries, while minimizing tax and probate impact. Failure to properly plan for the efficient transfer of assets can cost beneficiaries thousands of dollars and perhaps much more. Ignoring changes in estate and gift tax laws can be just as costly.”
People in their 40s should also still be making regular contributions to their retirement plans. This is a good time to make sure their asset allocations haven’t gotten out of whack.
“I think people don’t rebalance their portfolios [often enough],” Olson says. “If you set out to have a 50-50 split between stocks and bonds, and then you have a great year in the stock market, all of the sudden you’re not 50-50 anymore; you might be 60-40 or 70-30, and you’re taking on more risk than you thought you were.” She suggests investors check in with their financial advisors as often as quarterly to make sure their portfolios are still optimally distributed.
At age 50, Americans become eligible to put extra money in their 401(k)s, 403(b)s, and IRAs. Marsha Urban strongly suggests that her clients take advantage of the ability to make these catch-up contributions, especially if they’re not on track to fund their retirement years as comfortably as they would like. “Re-evaluate when you think you want to retire, where you are currently, and how your investments are performing,” she suggests. “If you aren’t on track, take advantage of any of those catch-up opportunities that you can. This year, the 401(k) regular contribution is $17,500, but people over 50 can add another $5,500. To the extent you have the wherewithal to take advantage of that, it can help significantly.”
Prepare for long-term care.
About 70 percent of Americans who reach age 65 are expected to need some type of long-term care, but only 7 percent have done any planning to prepare for it, says U.S. Bancorp’s Bill Benjamin. Considering that in 2012, the national average cost of a semi-private room in a nursing home was $81,000 annually, that can quickly wipe out an otherwise secure retirement nest egg.
“I’d say right around 50 is when you should consider long-term care insurance,” says Brummel. “But [the timing] has to do with hereditary health. So if there’s diabetes in the family, people might want to consider it earlier rather than later, because no insurance company will take you if you’re suddenly diagnosed.” So why not go ahead and buy long-term care insurance earlier? After all, insurance is cheaper when you’re younger, right? Well, yes, but Olson says it’s a matter of what’s important and when. People don’t have infinite money to fund infinite objectives.
“The probability of going into a nursing home that early, or needing that kind of care that early, is pretty low,” she explains. “People have certain life cycles. They’re concerned with other things initially, until their kids possibly are through college. Then they start thinking about retirement and long-term care. If you could do it earlier, great, but you have to balance your priorities.”
In fact, because of changes in priorities, people in their 50s may find they don’t really need their term life insurance policies as much anymore. Maybe their house is paid off and their children are no longer dependent on them. Marsich says these folks may benefit from new products that allow consumers to exchange a life insurance product for a long-term care product. There are also more flexible plans that allow purchasers to use their insurance funds in different ways depending on how their lives pan out.
“It used to be that you paid in a monthly amount and that bought a certain amount of long-term care, but if you never used it, you lost it,” Marsich says. “They have products now that you can pay a one-time lump sum, and if you never use it for long-term care, it goes back to your beneficiaries as a life insurance payout. If you ever want the money back, you can actually get the money back out of these policies. It’s in response to the baby boomers not being satisfied with the traditional long-term care policies.”
Ponder your health insurance costs.
The 50s are also an ideal time for people to scope out the health insurance horizon and make sure they’ve set aside enough money to purchase supplemental health insurance during their retirement years. “We’re not exactly sure where all the health care laws will go, but [right now] it’s very expensive,” Urban says. “In your 50s, you’re a little bit closer to knowing what the health care costs will be, because you’re closer to actually retiring. You might be able to look online and see, without preexisting conditions, how much does it cost a 65-year-old man or woman to get health insurance on an exchange that has certain types of coverages?”
Do the math.
Americans are increasingly skeptical about whether Social Security will still be available when they retire. That sometimes means they make irrational decisions about when to start receiving payments. “We find that people just take it as soon as they can get it, because they don’t think it’s going to be there,” Marsich says. “But that’s not always the best approach.”
Individuals can choose to begin receiving Social Security benefits any time during the eight-year window between their 62nd and 70th birthdays. But the earlier benefits begin, the lower the monthly payout will be. For example, a person who qualifies for $1,000 a month at “full retirement age” (66) would receive only $750 a month if she started receiving payments at age 62. If she waited until age 70, she’d get $1,320 a month.
The best decision depends on a number of factors, including hereditary longevity. Marsich suggests people in their 60s discuss the issue with their advisors or use an online Social Security calculator.
Plan your paychecks.
The 60s are a good time for a last-minute reality check. At this time of life, investors will be converting their portfolios into vehicles that can provide them with a monthly paycheck. But Olson says it’s a good idea to run the numbers one more time before taking the leap.
“Go back and look at your budget,” she says. “There are all of these statistics that say you need 75 or 80 percent of what you were making when you were working. But I don’t like those at all. I feel like every individual has their own idea of what they want their retirement to look like. So be really serious about doing that modeling so you know where you are in relationship to where you want to be.”
The amount in the IRA or the 401(k) may look enormous, she says, but what will it mean when it is transferred from wealth accumulation to wealth distributions? Would it be better to wait another year, or take a part-time job for a while?
“You have to look at that number,” she says, and say, “What does that mean for lifetime income?”