Retirement planning today is very different than it was 30 or 40 years ago. It is truly not your father’s (or mother’s) retirement. In fact, many people don’t even relate to the word “retirement.” Phrases like “second act,” “third age,” and “refirement” have been used to describe the stage of later life where people transition from full time work to other pursuits. Some people have even stated on surveys that they never plan to retire, period.
A few generations ago, defined benefit (DB) pension plans were plentiful. Workers were promised benefits according to a formula based on their income and years of service. Employers bore the actuarial risk of setting aside sufficient funds to provide a monthly income stream to workers for life but average retirements were short and lasted only about 5 years. Long-term workers with one employer throughout their career fared well under DB plans, especially those who were paid a good income
Today, DB pension plans are much less common and are found mostly in the public sector, large corporations, and companies with strong unions. The most common type of retirement plan today is the defined contribution (DC) plan (e.g., 401(k) plans) where workers bear all the investment risk. DC plan participants must decide if and how to invest and then select specific investment products. Benefits at retirement are based on accumulated savings and investment earnings.
DC plans are portable and especially suitable for workers who frequently change jobs. There are no lifetime income guarantees, as with DB plans, however. Rather, retirement income is available only for as long as assets last. Workers are responsible for converting their assets into income. In addition, average retirements today last 25 years with a possible range of 15 to 40 (or more) years, depending on age of retirement, family health history, personal health status, medical advances, and other factors.
All of these trends highlight the need for advance planning and personal responsibility in order to live comfortably in later life. Below are four retirement planning tips:
• Invest as much as you can as early as you can. When you get a raise or promotion, increase the amount saved in tax-deferred employer savings plans. Savings will be deducted automatically from your paycheck. Aim to save 10% of your gross income in your 20s and 30s and gradually boost your savings to 15% in your 40s and 20% or more by your 50s and 60s. Another good time to ramp up retirement savings is when a household expense (e.g., child care or car loan payments) ends.
• Invest the maximum allowed by law into a Roth or traditional individual retirement account (IRA). Workers with earned income can contribute $4,000 in 2007 ($5,000 for those age 50 or over with an additional $1,000 catch-up contribution). If married, you can also contribute an equal amount for a non-employed spouse into a Spousal IRA.
• Develop an investment asset allocation strategy and stick with it. Keep some stock or stock mutual funds in your portfolio to hedge inflation. Avoid being a market timer by moving money from stock to cash assets during volatile markets. Investors who do this often miss the “best market days” when the market rebounds and their long-term investment performance suffers.
• Have a plan and work your plan. In today’s self-reliant retirement planning environment, you are your own pension manager. Invest like a financial institution and not an individual (i.e., based on a well-thought out plan and not emotions like fear and greed). Follow a dollar-cost averaging strategy by investing a regular amount at a regular time interval (e.g., $100 per month).
catogory: personal finance