Archives for May 28, 2019

“Eventually, I’ll stop working.” Most of us think that and know it will happen, but millions of us worry whether we’re saving enough to live on once we do. We want to know: How much of my earnings should I set aside? What’s the magic number? 3%? 5%? 10%? More?

What your financial adviser won’t tell you:

Unfortunately, the retirement industry has spent decades largely avoiding the magic-number question. “There’s no magic number for everyone,” some say. “It’s complicated,” say others. And then they offer, sometimes for a fee and sometimes for “free,” to take our money and invest it for us — often without telling us whether it’ll be enough when the time comes.

Why will no one give us a magic number? They don’t want to be legally responsible when the number turns out to be too low, which, for some of us — especially those whose pay is low or whose investments are poor or who live long and need a nursing home for years — it will. The legal jitters are understandable, but they leave us in the dark about how much to save.

Don’t give up hope. There’s research that can help — from institutions that don’t have a conflict of interest because they don’t invest or give advice. My favorite is the Employee Benefits Research Institute in Washington, D.C. EBRI, as it’s called, gathered anonymous information on tens of millions of people and how they actually save. It won’t tell people what to do, but from its research there’s a pretty useful rule of thumb for young people: Count on your fingers and …

Save 10% — now

Between you and your employer, set aside at least 10% of your paycheck. If your employer contributes 3%, then your share is at least 7%. If the company kicks in 5%, then you save at least 5%. If your employer does nothing, set aside at least 10% of each paycheck on your own.

Of course, there will be times when you’re between jobs or you need your money for a pre-retirement-age emergency. In those cases, you can put your money in a Roth individual retirement account (IRA) account. That way, you can take your contributions out without penalty. (There are also Roth 401(k) accounts, though they have more complicated withdrawal rules.) Don’t let the fact that you might need money someday keep you from saving for retirement now.

It’s perfectly OK to consult a financial adviser and get more personalized recommendations, but if you can’t or don’t want to — or while you’re waiting to “get around to it” — set aside enough so that, together with your employer match, you’re putting aside at least 10%.

America’s No. 1 fear: golden years minus the gold

People are living longer. That’s both good news and bad: We hear about baby boomers moving into posh “active adult” communities, but we also hear about disabled and bedridden elderly requiring years’ worth of health aides and the constant help of their children. Either way, longer lives seem expensive.

And our capacity to lay the groundwork for retirement can feel pinched from all directions. Life can be expensive even in our earning years, with college tuition, housing and medical costs in the stratosphere. Student loans and credit-card debt intrude. Social Security, we’re told, is at risk. Lifetime pensions are, for most, a thing of the mythical past. All that most of us feel we can count on is a retirement account that’s at the mercy of the markets and, we suspect, doesn’t have enough in it. Many, of course, don’t even have that.

Experts often tell us how complicated this is to figure out — and why we should hire them to do it for us. And it is easy to make it complicated: We can try to decide — now, decades before we’re ready to even think about retiring — what our future earnings will be and how long we’ll work, what lifestyle we’d prefer in retirement, how much health care will cost decades down the road, how long we’ll live after retirement (with a margin for error, of course), how our money should be invested and what our investment returns will be (with, again, a margin for error). Not complicated enough? Add whether or not we’ll need funds at hand to support children or parents or other family members.

The result is confusion. Some people get financial advice. Others turn to online retirement calculators. Many, sadly, do nothing at all, falling back on a vow of resignation: “I’ll just keep working.” (Spoiler: Almost no one who says they’ll work until they die ends up doing so.) For still others, it means saving too little.

Modeling for millennials

How can EBRI’s model help? It estimates the risk of running out of money after retirement by taking into account many more factors than the usual online calculator: contributions, market changes, Social Security benefits and salary growth, as well as a range of health outcomes and longevity prospects. It can then estimate the risk that — for particular savings rates and income levels — a person’s expenses in retirement will overwhelm their savings plus Social Security benefits.

For this article, EBRI provided projections for today’s 25-year-olds at multiple income levels; we’ll interpolate the results to reflect the median income of today’s 25-year-olds, which is $30,000. (The projections assume that people will earn more as they get older.)

We then applied EBRI’s projections to three millennials. Their names have been changed, but they are all in their mid-20s. We’ll assume they’re average earners:

• Phillip, working in a startup, contributes 3% of pay to a retirement account. His employer contributes nothing.
• Ida, an office worker, contributes 3%, which her employer matches, for a total of 6%.
• John, working for a financial firm, contributes 8%. His employer contributes 4%, for a total of 12%.

Are they contributing enough, too much or too little? Here’s how, based on EBRI’s model, our millennials and their different savings practices would end up at retirement:

• If Phillip, from a current salary of $30,000, continues to contribute just 3%, he has a 56% chance of running through both his retirement savings and Social Security in his lifetime. (If he were earning $40,000 now, the odds improve, but his chance of running out of money still exceeds 40%.) Clearly, then, 3% isn’t enough.
• Ida, being a woman, will likely live longer, so her 6% total contribution will have to last longer, and the probability that neither it nor Social Security will be enough is 47%. Sounds like 6% is too low, as well.
• John, contributing 12% of pay, has less than one chance in four (23%) of running out of money.

Overall, the EBRI simulation model suggests that, in the income ranges of most millennials, a contribution rate of 10% starting in a worker’s mid-20s cuts the risk of running out of money in retirement to about 30%, less than one chance in three. Contributing more than 10% when you can will give you a better cushion.

Of course, everyone’s situation is and will be different, so 10% is a guideline, not a guarantee. (Furthermore, if you start later in life, 10% won’t be nearly enough.)

Digital piggy banks

By now you’re probably thinking, “This is easier said than done.” And you’re right. Saving for retirement is like dieting in that we’re better at making resolutions and excuses than making progress.

But technology makes the savings part easier, too. More and more employer plans will sign you up automatically. If your employer doesn’t have a plan, you can set up a Roth IRA with a bank or an investment company and have a portion of each paycheck deposited automatically. Some states, including Oregon, Illinois, California and Maryland (whose program I chair), are setting up IRA programs for small businesses that don’t offer retirement plans.

The good news is that, in one respect, retirement saving is easier than dieting: If you fall off the wagon, you can start again and feel better immediately.

Yes, life is complicated. Retirement plans don’t always turn out as planned. But if, while worrying about everything else, we each adhered to the 10% rule as much as we are able, there would be a lot less retirement insecurity and a lot more gold in the golden years.

Americans are worried about Social Security.

Whether it’s Transamerica’s annual retirement survey (44% of workers fear a reduction in or elimination of Social Security benefits), Gallup (67% of workers worry a “great deal” or “fair amount” about the Social Security system as of March 2019), or any of a variety of other surveys, the trend is clear. Americans fear that Social Security won’t be around (or at least won’t be as generous) in the future.

As the ratio of workers to retirees narrows — from between 3.2 and 3.4 between 1974 and 2008 down to a projected 2.2 in 2035 — the program will certainly be put under additional strain, and it is currently slated to run out of reserves in about 16 years.

Social Security’s Board of Trustees issues an annual report which reveals its exact prediction as to when Social Security will run out of money — and what happens next.

The deficits start shortly

According to the trustees’ report, the Old Age, Survivors and Disability Insurance (or OASDI) funds will start paying out more than they’re taking in next year. And by 2035, the combined funds of OASDI will be depleted.

(Technically speaking, OASI and DI are two separate programs — OASI is slated to deplete its reserves in 2034, with DI hanging on until 2052. But I digress.)

So, in short, Congress has about 16 years left to fix Social Security before it goes broke.

Here’s what happens if those efforts fail

If Social Security continues in its current arc and the trustees’ predictions are accurate, when the combined OASDI funds run out of money in 2035, Social Security will have to immediately reduce the benefits it pays out. OASDI will still be receiving money from payroll taxes, so the Social Security Administration will be able to pay out 80% of previously promised benefits.

Again, that differs between OASI and DI — OASI would be able to pay 77% of promised benefits when funds are depleted in 2034, and DI could pay 91% of benefits when its reserves empty in 2052.

That’s certainly quite a bit better than “Social Security folds up shop and stops all benefits” (which was never a serious risk — though a persistent myth), but it’s still not great. Consider that Social Security represents at least half of income for 48% of married retirees and 69% of unmarried retirees. That’s a hefty cut to their retirement livelihood — at a time when it can be difficult to make up the deficit. (And given how expensive healthcare is in retirement, it’s not as if they necessarily have a lot of wiggle room.)

So what can be done?

To ensure 75 years of solvency going forward, the trustees recommend either immediately increasing taxes or reducing benefits (or both). To solve the issue using only additional tax revenue, they recommend increasing the payroll tax to 15.1% (from today’s 12.4%). Their benefit cut solution is to either reduce Social Security payouts by 17% for everyone (including current retirees), or by 20% to all new beneficiaries starting in 2019. Or, again, some combination of the above.

As you can imagine, neither of these solutions is terribly politically palatable. Nonetheless, there are plenty of historical precedents — the 1983 bill that stabilized Social Security increased both funding and the retirement age. (Increasing the retirement age functions as a benefit cut for future retirees, even if it isn’t explained that way.)

Of course, waiting longer makes it worse. The trustees predict that waiting until 2035 — when the combined funds net run dry — would necessitate a 3.65 percentage point increase in the payroll tax (to 16.05%) or a permanent 23% benefit reduction.

One way to ease the pain

An intriguing third option — albeit with some risk attached — involves investing a portion of Social Security funds in the stock market. Currently, Social Security’s roughly $2.9 trillion fund surplus is invested in U.S. Treasuries. While those are certainly safe securities, they don’t offer a lot of opportunity for growth.

Boston College’s Center for Retirement Research released a report back in 2017 that makes a compelling case for the Social Security funds taking on some investing risk in exchange for significantly better potential returns. The authors analyzed stock market returns and concluded that the Social Security funds would be in better shape today had they been invested in stocks starting in either 1997 or 1984 — despite the 2001 and 2008 stock market slumps. Their simulations also predict that “investing a portion (a maximum of 40%) of Social Security trust fund assets in equities would reduce the need for greater payroll tax contributions or benefit reductions.” (To be precise, 97% of their simulations found the trust fund strengthened, assuming stock investment began as of the study’s publication in 2017.)

Now, I’d prefer that investing in stocks eliminate the need for tax increases or benefit losses, but a reduction in the painful changes the program will have to undergo would certainly be a welcome step forward.

What does this mean for you?

If you’re retired, I sincerely doubt you’ll face a benefit cut. It’s far more likely that the pain will fall on nonretired generations because most people understand how terrible it would be to force a massive benefit cut on current retirees.

If you’re still working, know that Social Security isn’t going to go belly-up and suddenly stop paying out benefits — even in the worst-case scenario. But you can’t necessarily depend on it as much as your parents’ generation did — so now’s the time to turbocharge your savings and build up your retirement income base. (And consider calling your Congressperson, if you have a strong opinion as to how the government should fix Social Security.)

One Seattle-area marketing professional told us she has mixed emotions about the word “retirement.” To her, it brings to mind a 70-year-old sitting in a rocking chair. Her retirement will be different.

She plans to “retire” from full-time work in 2020 — when she’ll be 30 years old. She says she will spend her life traveling the world, starting in Australia and New Zealand. She goes by the moniker “A Purple Life” online, and doesn’t disclose her real name because it’s easily identifiable and she doesn’t want her employer to know she’s thinking of retiring soon.

“I’m still planning to decide this upcoming November if my numbers are looking good enough to retire in October 2020,” she says. “I’m looking pretty good, but, based on the stock market, we’ll see.”

Her net worth, which she credits to scrimping although she makes a large salary for her age, now totals $340,000. To retire, she wants to reach $500,000, with dividends and other fixed payments, she hopes, seeing her through adulthood.

She isn’t alone in her dream of financial independence: freedom from debt — and from the rat race. She wants to live life on her own terms.

In recent years, interest in retirement at middle age, or even earlier, has taken off, helped, in part, by a popular blog by “Mr. Money Mustache.” The blog’s now-unmasked author, Pete Adeney, writes about his own experience of financial independence, living off investments and savings, rather than beholden to a paycheck. Adeney, a former software engineer from Canada who now lives in Colorado, retired in 2005 at age 30.

The movement has a name: FIRE, or financial independence, retire early.

There are no statistics on the number of FIRE adherents. The U.S. government doesn’t keep records, nor do retirement-investment companies such as Fidelity Investments. Still, the number of people who share stories on social media is exploding. There are more than 14,000 members in a Facebook group called Mustachians in Practice, in a nod to Mr. Money Mustache. Adeney says the blog, which has birthed dozens of others, has attracted tens of millions of visitors.

Those who aspire to early retirement live frugally. Some are known to ride bicycles instead of drive cars, live in so-called tiny homes or vans, grow their own food, make their own clothing and home products, and forgo modern conveniences such as smartphones and home Wi-Fi.

Once they’ve saved a sum they estimate will enable them to live without steady work in the future, they quit their full-time jobs and settle into early retirement. To be sure, many take on part-time, seasonal or occasional work to help make ends meet.

How much money is enough? First, set a “FIRE number,” a calculation based on the funds required for an extended retirement. Mr. Money Mustache has developed guidelines for determining that number, factoring in the often-recommended 4% withdrawal rate during retirement.

There are variations on the plan. Some people work part-time, pursuing a strategy called “barista FIRE,” while others start businesses. Some don’t work at all.

Many people have almost nothing saved for retirement

If you think FIRE sounds impractical, you’re not alone. The movement has taken plenty of criticism. Some has come from best-selling personal-finance author Suze Orman. She says she “hates” the movement.

“It is the biggest mistake, financially speaking, you will ever, ever make in your lifetime,” she says. Unexpected hardships, including sickness, accidents and unforeseen expenses, lurk around every corner, she says.

Another reality check: Most Americans won’t retire early, if they can afford to retire at all. One in five has no retirement savings, according to financial-services company Northwestern Mutual.

And one in three baby boomers, the generation for which retirement concerns are most immediate, has less than $25,000 saved for retirement.

That said, the FIRE movement is changing the retirement conversation. Gone are the days of fantasizing about spending one’s golden years on a golf course. Why not do that now, even if you have to make sacrifices along the way?

“There are corporate executives who have come into my office paying a mortgage, have kids in private school, and they’re exhausted in their 60s and want to retire,” says Josh Fein, a certified financial planner who works in Los Angeles and New York. “There have been a few times when it just wasn’t feasible, and they hadn’t thought about it their whole life. If FIRE can bring awareness to that earlier on, I’m all for it.”

Why FIRE is taking hold

For all its newfound popularity, FIRE is really just a new way of talking about an old concept, says Ed, a 50-year-old who hasn’t worked a full-time job since he was 36. (He doesn’t use his last name online or when speaking to the media because “talking about how much money you have is tacky.”)

Ed runs the Early Retirement Dude blog. He says information about how to retire early is so readily available now because so many people are documenting their journeys online.

“People don’t have to come up with it on their own in a vacuum,” he says.

Before financial independence got the “FIRE” branding, books such as Vicki Robin’s “Your Money or Your Life,” published in 1992, addressed the same frugality and freedom virtues, says Tanja Hester, 39, an early retiree and author of the Our Next Life blog and a book titled “Work Optional.”

It makes sense that FIRE is growing, says Emrys Westacott, author of the book “The Wisdom of Frugality” and a professor at Alfred University in Alfred, N.Y.

Computers and smartphones have accelerated the pace of work and life, he says. Constantly adapting to new technologies is difficult for older workers, who fear they’ll become obsolete, he says. “It’s like the joke in ‘Alice Through the Looking Glass,’ ” Westacott says. “You have to run really fast to stay in the same place.”

A bull-market tailwind

The growth of the movement has coincided with a bull market in U.S. stocks that began 10 years ago. The 2010s have produced an annual average return of 13.2%, observes the financial company Convoy Investments, compared with the long-term average of 9.6%. Weaker returns or stock-market crashes, as occurred in 2000 and 2008, could limit or scuttle FIRE fans’ plans.

Ed, the Early Retirement Dude, says that shouldn’t be a cause for concern. Since he has been retired for 15 years, he has faced and survived financial, and other, downturns, he says. His wife had breast cancer early in their retirement, but they had saved enough that they were able to pay for her treatment, he says.

“I have tried to teach people from the very beginning that stock-market volatility is just as irrelevant as the daily weather to your long-term investing success,” Adeney, of the Mr. Money Mustache blog, says. “As long as you aren’t trying to dance in and out of the market with the current mood of the news headlines, a little bit of stock volatility will actually help an early retirement saver along the way, because stock-market crashes are just a temporary sale on stocks.”

The sacrifices people make

For many, FIRE is predicated on significant sacrifice. Adeney advocates against owning a car, and suggests moving to an area with a lower cost of living and practicing other frugal habits, such as cooking at home and becoming adept at DIY projects instead of hiring others.

Hester, of the Our Next Life blog, says talk of ruthless thriftiness is overblown.

“This idea that you have to earn six figures, not have kids, that it has to be all or nothing — I think that’s silly,” she says. “Most people doing it are actually living normal lives. If you can maintain a middle-class lifestyle and grow your earnings, you can save for it pretty fast.”

The FIRE movement’s wider impact

FIRE is likely to remain a niche lifestyle, Adeney concedes. Most people will continue “the same path toward material abundance,” he says.

But FIRE will spark new thinking in some about what they need to be happy, he says. “At some point, people are going to realize that we reached the point of ‘more than enough to be happy’ long ago, and they will start seeing that you can choose three-day weekends forever, just by giving up things like a thousand-dollar iPhone and a 300-horsepower pickup truck.”

In the next two decades, concern about material excess and climate change could drive structural changes, says Westacott, the Alfred University professor.

The popularity of Marie Kondo’s “KonMari” method — essentially getting rid of things you don’t love or even need — shows that things might be changing.

“People are looking around and saying, ‘I don’t need all this crap,’ ” Westacott says. “You can really live a very pleasant life on quite a lot less.”

Since most universities don’t provide financial literacy education, college graduates are left with little to no knowledge when it comes to managing their money.

But conquering your financial life is just as important as landing your dream job. If you’re not keeping any of the money you’re making, snagging a sweet salary isn’t going to matter in the long run.

For those of you that have recently entered the real world and are trying your hand at this adulting thing for the first time, avoid making these mistakes that most grads are guilty of and you’ll already be ahead of the game.

Mistake #1: Spending too much money on housing

Personal finance is far from one size fits all — but there are a few popular rules of thumb that can serve as a great starting point. One is that you should spend no more than 28% of your salary on housing.

Since many of the most attractive jobs are located in cities that have a high cost of living, most grads end up spending way more than 28% on rent.

If your salary can’t compete with the pricey real estate near your office, you have a few options. The easiest and most common solution is finding a roommate to split costs with. If you prefer to live solo, you can usually find a spot outside of town that is less expensive and commute.

And last but not least, you can wait to relocate until you’ve moved up in your career. Staying local and living at home with your parents for a few years can actually give you a really solid financial foundation if done the right way.

Mistake #2: Not working student loans into your budget

If you have student loans (or any kind of debt), you may need to spend even less on housing. Financial experts recommend keeping your combined housing and debt payments under 36% of your salary.

Most student loans come with a grace period, so many grads make the mistake of finding a place to live before knowing when their repayment plan starts and how much they’ll actually owe each month.  

Your student loans are a fixed cost and it’s important to factor them into your budget before signing a lease.

Mistake #3: Not saving for retirement right away

You’ve probably heard the old saying “time is on your side” and while it may sound cheesy, it’s 100% true. The math does not lie — the sooner you start saving for retirement the better.

Let’s say two people save $100 each month for retirement, but one starts at age 25 and the other waits until they are 35 to start making contributions. With a 7% average annual rate of return, the person who starts at age 25 will have more than double the amount of money in their account when it’s time to retire at age 65. Even small contributions in your 20s will yield big results later in life.

On top of waiting to save for retirement, another piggy-back mistake that recent grads make is not taking full advantage of their employer’s match. If your company will match your retirement contributions, they are offering you free money. Don’t leave your match on the table.

Mistake #4: Not saving money from the start

Like drinking water or exercising, saving money is a habit. But 80% of working Americans are living paycheck-to-paycheck because they can’t build up their savings.

It’s a dangerous game to say, “I’ll start saving later,” but so many grads make this mistake.

The better move is to start saving now, even if it’s a small amount, to get in the habit of paying yourself first. Set up an automatic recurring transfer on each payday to move some of your cash out of checking and into a high-yield savings account.

Saving shouldn’t be an afterthought or a “maybe later” thing. It should be the first move you make the moment you get paid.

Mistake #5: Not tracking your money moves

If you care about your finances and are making moves, you need to be tracking your progress. Otherwise, how will you know if you’re moving in the right direction?

The best number to use when tracking financial progress is your net worth. This is calculated by simply subtracting your liabilities from your assets. If your net worth is consistently increasing over time, that’s a sign of good financial health.

Most grads don’t pay attention to this number, but you should calculate it as soon as you start working so that you have a clear picture of your financial situation right now and can make sure you are continuing to improve over time.