Retirement Planner: Money for Life

Retirement experts used to talk about finances as a three-legged stool: Social Security, pensions and personal savings. That's not enough to stand on anymore. For one thing, the pension leg has collapsed entirely at many companies. As I think about my own retirement (someday!), I see a five-legged stool: Social Security (it will be there for our generation), personal savings, freedom from debt, health insurance (for retirees under 65) and realistic work goals. If you have a pension, congratulations—that's icing on the cake. But none of these legs can be taken for granted or strengthened without thought. Good retirements take good planning. Here are some tips for getting started:

1. Plan to get out of debt.

When talking to people about their retirement experiences, I'm always struck by the amount of debt they're struggling to pay off. Often, it's medical debt, which can be hard to avoid. But other debts are preventable:

* Quit borrowing against your house. Bend all your efforts toward paying off your home equity lines and reducing your primary mortgage, too. If you find that you can't retire mortgage-free, think about selling your house and buying something smaller for cash.

* Get rid of consumer debt. It was never smart in the first place.

* Control your spending. You'll need to learn to live on a smaller amount of money once your paychecks stop. Start practicing well before retirement. Try putting half or more of your disposable income toward repaying debt and live on what's left. It's educational!

* Help your children only as a last resort. Too many parents are using needed retirement funds to bail their children out of various problems. Sometimes help is essential—say, for critical medical care. But preserving your retirement nest egg is more important than putting grandchildren through college. One way or another, the kids can work that out themselves.

2. Plan for health insurance.

If at all possible, don't retire without health insurance before you have Medicare. It's tough to find an affordable policy in middle age—that is, if you're insurable at all. Take these steps:

* Evaluate your current coverage. Corporate early retirees often get health insurance until 65, when they qualify for Medicare. Your premium and copayment may increase over the years, but your coverage will almost certainly stick. If you don't get retiree health benefits, scout for an individual policy before you retire. If you're unsuccessful, COBRA coverage keeps you in the company plan for 18 months, at your expense.

* For individual policies, check eHealthInsurance.com and also work with an insurance agent. Your most affordable choice will carry a high deductible—say, $2,500 to $5,000 per year. If you remain healthy, you won't have to use that deductible before Medicare clicks in.

* Quit smoking, lose weight and exercise. You must stay as healthy as you can, not only for the pleasure of it but to keep yourself out of medical debt. Even if you have insurance, it may not cover all your costs.

3. Plan your Social Security.

Deciding when to start taking benefits depends, of course, on your personal circumstances.

* If you have to retire early and are short of cash or are in poor health, you'll probably start at 62—the earliest age possible. But that cuts your personal benefit by at least 25 percent and your spousal benefit by at least 30 percent—for life. (The spousal benefit provides payments to a husband or wife who hasn't built a substantial account of his or her own.)

* If you can delay taking your benefit, you should. For each year you wait after your full retirement age, your starting check rises by 8 percent—a splendid, guaranteed "return." If you die, you'll also leave a larger benefit for your spouse. After age 70, the initial benefit stops going up.

* There's an exception for married people in good health when one of them has a small Social Security benefit. Typically, that's the wife. If she retires first, she should start her individual benefit at 62. When her husband retires, she'll switch to the spousal benefit. By using her own account first, she taps a benefit that otherwise would have gone to waste.

4. Plan for retirement savings.

By the time you reach the end of your working life, you should be saving 15 percent or more of your gross income, in addition to anything your employer contributes to your 401(k) or similar plan. Here's what else to do:

* Those with an old-fashioned lifetime pension are lucky dogs. It's an income you'll never outlive. If you're offered a lump sum in lieu of a monthly income, consider the following: (1) Could you use the lump sum to buy yourself an immediate annuity that pays more per month? If not and you want a fixed income, the company pension is the better deal. (2) Are you worried that your company might fail, taking your pension with it? If so, take the lump sum and roll it into an immediate annuity (if you want fixed income) or an individual retirement account invested in stock and bond mutual funds. Company pensions are insured by the Pension Benefit Guaranty Corp., but perhaps for a lower amount than you'd otherwise get. (3) Don't roll the money into a tax-deferred variable annuity. The expenses are high (and often hidden), which means that long-term performance will generally be sub-par. If you need more than a modest amount of the money, you'll pay a penalty to take it out during the first seven to 10 years, and you'll owe ordinary income taxes on the gains.

* Those with 401(k)s and similar plans should be setting aside the maximum the law allows from their pay. Invest the money in well-diversified stock and bond funds—maybe 60 percent stocks, 40 percent bonds. (The bonds protect you in case of a catastrophe in stocks. If you also have a pension, however, you can put more into stocks.)

* When you retire, you can generally leave the money in the 401(k) or else roll it into an IRA. The 401(k) advantage: You're familiar with the funds in the plan and your money is usually managed at low cost. The IRA advantage: You have a broader investment choice. If you die, your spouse can roll the money from either plan into an IRA of his or her own and let it accumulate tax-deferred. It's a little trickier for other heirs. They have to open what's called an "inherited IRA" and are not allowed to let the money accumulate untouched. They can, however, stretch out withdrawals over their lifetime. This option is always available when they inherit an IRA. Starting this year, it's potentially available if they inherit a 401(k)—but only if the plan documents allow it. So you have to check. Inherited IRAs and 401(k)s are a highly technical area where a lot of heirs and their advisers are making mistakes. If heirs other than a spouse try to roll the money into an IRA of their own, rather than following the inherited-IRA rules, the money becomes taxable all at once.

* Those without company plans should be saving in pre-tax IRAs (if you work for an employer) and SEP-IRAs or individual 401(k)s (if you're self-employed). If you've maxed out on your contribution, save in regular, after-tax accounts. Make these savings automatic—with contributions taken from your bank account each month.

* Spend your savings frugally. You may have 30 or more years to live in retirement, and you don't want to outlive your money. Your spending target should be no more than 4 percent of your total financial assets (stocks, bonds, cash) in your first retirement year. Each year after that, raise your take by the inflation rate. If you stick with that plan, your money should last for life. If you take more, you risk running out of money.

* Consider a visit to a financial planner who can run your finances through his or her computer and tell you where you stand. But not just any financial planner. Planners who sell products will find things for you to buy—and the commission makes them expensive. Look for a fee-only planner, who sells no products and charges only for the time spent. Two places to look: www.garrettplanningnetwork.com and www.napfa.org.

5. Plan on working!

The reality is that many would-be retirees haven't saved enough to support themselves for life. When considering whether you can quit, add together your annual pension, if any, your Social Security benefit and 4 percent of your personal retirement savings (4 percent of the lump sum; don't count interest and dividends separately). If that's enough to live on (and you have health insurance), you're good to go. If your job has gone away, plan on working part time to fill the gap between your expenses and your income without having to dip into savings right away.

Jane Bryant Quinn, the author of Smart and Simple Financial Strategies for Busy People, writes for Newsweek, Good Housekeeping and Bloomberg News.